SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB/A-1
ANNUAL REPORT
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997
Commission file No. 0-11447
DATAKEY, INC.
(Name of small business issuer in its charter)
MINNESOTA 41-1291472
(State of incorporation or organization) (I.R.S. Employer Identification No.)
407 West Travelers Trail, Burnsville, Minnesota 55337
(Address of principal executive offices)
Issuer's telephone number, including area code: (612) 890-6850
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.05 per share (Title of Class)
Check whether the Issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the Issuer was required to file such
reports) and (2) has been subject to such filing requirements for the last 90
days. YES X NO ____
Check if there is no disclosure of delinquent filers pursuant to Item 405
of Regulation S-B contained herein and no disclosure will be contained, to the
best of Issuer's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. [ X ]
Issuer's revenues for its most recent fiscal year: $5,977,464.
The aggregate market value of the voting stock (Common Stock) held by
non-affiliates was approximately $6,529,018 based upon the closing sale price of
the Issuer's Common Stock on March 13, 1998.
As of March 13, 1998, there were 2,887,235 shares of the Issuer's Common
Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Part II of this Annual Report on Form 10-KSB incorporates by reference
information (to the extent specific sections are referred to herein) from the
Issuer's Annual Report to Shareholders for the year ended December 31, 1997 (the
"1997 Annual Report").
Transitional Small Business Disclosure Format (check one) YES [ ] NO [ X ]
<PAGE>
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS, COMPLIANCE
WITH SECTION 16(a) OF THE EXCHANGE ACT
Directors
The names of the directors of the Company and other information with
respect to the directors are set forth below.
<TABLE>
<CAPTION>
NAME PRINCIPAL OCCUPATION DIRECTOR SINCE AGE
<S> <S> <C> <C>
Carl P. Boecher President and Chief Executive Officer of 1997 55
the Company
Gary R. Holland General Manager of Fargo Electronics 1995 56
John H. Underwood General Manager Professional Technologies 1983 58
Terrence W. Glarner President of West Concord Ventures, Inc. 1992 55
Thomas R. King Shareholder of Fredrikson & Byron, P.A., 1980 57
Attorneys at Law
Eugene W. Courtney President and Chief Executive Officer of 1995 62
HEI, Inc.
</TABLE>
Mr. Boecher has served as President and Chief Executive Officer of the
Company since December 1996. Mr. Boecher served as Vice President of Marketing
and Sales of the Company from January 1995 until December 1996. From May 1990 to
November 1994, Mr. Boecher served as Senior Vice President and Executive
Director of Business Development of DRS Military Systems, a division of
Diagnostic/Retrieval Systems in Oakland, New Jersey, a supplier of high
technology optical, data storage, processing and display and
simulation/stimulation systems and products. From 1971 to 1990, Mr. Boecher
served in several marketing positions with the Defense Systems Division of
Unisys Corporation, a supplier of data processing systems, products and
services, in St. Paul, Minnesota, most recently holding the position of
Executive Director, Product Marketing.
Mr. Holland has served as General Manager of Fargo Electronics, a
company that manufactures photo card equipment and products and provides related
services since June 1997. In addition, Mr. Holland has provided consulting
services as President of Decision Processes International of Minnesota, Inc.
since February 1996 and as the Managing Partner of Holland & Associates since
June 1992. From 1982 until 1992, Mr. Holland was President and Chief Executive
Officer of DataCard Corporation, a manufacturer of credit card equipment,
products and services. Mr. Holland also serves as a director of Check Technology
Corporation.
Mr. Underwood has served as General Manager of Professional
Technologies, which provides rapid prototype molding and injection molding
services, since January 1998. Mr. Underwood served as Chief Executive Officer of
the Company from June 1983 until December 1996 and as President from June 1994
until December 1996. From March 1983 to June 1983, he served as Executive Vice
President and Chief Operating Officer of the Company. He also served as the
Company's President from July 1983 until his appointment as Chairman in December
1991, serving as Chairman until November 1995. Except for a few months when he
was employed by Transistor Electronics Corporation, Mr. Underwood was employed
for 18 years in various capacities by Fabri-Tek, Inc., an electronics
manufacturer located in Minneapolis, Minnesota, serving most recently as general
manager of the systems division in the United States and Hong Kong. Fabri-Tek's
systems division produces core memories for the industrial and military
marketplace.
Mr. Glarner has served as President of West Concord Ventures, Inc., a
venture capital firm, since February 1993. Mr. Glarner also serves as a
consultant to Norwest Venture Capital Management, Inc., an entity affiliated
with Norwest Growth Fund, Inc. From 1976 to January 1993, he was employed by
North Star Ventures, Inc., serving as President from February 1988 to January
1993. Prior to 1976, Mr. Glarner was Vice President of Dain Bosworth. Mr.
Glarner also serves as a director of FSI International, Inc., Aetrium, Inc.,
CIMA Labs Inc. and Premis Corporation.
Mr. King has been engaged in the private practice of law in Minneapolis,
Minnesota since 1965. He is a shareholder of the law firm of Fredrikson & Byron,
P.A., which serves as general counsel to the Company. Mr. King has served as
Secretary to the Company since 1980. Mr. King also serves as a director of
Sunrise Resources, Inc., a company which provides lease financing for capital
equipment.
Mr. Courtney has served as President and Chief Executive Officer of
HEI, Inc., a company which designs and manufactures microelectronics, since
1990, and he served as HEI's Executive Vice President from 1988 to 1990. In
addition, Mr. Courtney serves as a director of HEI, Inc.
<PAGE>
Executive Officers
The names and positions of the executive officers of the Company, as
well as other information are set forth below.
<TABLE>
<CAPTION>
NAME POSITION WITH COMPANY AGE
<S> <S> <C>
Carl P. Boecher President and Chief Executive Officer 55
Alan G. Shuler Vice President and Chief Financial Officer 51
Michael J. Gallagher Vice President of Software and Systems 34
Engineering
Larry J. Haisting Vice President of Marketing and Customer 52
Service
Michael L. Sorensen Vice President and General Manager, 52
Electronic Products
</TABLE>
See Carl P. Boecher's biography above under Directors.
Alan G. Shuler has served as Vice President and Chief Financial Officer
of the Company since June 1992. From August 1991 to May 1992, Mr. Shuler served
as Vice President and Chief Financial Officer of Astrocom Corporation, a St.
Paul, Minnesota manufacturer of data communication equipment. From January 1988
through December 1990, Mr. Shuler was Senior Vice President and Chief Financial
Officer of FSI International, Inc., a Chaska, Minnesota manufacturer of
semiconductor equipment.
Michael J. Gallagher has served as Vice President of Software & Systems
Engineering of the Company since October 1997. From February 1996 to October
1997, Mr. Gallagher served as Engineering Manager of Custom Applications of
Secure Computing Corporation. From January 1988 to February 1996, Mr. Gallagher
served as Engineering Manager of System products for Unisys Corporation.
Larry J. Haisting has served as Vice President of marketing and
Customer Service of the Company since October 1997, prior to which he served as
Vice President of Marketing and Sales, beginning in February 1997 when he joined
the Company. From March 1992 to October 1996, Mr. Haisting was employed by St.
Paul Software, Inc., a software distributor in St. Paul, Minnesota, serving most
recently as Vice President, Marketing. From 1990 to 1991, Mr. Haisting was the
Industry Sales Manager of EDI Solutions, Inc., a software distributor in
Minneapolis, Minnesota. From 1975 to 1990, Mr. Haisting was involved in
management and sales for several software and computer companies.
Michael L. Sorensen joined the Company in April 1997 as Vice President
of Operations and became Vice President and General Manager, Electronic Products
on November 1997. From February 1995 to March 1997, Mr. Sorensen served as Vice
President of Operations for Despatch Industries, a custom oven and furnace
company, prior to which he provided consulting services to Despatch, beginning
in October 1994. From April 1992 to September 1994, Mr. Sorensen was the Plant
Manager of J. B. Martin Company, Inc., a manufacturer of three-dimensional
fabrics located in Leesville, South Carolina. Prior to April 1992, Mr. Sorensen
served in various engineering and operations positions with United Engineers and
Constructors, Inc., BASF Structural Materials, Inc., Celanese Corporation,
Abbott Laboratories and Corning Glass Works.
ITEM 10. EXECUTIVE COMPENSATION
Summary Compensation Table
The following table sets forth all cash compensation paid or to be paid
by the Company, as well as certain other compensation paid or accrued, during
each of the Company's last three fiscal years to the Chief Executive Officer
during fiscal 1997 and to the only other executive officer whose total annual
salary and bonus paid or accrued during fiscal year 1997 exceeded $100,000.
<TABLE>
<CAPTION>
Long Term Compensation
------------------------------------
Awards Payouts
------------------------- ----------
Restricted LTIP All Other
Name and Principal Fiscal Stock Awards Payouts Compensation
Year Annual Compensation ($) Options ($) ($)
Position Salary ($) Bonus ($) Other ($)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Carl P. Boecher 1997 120,637 -- 1,656(1) -- 15,000 -- 2,698(2)
President and Chief 1996 98,840 7,275 1,241 -- 25,000 -- 1,740
Executive Officer 1995 90,721 21,889 996 -- 50,000 -- 13,931
Alan G. Shuler 1997 101,364 -- 1,261(1) -- 10,000 -- 2,586(2)
Vice President and 1996 97,550 9,300 1,120 -- -- -- 1,943
Chief 1995 96,192 -- 939 -- 25,000 -- 811
Financial Officer
</TABLE>
- ------------------------------
(1) Reimbursement for taxes on supplemental benefits.
(2) Term insurance premium paid by the Company and 401(K) plan matching
contribution.
Option Grants During 1997 Fiscal Year
The following table provides information regarding stock options
granted during fiscal 1997 to the named executive officers in the Summary
Compensation Table. The Company has not granted any stock appreciation rights.
<TABLE>
<CAPTION>
Percent of Total
Number of Shares Options Granted to Exercise or
Underlying Options Employees Base Price
Name Granted in Fiscal Year Per Share Expiration Date
<S> <C> <C> <C> <C>
Carl P. Boecher 15,000 (1) 6% $3.00 03/09/07
Alan G. Shuler 10,000 (1) 4% $3.00 03/09/07
- ------------------
</TABLE>
<PAGE>
(1) The option was granted on March 10, 1997 and will become exercisable in
full on March 10, 2002, subject to acceleration if certain targets are
met. The exercise price is equal to the fair market value of the common
stock on the date of grant.
Option Exercises During 1997 Fiscal Year and Fiscal Year-End Option Values
The following table provides information as to options exercised by the
named executive officers in the Summary Compensation Table during fiscal 1997
and the number and value of options at December 31, 1997. The Company has no
outstanding stock appreciation rights.
<TABLE>
<CAPTION>
Value of
Number of Unexercised
Unexercised In-the-Money
Options at Options at
Shares December 31, 1997 December 31, 1997
Acquired Value Exercisable/ Exercisable/
Name on Exercise Realized Unexercisable Unexercisable(1)
<S> <C> <C> <C> <C>
Carl P. Boecher -- -- 42,500 exercisable $10,625
52,500 unexercisable $18,750
Alan G. Shuler -- -- 56,667 exercisable $ 2,083
20,000 unexercisable $ 8,750
</TABLE>
(1) Value is calculated on the basis of the difference between the option
exercise price and $3.75, the closing sale price for the Company's
common stock at December 31, 1997 as quoted on the Nasdaq National
Market, multiplied by the number of shares underlying the option.
Compensation of Directors
Directors' Fees. The independent Board members receive a $2,500 annual
retainer, $1,000 for attendance at each meeting of the Board of Directors and
$500 for attendance at each committee meeting; provided, however, that pursuant
to Mr. Holland's consulting agreement with the Company, such fees are not paid
to Mr. Holland during the term of such agreement. See "Related Transactions."
Stock Option Grants to Non-Employee Directors. The 1997 Stock Option
Plan provides for automatic option grants to each director who is not an
employee of the Company (a "Non-Employee Director"). Upon initial election, a
Non-Employee Director receives an automatic grant of a nonqualified option to
purchase 15,000 shares of the common stock at an option price per share equal to
100% of the fair market value of the common stock on the date of such election,
which option becomes exercisable to the extent of 3,000 shares immediately and
on each of the first four anniversaries of the date of grant. Each Non-Employee
Director who is re-elected as a director of the Company or whose term of office
continues after a meeting of shareholders at which directors are elected shall,
as of the date of such re-election or shareholder meeting, automatically be
granted an immediately exercisable nonqualified option to purchase 3,000 shares
of the common stock at an option price per share equal to 100% of the fair
market value of the common stock on the date of such re-election or shareholder
meeting. No director shall receive more than one option to purchase 3,000 shares
pursuant to the formula plan in any one fiscal year. All options granted
pursuant to these provisions shall expire on the earlier of (i) three months
after the optionee ceases to be a director (except by death) and (ii) ten (10)
years after the date of grant. Notwithstanding the foregoing, in the event of
the death of a Non-Employee Director, any option granted to such Non-Employee
Director pursuant to this formula plan may be exercised at any time within six
months of the death of such Non-Employee Director or on the date on which the
option, by its terms expires, whichever is earlier.
Employment Contracts and Termination of Employment Arrangements
The Company entered into a one-year employment agreement dated January
1, 1997, with Carl P. Boecher, the Company's President and Chief Executive
Officer, which replaced his January 9, 1995 agreement. The agreement
automatically renews for successive one-year terms unless terminated by either
party. The agreement has been automatically renewed for another one-year term
with an annual base salary of $126,000. The agreement provides for the payment
of a monthly car allowance of $500. The agreement does not provide for a bonus,
but Mr. Boecher is eligible to participate in the Company's Management Incentive
Plan. The agreement may be terminated with or without cause by either the
Company or Mr. Boecher upon thirty days' notice. If Mr. Boecher's employment is
terminated (i) by the Company without cause or by nonrenewal of the agreement,
(ii) by death or (iii) by disability, he is entitled to a severance payment
equal to his base monthly salary for twelve months. Mr. Boecher has agreed not
to compete with the Company for a period of one (1) year after termination of
his employment for any reason.
The Company entered into an employment agreement effective as of
January 1, 1995 with Alan G. Shuler, the Company's Vice President and Chief
Financial Officer, which agreement has a one-year term which automatically
renews for successive one-year terms if a termination notice is not given by
either party. The agreement has been automatically renewed for another one-year
term with a $103,480 annual base salary. The agreement provides for the payment
of a monthly car allowance of $400. The agreement does not provide for a bonus;
however, Mr. Shuler is eligible to participate in the Company's Management
Incentive Plan. The agreement may be terminated with or without cause by either
the Company or Mr. Shuler upon sixty days' notice. If Mr. Shuler's employment is
terminated by the Company without cause, he is entitled to his monthly base
salary for six months. If Mr. Shuler's employment is terminated within twelve
months of a change of control, or if he resigns within twelve months of a change
of control because of diminution of either position responsibilities or
remuneration, Mr. Shuler shall receive a severance payment equal to his annual
salary in effect at the time of the change of control, payable in twelve monthly
installments. Mr. Shuler has agreed not to compete with the Company during his
employment and during the time in which he is paid severance pursuant to the
agreement. Mr. Shuler also agreed that, during the one-year period following the
termination of his employment, for whatever reason, he will not solicit any of
the Company's employees to leave the Company and will not solicit the Company's
customers for the purpose of selling a competing product.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth the number of shares of the Company's
common stock and convertible preferred stock beneficially owned by (i) each
director and nominee for election to the Board of Directors of the Company; (ii)
each of the named executive officers in the Summary Compensation Table; (iii)
all directors and executive officers as a group; and (iv) to the best of the
Company's knowledge, all beneficial owners of more than 5% of the outstanding
shares of each class of the Company's stock as of April 8, 1998. Unless
otherwise indicated, the shareholders listed in the table have sole voting and
investment power with respect to the shares indicated.
<TABLE>
<CAPTION>
Convertible
Preferred
Common Shares Shares
Name (and Address of 5% Beneficially Percent of Beneficially Percent of
Holder) or Identity of Group(1) Owned(2) Class(2) Owned Class
<S> <C> <C> <C> <C>
Carl P. Boecher 52,500 (3) 1.8% -- --
Gary R. Holland 49,700 (4) 1.7% -- --
John H. Underwood 101,369 (5) 3.4% -- --
Terrence W. Glarner 19,600 (6) * -- --
Thomas R. King 15,950 (7) * -- --
Eugene W. Courtney 14,000 (8) * -- --
Alan G. Shuler 57,667 (9) 2.0% -- --
Norwest Corporation 245,600 (10) -- --
Norwest Equity Partners V 640,516 (11) 21.1% 150,000 100.0%
Okabena Partnership K 242,600 (12) 8.4% -- --
Timothy A. Stepanek 276,500 (13)(14) 9.6% -- --
David M. Winton and 254,500 (13) 8.8% -- --
Sarah H. Winton
Nathaniel S. Thayer 200,746 7.0% -- --
All Directors and Executive 326,786 (15) 10.3% -- --
Officers as a Group (10
persons)
- ---------------------------
</TABLE>
* Less than 1% of the outstanding shares of common stock.
(1) The addresses of the more than 5% holders are: Norwest Corporation and
Norwest Equity Partners V Norwest Center, Sixth & Marquette,
Minneapolis, MN 55479; Okabena Partnership K - 5140 Norwest Center, 90
South Seventh Street, Minneapolis, MN 55401; Timothy A. Stepanek and
David M. and Sarah H. Winton - 4422 IDS Center, 80 South Eighth Street,
Minneapolis, MN 55402; and Nathaniel S. Thayer, 150 Main Street, P.O.
Box 1325, Pawtucket, RI 02862.
(2) Under the rules of the Securities and Exchange Commission, shares not
actually outstanding are nevertheless deemed to be beneficially owned
by a person if such person has the right to acquire the shares within
60 days. Pursuant to such SEC rules, shares deemed beneficially owned
by virtue of a person's right to acquire them are also treated as
outstanding when calculating the percent of class owned by such person
and when determining the percentage owned by a group.
(3) Represents 52,500 shares which may be purchased by Mr. Boecher upon
exercise of currently exercisable options.
(4) Includes 49,000 shares which may be purchased by Mr. Holland upon
exercise of currently exercisable options and 700 shares held by Mr.
Holland's wife as custodian for their daughter.
(5) Includes 94,166 shares which may be purchased by Mr. Underwood upon
exercise of currently exercisable options.
(6) Includes 15,000 shares which may be purchased by Mr. Glarner upon
exercise of currently exercisable options.
(7) Includes 5,000 shares which may be purchased by Mr. King upon exercise
of a currently exercisable option.
(8) Represents 14,000 shares which may be purchased by Mr. Courtney upon
exercise of currently exercisable options.
(9) Includes 56,667 shares which may be purchased by Mr. Shuler upon
exercise of currently exercisable options.
(10) Represents shares held by a Norwest Bank Minnesota, N.A. ("Norwest
Bank"), a subsidiary of Norwest Corporation ("Norwest"), of which
242,600 shares are held by Norwest Bank as custodian for Okabena
Partnership K ("Okabena"). Norwest Bank has voting power but no
investment power over the shares it holds (see footnote (12) below with
respect to shares held for Okabena). Norwest disclaims beneficial
ownership of the shares held by Norwest Bank. All shares are held in a
fiduciary capacity. The Company has relied on information contained in
a Schedule 13G Amendment filed with the Securities and Exchange
Commission on January 30, 1998.
(11) Includes 150,000 shares which may be purchased by Norwest Equity
Partners V ("Norwest Equity"), a limited partnership, upon conversion
of preferred stock. Norwest Equity has sole voting and investment power
over the shares it holds; Itasca Partners V, L.L.P. is the managing
partner of Norwest Equity, and Daniel J. Haggerty, John E. Lindahl and
George J. Still Jr. are the three sole managing partners of Itasca. The
Company has relied on information contained in a Schedule 13D filed
with the Securities and Exchange Commission on April 11, 1997.
(12) The shares are held by Norwest Bank as custodian for Okabena (see
footnote (10) above), but Okabena has investment power over the shares
and it has the right to intercede and vote the shares itself. Kohler
Capital Management, Inc., a Minnesota corporation has been engaged to
provide portfolio management services and investment advice to Okabena,
but it does not have voting power of the shares. Okabena Investment
Services, Inc. is the Managing Partner of Okabena. The Company has
relied on information contained in a Schedule 13D Amendment filed with
the Securities and Exchange Commission on November 21, 1997.
(13) Includes 104,500 shares held by Parsnip River Company, a limited
Partnership, and 150,000 shares held by Bond Investment Partners, a
Limited Partnership. Mr. and Mrs. Winton and Mr. Stepanek are general
partners of the limited partnerships and share voting and investment
control over the shares.
(14) Includes 15,000 shares held by Mr. Stepanek's wife and children and
7,000 shares held in a family trust.
(15) Includes 302,333 shares which may be purchased by the executive
officers and directors upon exercise of currently exercisable options.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Pursuant to a consulting agreement dated November 1, 1995 between the
Company and Gary R. Holland, Chairman of the Company, which agreement was
terminated on June 30, 1997, Mr. Holland received an annual fee of $100,000,
payable in monthly installments, for providing services to management for a
minimum of six days during each four-week period during the term of the
agreement. In connection with entering the agreement in 1995, Mr. Holland
received an option to purchase 35,000 shares of the Company's common stock at
$3.625, the fair market value on the date of grant, which option was granted
under the Company's Consultant Stock Option Plan. As long as Mr. Holland
received compensation pursuant to the terms of the agreement, he was not
eligible to receive the retainer and meeting fees paid to directors as set forth
in "Compensation of Directors;" however, he was eligible to receive options
under the formula plans described in such section. In accordance with the
agreement, Mr. Holland was elected as a director and appointed as Chairman of
the Board on November 10, 1995. Mr. Holland agreed not to compete with the
Company as long as he was providing the Company with consulting services or
serving as a director of the Company. In addition, Decision Processes
International of Minnesota, Inc., a corporation of which Mr. Holland is a
principal, provided consulting services to the Company for approximately $50,000
in fiscal year 1997.
The Company and John H. Underwood, the Company's former President and
Chief Executive Officer, entered into a Separation Agreement and Release
("Separation Agreement") effective January 1, 1997. Pursuant to the Separation
Agreement, Mr. Underwood agrees that, through December 31, 1998, he will not (i)
compete with the Company, (ii) solicit any of the Company's employees to leave
the Company or (iii) interfere with the Company's customers. The Separation
Agreement provides that, through December 1998, Mr. Underwood shall receive
$12,500 each month, the amount of his monthly base salary on December 31, 1996,
and he shall be entitled to certain other benefits, including participation in
the Company's health coverage plans and outplacement fees not to exceed $6,000.
The termination dates of Mr. Underwood's stock options to purchase 16,666 shares
at $3.625 and 75,000 shares at $5.75 were extended to February 28, 1999. Mr.
Underwood agreed to release the Company from any and all rights and claims,
except as provided for in the Separation Agreement, in connection with his
employment and/or resignation.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
The following exhibits are included in this report: See
"Exhibit Index" immediately following the financial statements following the
signature page of this Form 10-KSB/A-1.
(b) Reports on Form 8-K
No reports on Form 8-K were filed by the Company during the
quarter ended December 31, 1997.
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Issuer has caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Dated: April 27, 1998 DATAKEY, INC.
BY: /s/ Carl P. Boecher
Carl P. Boecher
Chief Executive Officer and Director
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed by the following persons on behalf of the Company,
in the capacities, and on the dates, indicated:
SIGNATURES TITLES DATE
/s/ Carl P. Boecher Chief Executive Officer and April 27, 1998
Carl P. Boecher Director (Principal Executive
Officer)
/s/ Alan G. Shuler Vice President and Chief April 27, 1998
Alan G. Shuler Financial Officer (Principal
Financial and Accounting Officer)
* Director and Secretary April 27, 1998
Thomas R. King
* Director April 27, 1998
Terrence W. Glarner
* Chairman of the Board of April 27, 1998
Gary R. Holland Directors
* Director April 27, 1998
Eugene W. Courtney
* Director April 27, 1998
John H. Underwood
*/s/ Alan G. Shuler April 27, 1998
Alan G. Shulter as Attorney-in-Fact
pursuant to Power of Attorney filed
with Form 10-KSB for year ended
December 31, 1997
<PAGE>
DATAKEY, INC.
EXHIBIT INDEX TO ANNUAL REPORT
ON FORM 10-KSB
For the Fiscal Year Ended December 31, 1997
Exhibit No. Description
3.1 Restated Articles of Incorporation, as amended (Incorporated by
reference to Exhibit 3.1 to Form 10-K for fiscal year ended December
31, 1987)
3.2 Bylaws, as Amended (Incorporated by reference to Exhibit 3.2 to Form
10-K for fiscal year ended December 31, 1988)
10.1 1987 Datakey, Inc. Stock Option Plan (Incorporated by reference to
Exhibit 10.7 to Form 10-K for fiscal year ended December 31, 1987)*
10.2 Amendment dated March 15, 1991 to 1987 Datakey, Inc. Stock Option Plan
(Incorporated by reference to Exhibit 10.5 to Form 10-K for fiscal year
ended December 31, 1991)*
10.3 Amendments dated July 1, 1995 and March 19, 1996 to 1987 Datakey, Inc.
Stock Option Plan (Incorporated by reference to Exhibit 10.5 to Form
10-KSB for fiscal year ended December 31, 1996)*
10.4 License Agreement between CTS Corporation and the Company dated March
9, 1988 (Incorporated by reference to Exhibit 10.8 to Form 10-K for
fiscal year ended December 31, 1987)
10.5 Lease between the Company and Kraus-Anderson, Inc. dated June 3, 1987,
as amended on February 10, 1988, December 23, 1988, February 13, 1992
and April 1, 1992 (Incorporated by reference to Exhibit 10.12 to Form
10-K for fiscal year ended December 31, 1991)
10.6 Manufacturing Agreement between Duncan Industries and the Company dated
August 27, 1993 (Incorporated by reference to Exhibit 10.16 to Form
10-KSB for fiscal year ended December 31, 1993)
10.7 Employment Agreement between Alan G. Shuler and the Company dated
January 1, 1995 (Incorporated by reference to Exhibit 10 to Form 10-QSB
for fiscal year ended July 1, 1995)*
10.8 Consulting Agreement between Gary R. Holland and the Company dated
November 1, 1995 (Incorporated by reference to Exhibit 10.19 to Form
10-KSB for fiscal year ended December 31, 1995)*
10.9 Amendment dated February 11, 1997 to Consulting Agreement between Gary
R. Holland and the Company dated November 1, 1995 (Incorporated by
reference to Exhibit 10.18 to Form 10-KSB for fiscal year ended
December 31, 1996)*
10.10 Employment Agreement between Carl P. Boecher and the Company dated
January 1, 1997 (Incorporated by reference to Exhibit 10.19 to Form
10-KSB for fiscal year ended December 31, 1996)*
10.11 Separation Agreement and Release between John H. Underwood and the
Company dated January 1, 1997 (Incorporated by reference to Exhibit
10.20 to Form 10-KSB for fiscal year ended December 31, 1996)*
10.12 1997 Management Incentive Plan, as amended March 10, 1997 (Incorporated
by reference to Exhibit 10 to Form 10-QSB for fiscal quarter ended June
28, 1997)*
10.13 Lease Amendment No. 5 dated December 17, 1996 to Lease between the
Company and Kraus-Anderson, Inc. dated June 3, 1987 (Incorporated by
reference to Exhibit 10.22 to Form 10-KSB for fiscal year ended
December 31, 1996)
10.14** Employment Agreement between Michael L. Sorensen and the Company dated
April 16, 1997*
10.15** 1997 Stock Option Plan*
10.16** Forms of Incentive and Nonqualified Stock Option Agreements under 1997
Stock Option Plan*
13.1 Portions of 1997 Annual Report
21.1 Subsidiaries of the Company (Incorporated by reference to Exhibit 21.1
to Form 10-KSB for fiscal year ended December 31, 1994)
23.1** Independent Auditors' Consent
24.1** Power of attorney for Carl P. Boecher, Alan G. Shuler, Thomas R. King,
Terrence W. Glarner, Gary R. Holland, Eugene W. Courtney and John H.
Underwood (included on the signature page of this Form 10-KSB)
27** Financial Data Schedule (filed with electronic version only)
* Designates a management contract or compensatory plan or arrangement.
** Previously filed with original Form 10-KSB for year ended December 31, 1997.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION & RESULTS OF
OPERATIONS
Results of Operations
The table below summarizes changes in selected operating indicators, showing
certain income, cost and expense items as a percentage of total revenue for each
of the past three years. Inflation has not been a significant factor in
Datakey's operations to date.
Percentage of Total Revenue
Year Ended December 31, 1997 1996 1995
-------- --------- --------
Revenue........................ 100% 100% 100%
Cost and Expenses
Cost of goods sold............. 73% 65% 67%
Research and development....... 53 35 10
Marketing and sales............ 29 20 15
General and administrative..... 12 18 9
-------- --------- --------
Total cost and expenses..... 167 138 101
Interest income................ 2 6 5
Income (loss) before income
taxes.......................... (65) (32) 4
Income taxes (benefit)......... 5 (6) 2
-------- --------- --------
Net income (loss).............. (70) (26) 2
-------- --------- --------
Comparison of 1997 with 1996
Total Revenue: Total revenue was $5,977,000 in 1997, a decrease of 9 percent
from $6,558,000 in 1996. The revenue decrease is primarily due to customer
requested delays in major electronic products customer shipments during the
second half of 1997 resulting from delays, cancellation, or non-renewal of
orders from their customers. The Company anticipates that sales of electronic
products will continue to decrease in 1998. Its future growth will depend
primarily on the market acceptance of new end-user products introduced to the
information security marketplace.
Gross margins: The gross profit margin decreased to 27 percent in 1997 from 35
percent in 1996 primarily as a result of lower revenue, product costs associated
with zero charge evaluation units to customers, and increases in reserves for
inventory obsolescence.
Research and development: Research and development expenses increased 41 percent
to $3,186,000 in 1997 from $2,263,000 in 1996 due to the Company's significant
increase in product development activities for token-based information security
systems.
Marketing and sales, General and administrative: Marketing and sales expense in
1997 increased 31 percent to $1,716,000 from $1,312,000 in 1996 due to a planned
increase in product promotion expense to achieve market introduction of the new
token-based information security systems.
General and administrative expenses decreased 38 percent to $713,000 in 1997
from $1,156,000 in 1996 primarily due to an accrual in 1996 for severance pay
and benefits due the Company's former chief executive officer.
Interest income: Interest income decreased 53 percent to $170,000 in 1997 from
$361,000 in 1996 due to a decline in the Company's investment in interest
bearing investments.
Income tax expense (benefit): The Company recorded an income tax expense of
$325,000 in 1997 as compared to an income tax benefit of $388,000 in 1996. As a
result of the net operating loss carryover in excess of $5,000,000 at December
31, 1997, the Company determined that the realization of the future tax benefit
of the operating losses for tax purposes was uncertain and, accordingly, the
deferred tax asset of $325,000 recorded at December 31, 1996, was entirely
reserved and charged to expense in 1997.
<PAGE>
Comparison of 1996 with 1995
Total Revenue: Total revenue was $6,558,000 in 1996, a decrease of 9 percent
from $7,219,000 in 1995. The revenue decrease was primarily due to customer
requested delays in commercial OEM product shipments during the second half of
1996 resulting from delays in shipments to their customers.
Gross margins: The gross profit margin increased to 35 percent in 1996 from 33
percent in 1995 in spite of a reduction in revenue which normally reduces the
margin percentage. The improved margin percentage was primarily due to increases
in product selling prices in excess of the increases in material and
manufacturing costs.
Research and development: Research and development expenses increased 221
percent to $2,263,000 in 1996 from $704,000 in 1995 due to the Company's
significant increase in product development activities for new end-user
products.
Marketing and sales, General and administrative: Marketing and sales expense in
1996 increased 17 percent to $1,312,000 from $1,124,000 in 1995 due to an
increase in product promotion expense for newly developed and in-development
end-user products.
General and administrative expenses increased 73 percent to $1,156,000 in
1996 from $670,000 in 1995 primarily due to an accrual for severance pay and
benefits due the Company's former chief executive officer.
Interest income: Interest income decreased 6 percent to $361,000 in 1996 from
$381,000 in 1995 due to a decline in the Company's investment in interest
bearing investments.
Income tax expense (benefit): Income tax benefit for 1996 was $388,000 as
compared to an income tax expense of $106,000 in 1995. The benefit is related to
the 1996 loss before taxes of $2,094,000 for which the Company recorded a
deferred tax asset of $325,000, and 1995 expense is related to the $282,000
income before taxes.
Liquidity and Capital Resources
The Company had a reduction of $4,828,000 in cash and held-to-maturity
marketable debt securities in 1997 compared to a reduction of $834,000 in 1996.
The 1997 reduction in cash and marketable debt securities resulted primarily
from significant expenditures, totaling $4,902,000, in research and development
and marketing expenses principally related to the Company's new product
development activities. Inventory decreased $46,000 to $1,083,000 as of December
31, 1997, compared to $1,129,000 as of December 31, 1996. Accrued compensation
expense decreased by $129,000 primarily due to the payment of severance pay and
benefits due the Company's former chief executive officer. The Company invested
$1,151,000 in the purchase of equipment and maintenance of licenses and patents
in 1997, compared to $515,000 in 1996. The 1997 increase is primarily
attributable to prepaid license fees related to licensed software that will be
bundled with the Company's information security systems and purchase of
automated equipment to improve factory efficiency. Cash, cash equivalents, and
investment in held-to-maturity marketable debt securities as of December 31,
1997, totaled $1,305,000 as compared to $6,133,000 as of December 31, 1996. See
"Outlook". Datakey's balance sheet reflects $1,951,000 in working capital and a
current assets to current liabilities ratio of 2.7 to 1 as of December 31, 1997.
<PAGE>
Outlook
Certain statements in the following Outlook section and in other parts of this
Annual Report are forward looking and are based upon current expectations. These
statements are forward looking and actual results may differ materially due to
risks and uncertainties, including those set forth below.
Revenue: Shipment delays experienced in the second half of 1997 are expected to
continue through the first half of 1998 and likely will result in a reduction in
electronic products revenue for the year as compared to 1997. New end-user
products being introduced to the information security marketplace are expected
to result in significant revenue during the second half of 1998. If this revenue
meets the Company's present expectations, the total revenue from the new
products could exceed the revenue from the electronic products group.
Gross margins: A gradual improvement in gross profit margins during 1998 is
expected through selective price increases, effective material purchasing, an
increase in revenue without an attendant increase in factory overhead and
improvements in manufacturing efficiency.
Research and development: The Company will continue to fund new product
development activities in 1998 but at about 45 percent less than in 1997.
Marketing and sales, General and administrative: Marketing and sales expenses
are expected to increase about 40 percent in 1998 to support new product
introductions and the expected increase in revenue, but will be about the same
percent of revenue provided revenue from new product sales materializes as
expected. General and administrative expenses in 1998 are expected to increase
slightly from the 1997 level.
Interest income (expense): Interest income is expected to decline materially in
early 1998 as the Company intends to use cash and cash equivalents to fund
continuing product development and marketing activities to support the Company's
entry into advanced information security products. Beginning in the second or
third quarter the Company expects to borrow money and begin incurring interest
expense under the recently arranged bank line of credit.
Income tax expense (benefit): As a result of a net operating loss carry-forward,
the Company does not expect to record an income tax benefit or expense during
1998.
Expected first half loss: The Company expects to report a loss in the first half
of 1998 but may return to profitability by the end of 1998 if revenue from the
new product line materializes as expected.
Liquidity and capital resources: The Company plans to continue new product
development in 1998 at a lower level than in 1997 and marketing activities will
continue at an increased level during 1998. The Company expects to spend
$4,000,000 to $4,500,000 on these activities. Inventory levels are expected to
increase slightly in 1998 to support advanced information security products as
well as electronic products. 1998 investments in equipment and maintenance of
licenses and patents are expected to return to a level of $500,000 to $550,000.
The Company believes its working capital and cash equivalent investments
together with its bank line of credit are sufficient to fund its planned
operations and continued development and promotional activities during 1998,
provided that the revenue from new products materialize as expected. The bank
line is scheduled to expire in May 1998, but the Company expects to be able to
renew it for another year. The Board of Directors believes the prudent course of
action is for the Company to seek additional debt or equity financing, and the
Company is currently discussing financing options with several local
broker-dealers.
<PAGE>
Risks and Uncertainties
Rapid technological change: Datakey's information security end-user products
such as SignaSURE CIP and SignaSURE ESS will integrate hardware tokens with
software that provides a much higher level of security than software
implementations alone. There is a possibility that software-only solutions may
overcome this deficiency in the future.
Customer acceptance: While Datakey performs market research and beta testing
to determine the viability of its new products, actual user acceptance will
ultimately dictate the success of the marketing and sales efforts of new
products such as SignaSURE CIP and ESS. Although the Company believes that the
decision to fund these new products is correct, there are no assurances that
investments already made and additional investments planned for 1998 will result
in a financial return.
Product delivery schedules: Delays in the release of new products will cause
operational inefficiencies, increased development costs and reduced revenues.
Price competition: While Datakey believes that its strategy of providing
token-based product solutions at a price that is competitive with software-only
products is attainable, there are no assurances that competitive pressures will
not force the Company to accept reduced margins to compete in the future. Large
companies with significantly greater resources have recognized the need for
information security and could enter this market as competitors with much
greater financial resources. A portion of the new end-user products' cost
consists of royalties and license fees which would need to be re-negotiated in
order to maintain acceptable profit margins.
Integrated information security products: Although the Company's new products
will operate seamlessly with popular application programs, new application
programs that integrate information security into their product could erode the
future market for these Datakey products.
Marketing and sales: The future revenue of Datakey end-user systems is
dependent on the success of a new and untested marketing and direct sales
organization.
Need for information security: Corporate utilization of the Internet and
internal intranets dictate a need for information security, but there are no
assurances that other, more secure information transmission media may not become
available in the future that would preclude the need for the type of information
security provided by the Company's products.
Financing: There is no assurance that the Company's current negotiations with
broker-dealers will lead to a financing on acceptable terms. Should there be a
delay in new orders or if new product revenue does not materialize to the extent
currently projected, the inability to obtain acceptable financing could
jeopardize the Company's ability to maintain its current business operations.
Other Matters
The Company has begun its analysis of the impact, if any, from the changeover of
various computer systems during the year 2000. Based upon its internal analysis
and results of questions posed to major software and service suppliers, the
Company feels that year 2000 will have no significant financial or operational
impact.
