<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(X) QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 28, 1997
Commission File Number 0-11447
DATAKEY, INC.
(Exact name of small business issuer as specified in its charter)
MINNESOTA 41-1291472
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
407 WEST TRAVELERS TRAIL, BURNSVILLE, MN 55337
Issuer's telephone number: (612) 890-6850
_________________________________________________________________
(Former name, former address and former fiscal year,
if changed since last report)
Check whether the issuer (1) filed all reports required to be
filed by Section 13 or 15(d) of the Exchange Act during the past 12
months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes /x/ No / /
APPLICABLE ONLY TO CORPORATE ISSUERS
The number of shares outstanding of the issuer's common
equity, as of August 11, 1997, is 2,887,235.
Transitional Small Business Disclosure Format (check one):
Yes / / No /x/
1
<PAGE>
<TABLE>
PART I. FINANCIAL INFORMATION
ITEM I. FINANCIAL STATEMENTS
DATAKEY, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
<CAPTION>
June 28, December 31,
1997 1996
------------ -----------
(UNAUDITED)
<S> <C> <C>
ASSETS
------
CURRENT ASSETS
Cash and cash equivalents $1,324,361 $140,030
Investment in held-to-maturity securities 1,589,644 5,993,228
Trade receivables, less allowance for
doubtful accounts of $46,700 and $45,000 1,215,295 634,538
Inventories 1,799,969 1,128,907
Prepaid and other 99,381 46,962
----------- ----------
Total current assets 6,028,650 7,943,665
----------- ----------
OTHER ASSETS
Deferred taxes 325,000 325,000
Prepaid licenses at cost,less amort of $21,580 in 1997 1,060,085 129,750
Patents at cost, less amortization
of $123,739 and $105,531 100,897 99,236
----------- ----------
1,485,982 553,986
----------- ----------
EQUIPMENT AND LEASEHOLD IMPROVEMENTS, at cost
Production tooling 1,188,149 1,179,021
Equipment 2,965,463 2,561,659
Furniture and fixtures 276,407 267,482
Leasehold improvements 276,904 234,452
----------- ----------
4,706,923 4,242,614
Less accumulated depreciation (3,078,546) (2,840,909)
----------- ----------
1,628,377 1,401,705
$9,143,009 $9,899,356
=========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES
Accounts payable $925,222 $559,280
Accrued severance obligation 243,400 332,000
Accrued license fees-current portion 439,000 0
Accrued expenses 552,689 315,549
Total current liabilities 2,160,311 1,206,829
----------- ----------
Accrued license fees, less current portion 219,500 0
SHAREHOLDERS' EQUITY
Convertible preferred stock, voting, stated value
$2.50 per share; authorized 400,000 shares;
issued and outstanding 150,000 375,000 375,000
Common stock, par value $.05 per share;
authorized 10,000,000 shares;issued and
outstanding 2,887,235 and 2,882,069 144,362 144,103
Additional paid-in capital 4,089,283 4,070,815
Retained earnings 2,154,553 4,102,609
----------- ----------
6,763,198 8,692,527
----------- ----------
$9,143,009 $9,899,356
=========== ==========
</TABLE>
See Notes to Consolidated Financial Statements
2
<PAGE>
<TABLE>
DATAKEY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
<CAPTION>
Three Months Ended Six Months Ended
June 28, June 29, June 28, June 29,
1997 1996 1997 1996
------ ----- ----- -----
<S> <C> <C> <C> <C>
Revenue $1,934,129 $1,912,123 $3,343,930 $3,647,840
Cost of goods sold 1,195,375 1,203,841 2,130,247 2,241,176
---------- ---------- ---------- ----------
Gross Profit 738,754 708,282 1,213,683 1,406,664
Operating expenses:
Research, development
and engineering 1,047,175 525,432 2,063,527 800,008
Marketing and sales 393,625 340,310 788,000 622,566
General and administrative 217,810 233,953 429,366 442,928
---------- ---------- ---------- ----------
Total operating expenses 1,658,610 1,099,695 3,280,893 1,865,502
---------- ---------- ---------- ----------
Operating loss (919,856) (391,413) (2,067,210) (458,838)
Interest income 43,537 91,431 119,154 185,412
---------- ---------- ---------- ----------
Loss before
income taxes (876,319) (299,982) (1,948,056) (273,426)
Income tax expense 0 (107,600) 0 (97,600)
---------- ---------- ---------- ----------
Net loss ($876,319) ($192,382) ($1,948,056) ($175,826)
========== ========== ========== ==========
Net loss per common share ($0.30) ($0.07) ($0.67) ($0.06)
========== ========== ========== ==========
Weighted average number of
common shares outstanding 2,887,235 2,879,087 2,886,023 2,841,788
========== ========== ========== ==========
</TABLE>
See Notes to Consolidated Financial Statements
3
<PAGE>
<TABLE>
DATAKEY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<CAPTION>
Three Months Ended Six Months Ended
June 28, June 29, June 28, June 29,
1997 1996 1997 1996
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
CASH FLOWS FROM
OPERATING ACTIVITIES
Net loss ($ 876,319) ($ 192,382) ($1,948,056) ($ 175,826)
Adjustments to reconcile net loss to net cash
provided by (used) in operating activities:
Depreciation 122,575 115,158 237,637 225,530
Amortization 30,827 35,226 39,788 69,793
Change in assets and liabilities
(Increase) decrease:
Trade receivables (453,579) (133,063) (580,757) (196,890)
Inventories (166,338) 85,824 (671,062) 64,859
Prepaid expenses and other 6,399 10,992 (52,419) (31,697)
Prepaid license fees (103,665) 0 (183,665) 0
Refundable income taxes 0 46,642 0 46,642
Increase (decrease) in:
Accounts payable 4,887 91,714 365,942 27,220
Accrued expenses (7,258) 90,436 237,140 44,977
Accrued license fees (109,750) 0 (109,750) 0
Accrued severance (47,100) 0 (88,600) 0
Deferred taxes 0 (68,531) 0 (68,531)
Income taxes payable 0 (9,586) 0 0
---------- ---------- ---------- ----------
Net cash provided by (used in)
operating activities (1,599,321) 72,430 (2,753,802) 6,077
---------- ---------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of tooling and equipment (200,446) (211,361) (464,309) (259,780)
Purchase of held-to-maturity
securities (41,192) (1,335,029) (113,999) (2,592,125)
Proceeds from maturity of
held-to-maturity securities 2,502,421 2,091,000 4,517,583 3,269,000
Patent license costs (19,457) (24,353) (19,869) (30,424)
---------- ---------- ---------- ----------
Net cash provided by
investing activities 2,241,326 520,257 3,919,406 386,671
---------- ---------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES
Net proceeds from issuance of
common stock 0 164,918 18,727 166,730
---------- ---------- ---------- ----------
Net cash provided by financing
activities 0 164,918 18,727 166,730
---------- ---------- ---------- ----------
Increase in cash
and cash equivalents 642,005 757,605 1,184,331 559,478
CASH AND CASH EQUIVALENTS
Beginning 682,356 515,133 140,030 713,260
---------- ---------- ---------- ----------
Ending $1,324,361 $1,272,738 $1,324,361 $1,272,738
========== ========== ========== ==========
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING
AND FINANCING ACTIVITIES
Obligation recorded in connection with prepaid
license fees $0 $0 $768,250 $0
---------- ---------- ---------- ----------
</TABLE>
See Notes to Consolidated Financial Statements
4
<PAGE>
DATAKEY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
GENERAL
In the opinion of management, the accompanying unaudited financial
statements contain all adjustments necessary to present fairly
Datakey's financial position as of June 28, 1997 and December 31,
1996 and results of its operations and cash flows for the three-
month and six-month periods ended June 28, 1997 and June 29, 1996.
The adjustments that have been made are of a normal recurring
nature.
The accounting policies followed by the Company are set forth in
Note 1 to the Company's financial statements in the 1996 Datakey,
Inc. Annual Report and in Form 10-KSB for the year ended December
31, 1996.
INVESTMENT IN HELD-TO-MATURITY SECURITIES
The Company held marketable debt securities with an amortized cost
of $1,589,644 as of June 28, 1997. As it is the intention of the
Company to hold these securities to maturity, they are accounted
for as "Held-to-Maturity Securities" as defined in FASB Statement No.
115. The market value of these U.S. Treasury Bill securities is
$1,589,282. The unrealized loss, therefore, is $362.
All of the Securities have a maturity date of less than twelve
months. The Company has no marketable debt securities which are
classified as Available-For-Sale Securities or Trading Securities.
RECENT ACCOUNTING PRONOUNCEMENT
In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards ("SFAS") No. 128,
Earnings Per Share, which is effective for interim and annual
reporting periods ending after December 15, 1997. The
implementation of SFAS No. 128 is expected to change earnings per
share by an immaterial amount.
SFAS No. 128 supersedes Accounting Principles Board Opinion No. 15,
Earnings Per Share, and replaces the presentation of primary
earnings per share with a presentation of basic earnings per share.
It also requires dual presentation for all entities with complex
capital structures and provides guidance on other computational
changes.
5
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
DATAKEY, INC. AND SUBSIDIARY
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
RESULTS OF OPERATIONS
REVENUE - Net sales for the three-month period ended June 28,
1997 increased by $22,006, or 1%, compared to the comparable 1996
period, while net sales for the six-month period declined by
$303,910, or 8%, due to a reduction in shipments to OEM product
customers in the first quarter of 1997. Revenue in the OEM
products business continues to be volatile from quarter to quarter and may
be soft again in the third quarter. The Company is continuing its
development of advanced system-level products for the information
security market. The initial versions of end-user products for the
information security marketplace are either currently available for
sale or will be available in the third quarter and, based upon
current expectations, are expected to result in additional revenue
during the second half of 1997. As with any new product line,
revenue will depend on customer acceptance, the extent of which is
difficult to assess at this time. If revenue from the new product
line meets the Company's present expectations, the total revenue in
1997 will exceed the 1996 level.
GROSS PROFIT MARGINS - Gross profit as a percentage of revenue
increased to 38% in the three-month period ended June 28, 1997 from
37% in the comparable period but declined to 36% in the six-month
period compared to 39% in the 1996 period. The increase in margin
percentage in the three-month period and decrease in the six-month
period are primarily related to absorption of fixed factory overhead
which is favorable when sales increase and unfavorable when sales
decline.
OPERATING EXPENSES - Operating expenses increased by $558,915
and $1,415,391, or 51% and 76%, in the three-month and six-month
periods ended June 28, 1997, as compared to the same periods in
1996. The increased expenses are primarily attributable to a
substantial increase in research and development and marketing
expenses necessary to accelerate the market introduction of
sophisticated electronic token-based systems targeted at the rapidly
emerging corporate information security marketplace. Research and
development expenses are expected to decline during the second half
as compared to the first half but will exceed the amounts from the
second half of 1996. Marketing and sales expenses are expected to
increase by 15 to 20 percent in the second half of 1997, compared
to the first half, to support new product introductions and the
expected increase in revenue. General and administrative expenses
in 1997 are expected to decrease slightly from the 1996 level and
will remain at approximately the quarterly rate reflected in the
second quarter.
6
<PAGE>
INTEREST INCOME - Interest income during the three-month and
six-month periods ended June 28, 1997, decreased $47,894 and
$66,258, or 52% and 36% respectively, from the comparable periods
in 1996. The lower level of interest income is a direct result of a
reduced level of investment in held-to-maturity securities and
interest bearing cash and cash equivalents. Interest income is
expected to remain lower in 1997 as the Company intends to continue
using the proceeds from maturing investments to fund continuing
product development and marketing activities to support the
Company's advanced information security products.
INCOME TAXES - As of December 31,1996 the Company recorded an
income tax asset of $325,000 related to its net operating loss
carryforwards. Management believes it is more likely than not that
the Company will realize income in the future from its existing OEM
products business, as well as income from its new advanced
information security products business that will allow the Company
to utilize a portion of the net operating loss carryforward to
reduce future taxable income. However, the net deferred tax asset
could be increased or reduced in the future if management's
estimates of taxable income during the carryforward period change.
The Company has not recorded a tax benefit in the current quarter,
related to current operating losses, and does not plan to record a
tax benefit in future quarters until such time as the profitability
outlook in future periods justifies the resumption of income tax
benefits.
FINANCIAL CONDITION - During the six-month period ended June
28, 1997, the Company had a net increase in cash and cash
equivalents of $1,184,331, compared to an increase of $559,478 in
the comparable 1996 period. Investment in held-to-maturity
securities decreased $4,403,584 in the 1997 period compared to a
decrease of $676,905 in the 1996 period. Cash, cash equivalents
and investment in held-to-maturity securities were $2,914,005 at June
28, 1997, compared to $6,133,258 at December 31, 1996. The decrease
of $3,219,253 is primarily the result of funding operating losses
and other operating activities equal to $2,753,802 and $464,309
in purchases of tooling and equipment for the six months ended June
28, 1997.
Datakey's balance sheet continues to reflect a strong financial
position, with $3,868,339 in working capital and a current assets
to current liabilities ratio of 2.8 to 1 as of June 28, 1997. The
Company plans to continue new product development and marketing
activities during the remainder of 1997 and expects to spend about
$2.0 to $2.2 million on these activities in the second half.
Inventory levels increased $670,000 in the first half primarily as
a result of acquiring components to support sales of newly
developed products which have not yet sold in material quantities.
Trade receivables increased by $580,000 in the six-month period ended
June 28, 1997, due to a substantial increase in revenue in June, 1997,
compared to December, 1996.
7
<PAGE>
The inventory levels are expected to level out in the second half
of 1997 as the new products are sold. Investments in equipment and
maintenance of licenses and patents in the second half of 1997 are
expected to be about $250,000 primarily related to prepaid license
fees for client and server software to be bundled with the
Company's information security products. This spending has been and
will continue to be funded by a reduction in the Company's marketable
debt securities.
The Company's working capital and investments are sufficient to
fund its planned operations and continued development and promotional
activities in 1997. The Company's ability to fund its business in
1998 with its own cash resources will depend primarily on the
successful introduction and marketing of its end-user products. In
the event that the Company's end-user products do not receive the
market acceptance currently projected, or such market acceptance is
slow to develop, the Company will require debt or equity financing
to fund its business. Such financing may or may not be available
depending on the success of its new product line.
EXPECTED LOSS - The Company expects to report a loss in 1997.
Although the Company expects to have several end-user products
available for sale in the second half of 1997, the marketability of
these products will not be known until at least late 1997. The
extent of the Company's loss will depend directly on product
availability and market acceptance.
CAUTIONARY STATEMENTS
This Management's Discussion and Analysis contains certain forward
looking statements relating primarily to the introduction of the
Company's information security end-user products and the anticipated
generation of revenue from such products. These statements
are subject to certain risks and uncertainties which could cause
results to differ from those projected. These risks and uncertainties,
in addition to those discussed above, include: (i) the ability of the
Company to successfully develop all of the new products under
development; (ii) the capability of the new products to function as
currently anticipated; and (iii) market acceptance of the new
products.
8
<PAGE>
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY SHAREHOLDERS
DATAKEY, INC. AND SUBSIDIARY
The Company held its Annual Meeting on Wednesday, June 4, 1997.
Proxies for the Annual Meeting were solicited pursuant to
Regulation 14 under the Securities Exchange Act of 1934. There was no
solicitation in opposition to management's nominees as listed in
the Company's proxy statement, and all nominees were elected.
By a vote of 2,583,265 shares in favor, with 163,825 shares opposed
and 3,185 shares abstaining, the shareholders set the number of
directors to be elected at six (6).
The following persons were elected to serve as directors of the
Company, by the votes indicated, until the next annual meeting of
shareholders:
NUMBER OF NUMBER OF
NOMINEE VOTES FOR VOTES WITHHELD
__________________ ___________ ________________
John H. Underwood 2,579,572 170,703
Terrence W. Glarner 2,587,972 162,303
Thomas R. King 2,587,972 162,303
Gary R. Holland 2,587,972 162,303
Eugene W. Courtney 2,587,972 162,303
Carl P. Boecher 2,587,972 162,303
The shareholders approved, by a vote of 1,360,839 for, 646,356
against, 8,200 abstaining and 734,880 broker non-votes, the
Company's 1997 Stock Option Plan.
The shareholders also ratified the appointment of McGladrey &
Pullen, LLP, as independent auditors for the Company for the fiscal
year ending December 31, 1997, by a vote of 2,737,700 shares in
favor, 7,000 shares opposing and 5,575 shares abstaining.
9
<PAGE>
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) Exhibits
Exhibit 10 Amended 1997 Management Incentive Plan
Exhibit 27 Financial Data Schedule (only filed with
electronic copy)
(b) The Company was not required to and did not file a Form 8-K
during the quarter ended June 28, 1997.
10
<PAGE>
SIGNATURES
In accordance with the requirements of the Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
Dated August 11, 1997 DATAKEY, INC.
BY: /s/ Carl P. Boecher
Carl P. Boecher
President & Chief Executive
Officer
(Principal Executive
Officer)
BY: /s/ Alan G. Shuler
Alan G. Shuler
Vice President & Chief
Financial Officer
(Principal Financial and
Accounting Officer)
11
<PAGE>
DATAKEY, INC.
EXHIBIT INDEX TO FORM 10-QSB
FOR QUARTER ENDED JUNE 28, 1997
EXHIBIT NO. DESCRIPTION
___________ ________________________________
10 Amended 1997 Management Incentive
Plan
27 Financial Data Schedule
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> JUN-28-1997
<CASH> 1,324,361
<SECURITIES> 1,589,644
<RECEIVABLES> 1,261,995
<ALLOWANCES> 46,700
<INVENTORY> 1,799,969
<CURRENT-ASSETS> 6,028,650
<PP&E> 4,706,923
<DEPRECIATION> 3,078,546
<TOTAL-ASSETS> 9,143,009
<CURRENT-LIABILITIES> 2,160,311
<BONDS> 0
0
375,000
<COMMON> 144,362
<OTHER-SE> 6,243,836
<TOTAL-LIABILITY-AND-EQUITY> 9,143,009
<SALES> 1,934,129
<TOTAL-REVENUES> 1,934,129
<CGS> 1,195,375
<TOTAL-COSTS> 1,195,375
<OTHER-EXPENSES> 1,658,610
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (1,948,056)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,948,056)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,948,056)
<EPS-PRIMARY> (.67)
<EPS-DILUTED> (.67)
</TABLE>
1997 MANAGEMENT INCENTIVE PLAN
February 27, 1997
Amended March 10, 1997
SECTION I: LONG TERM INCENTIVE PLAN (LTIP) OPTION GRANTS
1. The LTIP applies to the Management team and other recommended
employees who are key contributors including sales personnel.
Options will be granted on an annual basis.
2. The LTIP is based on corporate revenue growth and RONAEBIT
(the metrics). RONAEBIT is defined as: earnings before
interest and taxes/average net assets employed, and is
calculated using the financial results from the two fiscal
years ending just prior to the grants.
3. The individual's target participation units are based on
his/her contribution to these metrics.
4. The Company will grant LTIP benefits in the form of Datakey
incentive stock options under the Company's 1997 Stock Option
Plan. The number of shares underlying the options for each
participant and the exercise price will be defined at the
beginning of a fiscal year, using the Company's financial
performance figures from the previous two years. The actual
vesting schedule will depend on the Company's financial
results during the two fiscal years.
5. The LTIP option grants will be made based on the following
formula: Individual target participation units x LTIP
performance factor (from table below).
6. RONAEBIT is calculated after all incentives are paid.
<TABLE>
<CAPTION>
LTIP PERFORMANCE FACTOR TABLE
Revenue Growth for 2 Year Period
RONAEBIT <25% 25% 50% 75% 100% 125% or >
<S> <C> <C> <C> <C> <C> <C>
<15% 0 0 0 0 0 0
15% 0 0 0.25 0.5 .75 1
25% 0 0.25 0.5 1 1.5 2
35% or > 0 0.5 0.75 1.5 2.25 3
</TABLE>
This table may be interpolated for incentive payout calculation.
SECTION 2: LTIP NOTES AND ASSUMPTIONS
The RONAEBIT calculation for the previous two-year period is
determined using operating income after deductive the short-term
bonus accrual expense. Since the stock options will be granted at
the fair market value on the date of grant with a fixed number of
options and fixed term, no compensation expense will be recorded
during the operating periods. The only accounting transactions
that will take place during the two-year period after the grant
include (i) the footnote disclosure for FAS123 and (ii) the common
stock equivalent calculation that is taken into account in
determining primary and fully diluted shares for EPS calculations.
Early in each fiscal year, each manager will be granted an option
to purchase such number of shares equal to three times the "LTIP
financial performance figure" for such person. Based on year-end
financial results of the following two years, if the company's
performance during such two-year period qualifies for a "1 times
payout," the first set of options will vest immediately. If the
performance qualifies for "2 times payout," the second set will
vest, and if it qualifies for "3 times payout," the third set of
options will vest. In the event none of the performance criteria
are met for such two-year period, all the options will vest at the
end of 5 years.
<PAGE>
Since the number of shares and the price must be determined at the
time the option is granted in order for compensation expense to be
avoided, there is no provision for interpolation of the number of
shares. In other words, if the base number of shares (the LTIP
financial performance figure) is 5,000, then the individual gets
early vesting of 5,000, 10,000 or 15,000 shares and no intervals in
between. If the minimum level is not reached, all 15,000 shares
will vest at the end of five years. To accommodate the same result
as interpolation of shares, the vesting schedule will reflect the
financial performance level. For example, at a performance level
of .25 in the above LTIP table (50% revenue growth and 15% RONAEBIT
or 25% revenue growth and 25% RONAEBIT), the number of shares in
this example will be as follows:
(At .50 the first set is vested in 3.50 years and at .75 level the
first set is vested at 2.75 years).
5,000 shares vested in 4.25 years first set
5,000 shares vested in 5.00 years second set
5,000 shares vested in 5.00 years third set
-----
15,000 Total
At performance level of 1, the number of shares and the vesting is
as follows:
5,000 shares vested in 2.00 years first set
5,000 shares vested in 5.00 years second set
5,000 shares vested in 5.00 years third set
-----
15,000 Total
At performance level of 2, the number of shares and the vesting is
as follows:
5,000 shares vested in 2.00 years first set
5,000 shares vested in 2.00 years second set
5,000 shares vested in 5.00 years third set
-----
15,000 Total
At performance level of 3, the number of shares and the vesting is
as follows:
5,000 shares vested in 2.00 years first set
5,000 shares vested in 2.00 years second set
5,000 shares vested in 2.00 years third set
-----
15,000 Total
To determine the vesting if performance falls in between levels 1,
2 and 3, the number of years for vesting is determined by using the
following vesting schedule for the fractional performance and
adding that to the shares with full performance:
.25 4.25 years
.50 3.50 years
.75 2.75 years
At a performance level of 2.25, for example, the vesting is as
follows:
5,000 shares vested in 2.00 years first set
5,000 shares vested in 2.00 years second set
5,000 shares vested in 4.25 years third set
-----
15,000 Total
<PAGE>
SECTION 3: ANNUAL INCENTIVE PLAN (AIP)
1. The AIP applies to the Management team (as selected by the
Company's Board of Directors) and other key contributors
except sales personnel (who participate under a separate
plan).
2. The AIP rewards corporate revenue growth and reduced operating
losses before tax. (See table below).
3. Participation level (target bonus percentage) is based on the
individual's planned contribution to these metrics.
4. The Individual Performance Coefficient is a numerical rating
of 0.5-1.0 recommended by the President and approved by the
Compensation Committee on the individual's actual contribution
to the measurement metrics.
5. The Plan formula is: Base compensation x financial performance
coefficient x target bonus percentage x individual performance
coefficient.
6. Pre-tax operating loss for calculation purposes is defined as
the loss before incentive payout.
<TABLE>
Financial Performance Coefficient Table
REVENUE PRETAX OPERATING LOSS
110% plan plan to 75% plan to
>110% plan to plan 75% plan 50% plan <50% plan
<S> <C> <C> <C> <C> <C>
<90% plan 0 0 0 0 0
90% plan to
100% plan 0 .25 .5 .75 1
100% plan to
120% plan 0 .5 1 1.2 1.4
120% plan to
140% plan 0 .75 1.2 1.5 1.8
>140% plan 0 1 1.4 1.8 2.2
</TABLE>
This table may not be interpolated for incentive payout
calculation.
