SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
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"). Portions of the Company's definitive Proxy Statement for
its Annual Meeting of Shareholders to be held on June 2, 1998 are incorporated
by reference pursuant to Rule 12b-23 into Items 9, 10 and 11 of Part III.
Transitional Small Business Disclosure Format (check one) YES [ ] NO [ X ]
<PAGE>
PART I
ITEM 1. DESCRIPTION OF BUSINESS
General
Datakey, Inc. (the "Company") was incorporated under the laws of the
State of Minnesota in 1976 under the name "The Systems Group, Inc." In 1980, the
Company changed its name to Datakey, Inc. The Company provides product,
subsystem and system solutions to record, store and transmit electronic
information. Datakey also manufactures and sells products and systems directed
to the information security market which will enable user identification and
authentication, secure data exchange and information validation. It also
provides OEM products, consisting of proprietary memory keys, cards and other
custom-shaped tokens that serve as a convenient way to carry electronic
information and are packaged to survive in portable environments.
The Company's first portable information system, consisting of an
electronic key and support electronics, was introduced in 1981 for applications
requiring convenient storage, transportation and management of information. The
Company's current system utilizes semiconductor technology to provide a storage
device more versatile than conventional portable information products such as
keys, badges and magnetic stripe cards. The Company's current product line of
portable data carriers and associated interface products provide up to
16,384,000 bits of data storage which are used in a wide range of applications
including communications security, computer security, facility security, vending
and process control.
Each of the Company's personal portable information systems consists of
one or more portable data carriers, access devices and, for certain models,
interface modules containing microprocessors. These components, together with
the user's processor-based equipment, function as an integrated system allowing
instantaneous processing of personalized data carried within a portable data
carrier. Through the incorporation of advanced semiconductor memory technology,
the Company's portable data carrier is able to store and carry substantial
amounts of information. When the portable data carrier is used in conjunction
with the other components of the Company's system, information can be
selectively altered, added to or erased, as required, to effectively and
reliably manage or control a particular activity or transaction.
The Company has introduced an end-user system level product which is
designed to provide electronic signatures on computer aided drafting (CAD)
drawings and additional end-user systems that are designed to provide advanced
information security utilizing digital signatures and encryption. These systems
incorporate hardware and software to provide a higher level of security than is
obtainable with current software only solutions.
Current Products and Products Under Development
Electronic Products
Portable Data Carrier Devices. Portable data carriers are electronic
memory devices which store information. They have a plastic exterior, are in the
forms of keys, cards, or custom shaped tokens and encapsulate semiconductor
memory. Certain devices have been designed to store information which may be
retrieved, altered, erased or updated; while other devices have been designed to
store one-time programmable information which may be retrieved but not altered
or updated. The storage capacities of the Company's portable memory devices
range from 1,024 bits (150 alphanumeric characters) to 16,384,000 bits. The
portable data carriers are priced generally between $2 and $100 per unit,
depending on capacities and quantities purchased.
<PAGE>
Access Device. The access device is the element into which a portable
data carrier is inserted to provide the interconnection between the portable
data carrier and the electronic interface circuitry or the host processor-based
equipment. It is through this physical interconnection that the data contained
in the portable data carrier's memory is transmitted to the electronic interface
or to the host interface. Several models of the access device have been
developed to handle the Company's different portable data carriers. The access
devices are priced generally between $15 and $120 per unit, depending on models
and quantities purchased.
Interface. The interface is the electronics control module between the
access device and a customer's processor-based equipment. This module is used
with the Company's serial communication key and contains all the necessary
electronics to control information within the key and to coordinate the
information requests of the host equipment. This communication process is
managed by the system's firmware, which is a software program existing within
the interface. For some applications, this firmware structures, secures and
verifies the information within the portable device, and may allow separate
groups or files of data to reside in a single portable device and be secure from
access except by equipment authorized to manage a particular group or file of
data. The interface is priced between $70 and $120 per unit, depending on models
and quantities purchased.
Integrated System Solutions
For the past two years, Datakey has been developing new products that
provide advanced security solutions to the problems of organizations, worldwide.
The first release of these token-based information security systems was
introduced in September 1997 and additional versions are expected to be
introduced in the first half of 1998. The launch and success of such products is
dependent on further successful development efforts and market acceptance, along
with other risks. See "Forward Looking Statements."
SignaSURE CIP. Password-based software programs that implement
public-key cryptography technology for information security offer easier
operation and improved data integrity over older symmetric cryptography
software. Password-based security, however, is insufficient for private networks
with connections outside of the corporation. The Company's SignaSURE CIP
(Cryptographic Interface Provider) is designed to solve this problem, allowing
the Internet to be used safely for electronic commerce.
SignaSURE CIP allows users and value-added resellers to upgrade their
software-only systems to token-based information security and gain the benefit
of secure Internet operation. Token-based information security implements a
two-level security scheme--something that is owned (a hardware token) and
something that is known (a password to activate the token)--for a much stronger
level of security than password-based software solutions. SignaSURE CIP provides
token upgrades for Cryptoki or PKCS-11 standard information security interface
applications and for applications that incorporate Microsoft's CryptoAPI. These
products offer "load, plug and play" convenience for strong information
security.
SignaSURE CIP products include a user-unique smart card or smart key
that holds the critical information to perform the cryptographic functions
necessary for information privacy and data integrity, a companion reader/writer
that plugs into a computer's serial port, PCMCIA port or floppy disk drive, and
software which is loaded into the workstation and interfaces to the application
program. The Company introduced, in September 1997, a version of SignaSURE CIP
that utilizes the standard PKCS #11 (Cryptoki) Interface and plans to release in
early 1998 a version that utilizes Microsoft's CryptoAPI.
<PAGE>
SignaSURE DTK. As public-key information security grows due to the
technology's adoption by well-known software companies such as Microsoft and
Netscape, smaller software developers are also implementing public-key
information security into their specialized applications. Because no easy method
was available for smaller application developers to implement a token-based
public key infrastructure, the Company developed its SignaSURE DTK (Developers
Tool Kit) so that developers could easily and cost-effectively launch their
applications with the much stronger, token-based information security.
SignaSURE DTK is a turnkey package that the Company designed to allow
software developers to integrate Datakey hardware tokens and a public-key
infrastructure into their applications. DTK includes up to three main
components: hardware cryptographic tokens, interface and integration software
and security infrastructure products. DTK is available in four configurations
ranging from just a token with a reader/writer and integration software, to the
full public-key infrastructure configuration that issues and manages hardware
tokens and digital certificates. This product flexibility allows user-developers
who utilize SignaSURE DTK to integrate just what is needed for their
application. The Company began selling the SignaSURE DTK in mid-1997.
SignaSURE EDM. Design and drafting was revolutionized several decades
ago with the introduction of computer aided-design (CAD) software. However,
engineers still must print their CAD-created designs, approve the documents with
hand-written signatures, and archive these hand-signed originals to maintain
change control and ensure design traceability. The Company's SignaSURE EDM
(Electronic Document Manager), which Datakey began to sell in late 1996,
provides a way to sign an electronic document to ensure its authenticity, thus
eliminating the need for hand-signed originals and all of the storage and
archiving requirements for paper-based engineering drawings and documents.
SignaSURE EDM adds digital signatures to CAD and other documents to
ensure document authenticity, configuration control and conformance to ISO 9000
document management requirements. SignaSURE EDM provides for copying,
distributing and archiving of electronically generated documents with a level of
authenticity formerly obtainable only with hand-signed paper documents. It
answers questions of document authorship, integrity and culpability quickly,
easily and unambiguously. With SignaSURE EDM, documents in electronic form can
be transmitted over local area networks, intranets and the Internet with their
authenticity assured.
SignaSURE EDM includes a smart card or smart key that generates the
user's digital signature, a companion reader/writer that plugs into a computer's
serial port, and a software program which is loaded into the workstation.
SignaSURE EDM operates on all Windows operating systems, is compatible with all
CAD programs and file formats, and moves design and drafting to a paperless
environment. A new SignaSURE version of EDM with a more "windows like" look and
feel is scheduled for release in the second quarter of 1998.
SignaSURE ESS. Many of today's organizations have made the transition
from large mainframe systems to more flexible, but much less secure,
client-server networks and intranets. Client-server networks and intranets allow
digital information to reside on networks, rather than at the desktop so
authorized users can access the same information. Authorized users can include
company employees, suppliers and customers who can be connected to the network,
or located remotely from the enterprise. With the advent of the Internet,
information transmission over any distance can be accomplished quickly and cost
effectively, but not securely. Datakey believes its SignaSURE ESS (Enterprise
Security Suite) offers a solution to manage a network, intranet and Internet
computing structure to allow authorized users ready access to information, but
deny it to the unauthorized. Information can then be transmitted securely and
stored safely on both private and public networks without privacy and data
integrity concerns.
<PAGE>
SignaSURE ESS is an integrated end-to-end data security system that the
Company believes will assure secure network access, confidential information
exchange, integrity of data and transaction non-repudiation. Secure,
personalized smart tokens are employed within a public key infrastructure to
provide a higher level of information security than is provided by software-only
solutions. Security functions are integrated into applications like Microsoft
Office(TM), thereby providing seamless security operation to the user. SignaSURE
ESS will operate over the Internet, and wide and local area networks enabling
secure information exchange for all users, whether local or remote to the
enterprise.
SignaSURE ESS includes a user-personalized smart card or smart key
hardware token and companion reader/writer for workstation or laptop that
perform the functions necessary for information privacy and data integrity. It
also incorporates client software that manages secure information and interfaces
to applications, and server-based, enterprise infrastructure hardware and
software that initialize SignaSURE ESS and continually ensures all users are
authorized. The Company expects to begin selling SignaSURE ESS in the second
quarter of 1998.
The following chart shows the Company's SignaSURE products:
<TABLE>
<S> <C> <C> <C> <C> <C> <C>
SignaSURE Product
- ----------- --------------------------- -----------------------------------------------------------
Attribute CIP CSP DTK EDM ESS
- ----------- --------------------------- ----------- ---------- ----------- ---------- -------------
Customer Organizational End-User x x x
Engineer/Architect End-User x
Software Developer x
- ----------- --------------------------- ----------- ---------- ----------- ---------- -------------
System Type Integrated Solution x x
Add-on Subsystem x x
Component x
- ----------- --------------------------- ----------- ---------- ----------- ---------- -------------
Application Information Security x x x
Paperless Automation x
Token Integration x x x
- ----------- --------------------------- ----------- ---------- ----------- ---------- -------------
Hardware Datakey Smart Token x x x x x
Datakey Reader/Writer x x x x x
- ----------- --------------------------- ----------- ---------- ----------- ---------- -------------
Software Security Solution x x
Token Interface x x x
- ----------- --------------------------- ----------- ---------- ----------- ---------- -------------
</TABLE>
Year 2000
The Company's products are designed on an operating system which uses
four digits in designating the year. As a result, these products can distinguish
the year 2000 from the year 1900; therefore, the year 2000 will not cause
problems.
Research and Development
During 1997, the Company continued the development of portable data
carriers to expand its line of standard products as well as newly designed
custom products. The Company also substantially increased its development of
token-based information security products.
As the need for computer security products continues to grow, the
Company has been expending significant effort into development of token-based
computer information security systems. The Company's SignaSURE line of
information security products, which were initially released for sale during
1997, are designed to provide encryption and digital signatures required for
electronically generated documents on computer networks.
<PAGE>
The technology involved in information systems in undergoing rapid
expansion and advancement which could result in the development of new products
and systems which may make the Company's present information security products
obsolete. The initial development effort for the Company's information security
products was completed in 1997 but the Company must continue to improve its
present information security products in order to remain competitive.
In 1997, 1996 and 1995, research and development expenses were
$3,186,000, $2,263,000 and $704,000, respectively. The Company expects that
research and development expenses in 1998 will be about 45% less than in 1997.
Manufacturing
The Company's in-house manufacturing capabilities include
microelectronic assembly, plastic injection molding, automated surface mount
assembly, and general electronic assembly. The Company also utilizes independent
subcontractors from time to time to perform certain manufacturing functions. The
Company provides a 90-day warranty on domestic sales, a 180-day warranty on
sales to its international distributors to cover the longer shelf life of the
Company's products, and a 180-day warranty on sales to the government.
In an effort to more efficiently produce products, to reduce product
costs, and to increase its manufacturing flexibility, the Company intends to
continue to improve certain manufacturing processes and add capital equipment to
its manufacturing operations. While the Company believes that these steps will
provide a greater level of control over, and flexibility in, its manufacturing
processes, there are no assurances that the Company's ability to produce
products and to meet required delivery schedules will be sufficiently improved
to meet the demands created by increased sales and more complex manufacturing
processes.
Sources of Supply
The Company purchased microprocessors for its advanced information
security products (the SignaSURE line of products) from a single supplier in
1997. This supplier also provided a proprietary card and key (token) operating
system which will be discontinued after the current supply of microprocessors is
depleted. The Company has also developed its own proprietary card operating
system which is "masked" into a new microprocessor. The new microprocessor is
being purchased from a different single supplier, will be placed into smart
cards and smart keys and introduced to the marketplace when the current supply
of microprocessors is depleted.
Due to the unique nature of these cryptographic microprocessors, there
are currently a limited number of alternative sources of supply and, due to
different operating systems and other characteristics, one supplier's
microprocessors are not easily interchanged with another. Should the newly
arranged source of supply become inadequate or inferior to other offerings in
the future, the Company will be required to incur a significant cost and
possibly experience a gap in supply to switch to a new supplier.
The Company has several qualified sources from which to purchase
printed circuit boards and electronic components for most of its standard
portable data carriers. The components for the Company's products are, in
general, available from multiple suppliers. Some of the plastic components are
molded on the Company's in-house molding equipment or suppliers' molding
equipment using Company-owned tooling.
<PAGE>
The Company purchases integrated circuits primarily through nationwide
multivendor distributors. If, for any reason, the Company would have to cancel
or reduce a particular integrated circuit order, it might thereafter have to pay
a higher price for the integrated circuits. Since general economic conditions
have an effect on the supply and cost of integrated circuits, there is no
guarantee that the Company will be able to obtain adequate quantities of
integrated circuits to meet all of its production needs during periods of short
supply.
Significant Customer
The Company sells its electronic products to a number of commercial
original equipment manufacturers (OEMs) and other customers, including
governmental entities. At this time, the Company is not dependent on any one
customer or few customers, the loss of which would have a material adverse
effect on its business.
Marketing
General. While there appears to be a broad range of applications and
potential customers for portable data carriers, no single application group has
evidenced strong, long-term growth potential. The diversity of potential
applications has made it difficult for the Company to focus its limited
marketing resources. In 1995, sales to OEM customers increased 23% to
$7,219,000, in 1996 they decreased 9% to $6,559,000, and in 1997 they decreased
11% to $5,868,000. The Company believes that commercial OEM sales may decrease
again in 1998.
New end-user products being developed for the information security
marketplace were introduced in 1997 and, based upon current expectations, are
expected to result in material revenue during the second half of 1998. As with
any new product line, revenue will depend on customer acceptance, the extent of
which is difficult to assess at this time.
Market of OEM Products. To date, most applications in the commercial
and government market have used the Data Key for electronic security and
equipment control applications. The Company is seeking to develop other
long-term business in this market. The Company markets its products to both
domestic and international customers using the following channels.
Domestic. The Company markets its portable information
products domestically through a combination of direct and indirect sales
personnel. In addition, it utilizes advertising, trade shows and direct mail to
reach its buying audience. In 1997, 1996 and 1995, OEM sales to domestic
customers, and the corresponding percentage of total revenue, were approximately
$4,068,000 (68%), $4,653,000 (71%) and $5,312,000 (74%), respectively.
International. The Company presently markets its portable
information products internationally through an independent sales agent in the
United Kingdom and agents and/or distributors in Columbia, Australia, Belgium,
the Netherlands and Germany. The Company has customers in other countries who
are handled on a direct basis from the Company's headquarters in the United
States. The Company intends to expand into other international market areas in
the future. In 1997, 1996 and 1995, OEM sales to international customers, and
the corresponding percentage of total revenue, were approximately $1,800,000
(30%), $1,906,000 (29%) and $1,907,000 (26%), respectively.
<PAGE>
End-User Products
Datakey plans to market and sell its advanced information security
products (the initial offerings in its end-user systems line) through a
combination of direct sales and marketing personnel, dealers, distributors,
value added resellers and system integrators/developers.
The direct sales and marketing personnel will concentrate primarily on
relationships with large security-conscious organizations either through direct
or indirect contact, establishing alliances with system integrators/developers
and setting up dealer/distributor relationships for its products. The future
revenue of Datakey end-user systems is dependent on the success of a new and
untested marketing and direct sales organization. Also, see "Risks and
Uncertainties" in the Management's Discussion and Analysis contained in the
Company's 1997 Annual Report, portions of which are included in Exhibit 13.1 of
this Report.
Backlog
As of March 9, 1998, the Company had an order backlog, totaling
approximately $3,047,000, including approximately $404,000 with scheduled
shipment dates in 1999, compared to $4,127,000 a year ago, $1,187,000 of which
were scheduled for shipment in 1998. Although the orders contain scheduled
shipment dates, they may be accelerated, delayed or canceled at the customer's
request. The Company does not believe that the current backlog is necessarily
indicative of future backlog levels.
Competition
Electronic Products. The Company's primary competition for its
electronic products sold to OEMs is presently, and is expected to remain,
conventional portable information systems, such as keys and cards, and more
advanced portable information systems including those in the familiar credit
card format, such as "smart cards," Personal Computer Memory Card Industry
Association (PCMCIA) cards, magnetic stripe cards, bar-code cards and laser
technology cards. The Company's products, when used as a portable data base, may
also compete with centralized data base systems. Many of the manufacturers of
these portable information devices and systems are large, well-established
companies.
A number of European and Japanese firms continue to develop and refine
the smart card technologies. Some of these companies have established branch
offices in the United States to explore the United States market. To date, the
smart card has been used primarily in Europe, where it has been implemented in
prepaid telephone systems. In the United States, smart cards are currently being
used mainly in field trial environments. Although the Company does not have
complete information about the status of these trials, the Company believes
that, in time, the smart card will be successfully developed and could become a
competitor, especially in those markets which have a history of using a card or
a preference for card-type devices.
Memory cards, such as PCMCIA standard cards, are functionally
equivalent to the Company's portable data carriers in that they utilize
semiconductor memory in card-shaped devices made of plastic. Memory cards
generally have larger memory capacities than the devices currently offered by
the Company and historically incorporated volatile, battery-backed memory
elements. More recently, nonvolatile (principally "Flash Memory") memory
elements which do not require battery backup have become more prominent. They
are used in such applications as laser printer fonts, instrumentation,
electronic lettering machines and fax/modems, and are also used as replacements
or "add ons" to diskettes and hard drives for data storage in certain desktop,
notebook and smaller portable computers.
<PAGE>
Magnetic stripe cards are relatively inexpensive and are used
extensively in the access control industry and in the banking and credit card
industries. These markets are not priority markets for the Company's portable
information devices. Magnetic stripe cards are not conveniently updated, have
limited storage capacity and generally have a useful life of one or two years.
As a result, the Company believes its products are technologically superior and
may be more cost-effective for applications requiring more complex technologies.
Another technology utilizes a strip of reflective material which is
laminated into a card. Information is inscribed on this material through use of
a laser beam. Since these cards can contain several million bits of information,
the Company believes that this technology will be a competitor in portable
information markets where very large information storage capacities are required
and instantaneous management of information is not essential.
The Company's ability to compete in the portable information market
will depend primarily on its ability to demonstrate superior product performance
at cost-effective prices and on the enhanced features of its system which make
it more effective than competing systems.
Integrated System Solutions. Datakey currently offers token-based
(smart card, smart key) information security systems which are primarily
utilized in encryption for electronic mail privacy, private and secure file
transfer and digital signatures for electronic document authentication. The
Company also sells a digital signature based product, known as SignaSURE EDM,
which enables users to electronically sign computer-aided drafting (CAD)
documents. The Company is continuing a significant product development effort to
expand the applications and ease-of-use of its products and systems. See
"Products--Integrated System Solutions."
Competition in the information security business is varied with
companies offering hardware solutions, software solutions and combinations of
hardware and software solutions. As awareness for security on the Internet,
company intranets and on other local area networks has increased over the past
few years, many companies have introduced software and/or hardware based
products to provide security. These products range from software-based password
only systems to firewalls, which may be very sophisticated. Other applications
are using hand held hardware devices, commonly referred to as tokens, to provide
access to networks and, in some cases, use encryption and digital signatures to
further secure networks.
The Company's advanced information security products, some of which are
released and some of which are currently in development, are based upon a smart
card or smart key and utilize encryption and digital signatures. They also
include extensive software to make the system user-friendly and seamless with
common desktop software packages. The Company feels this will provide a unique
combination of advanced security features at a reasonable selling price. There
are several companies operating in this highly competitive and rapidly changing
marketplace, however, and many of such companies have strong name recognition
and vast financial resources. The Company believes it can compete on the basis
of its unique design and ease of use. The initial reception to the Company's
products in the marketplace, beginning in late 1997, has been encouraging and
sales of evaluation units and units for pilot programs have been progressing
very well. There are no assurances, however, that the existing and future
products will, in the long term, be accepted in the marketplace.
<PAGE>
Patents and Trademarks
The Company has been granted several patents by the United States
Patent and Trademark Office relative to the Data Key, its key interface and its
overall portable information device technology. The Company has sought and will,
when appropriate, continue to seek patent protection in several foreign
countries. The federal registration of the Datakey trademark was approved in
1985. The Company also has patents in application or in the filing process. In
an industry characterized by rapid technological change, the Company believes
that the knowledge, experience and creativity of its employees will prove to be
more important than patent protection.
Employees
The Company presently employs 55 full-time employees, 14 of whom are
involved in manufacturing, 5 in materials handling, 3 in quality assurance, 14
in engineering, 11 in marketing/sales and 8 in general and administrative areas.
In addition, the Company uses contract labor during peak production times and
for major projects. The Company's employees are not subject to a collective
bargaining agreement, and the Company believes that its employee relations are
good.
Forward Looking Statements
Certain statements made in this Form 10-KSB, which are summarized here, are
forward-looking statements that involve risk and uncertainties, and actual
results may be materially different. Factors that could cause actual results to
differ include, but are not limited to those identified:
- -- The expectation that Datakey in the first half of 1998 will introduce
additional versions of its token-based information security systems, a new
version of SignaSURE CIP, and a new version of SignaSURE EDM is subject to
the risk of unanticipated problems or delays in development and depends
upon market acceptance and demand, as well as other general market
conditions and competitive conditions within this market, including the
introduction of products by competitors.
- -- The expectation that Datakey will begin to sell SignaSURE ESS in the second
quarter of 1998 depends upon successful development efforts and meeting the
currently scheduled timetable for such development.
- -- The expectation that the Company will continue to improve its manufacturing
processes, leading to more efficient production, depends on the Company's
ability to monitor such processes and to add capital equipment to its
manufacturing operations.
- -- The expectation that the Company will expand sales in international markets
depends on the acceptance of its products in such markets, the quality and
performance of the Company's products as compared to competitive products,
the effectiveness of relatively new marketing and sales personnel, and
other general market and competitive conditions within such markets.
ITEM 2. DESCRIPTION OF PROPERTY
The Company's corporate offices and manufacturing facility, located at
407 West Travelers Trail, Burnsville, Minnesota, consists of 18,488 square feet.
Approximately one-half of the space is used for manufacturing and warehousing,
and the balance for present and future office space. All of this space is rented
under a lease which extends through June 1999. The Company also utilizes
approximately 2,400 square feet in a nearby office under a sublease that expires
in May 1999. The annual rent expense for the space currently occupied is
$156,000, plus a portion of the operating expenses and real estate taxes. The
Company believes its space is sufficient for its needs in the foreseeable
future, and it believes its property is adequately insured.
<PAGE>
ITEM 3. LEGAL PROCEEDINGS
There are no material legal proceedings pending to which the Company is
a party or of which any of its property is the subject.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during
the fourth quarter of fiscal year 1997.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock is traded on the Nasdaq National Market
System under the symbol DKEY. The high and low sale prices for the common stock
by quarter as reported by Nasdaq are set forth in the following table for 1997
and 1996.
On March 13, 1998, the Company had approximately 1,100 shareholders,
including approximately 800 beneficial owners. The Company has never paid
dividends and does not plan to in the foreseeable future.
Sale Prices
High Low
1997
1st Quarter................................. $4 7/8 $2 1/4
2nd Quarter................................. $4 7/8 $1 7/8
3rd Quarter................................. $4 1/4 $3
4th Quarter................................. $4 1/4 $3 1/8
1996
1st Quarter................................. $5 7/8 $3 3/4
2nd Quarter................................. $8 3/4 $3 7/8
3rd Quarter................................. $7 3/4 $4 1/4
4th Quarter................................. $5 3/8 $3
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
The information required by Item 6 is incorporated by reference from
the Company's 1997 Annual Report, a portion of which is included herewith in
Exhibit 13.1 to this Report.
<PAGE>
ITEM 7. FINANCIAL STATEMENTS
The following financial statements of the Company are included
immediately following the signature page of this Report on the pages indicated:
Page
Independent Auditor's Report F-1
Consolidated Balance Sheets as of December 31, 1997 and 1996 F-2
Consolidated Statements of Operations for Years Ended
December 31, 1997, 1996 and 1995 F-4
Consolidated Statements of Stockholders' Equity for Years
Ended December 31, 1997, 1996 and 1995 F-5
Consolidated Statements of Cash Flows for Years Ended
December 31, 1997, 1996 and 1995 F-7
Notes to Consolidated Financial Statements F-9
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS,
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
The information required by Item 9 regarding the Company's directors
and executive officers is incorporated by reference to the Company's proxy
statement for its 1998 Annual Meeting of Shareholders under the captions
"Determination of Number and Election of Directors" and "Executive Officers of
the Company." The Company's proxy statement will be filed pursuant to Rule 14a-3
within 120 days after the close of the fiscal year for which this report is
filed.
The information relating to compliance with Section 16(a) of the
Exchange Act is incorporated by reference to the Company's proxy statement for
its 1998 Annual Meeting of Shareholders under the caption "Compliance With
Section 16(a) of the Exchange Act."
ITEM 10. EXECUTIVE COMPENSATION
The information required by Item 10 is incorporated by reference to the
Company's proxy statement for its 1998 Annual Meeting of Shareholders under the
caption "Executive Compensation."
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 11 is incorporated by reference to the
Company's proxy statement for its 1998 Annual Meeting of Shareholders under the
caption "Security Ownership of Management and Certain Beneficial Owners."
<PAGE>
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
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.
(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: March 26, 1998 DATAKEY, INC.
BY: /s/ Carl P. Boecher
Carl P. Boecher
Chief Executive Officer and Director
(Principal Executive Officer)
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:
POWER OF ATTORNEY
Each person whose signature appears below constitutes and appoints Carl
P. Boecher and Alan G. Shuler as his true and lawful attorneys-in-fact and
agents, each acting alone, with full power of substitution and resubstitution,
for him and in his name, place and stead, in any and all capacities, to sign any
or all amendments to this Annual Report on Form 10-KSB and to file the same,
with all exhibits thereto, and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorneys-in-fact and
agents, acting alone, full power and authority to do and perform each and every
act and thing requisite and necessary to be done in and about the premises, as
fully to all intents and purposes as he might or could do in person, hereby
ratifying and confirming said attorneys-in-fact and agents, acting alone, or his
substitute or substitutes, may lawfully do or cause to be done by virtue
thereof.
SIGNATURES TITLES DATE
/s/ Carl P. Boecher Chief Executive Officer and March 26, 1998
Carl P. Boecher Director (Principal Executive
Officer)
/s/ Alan G. Shuler Vice President and Chief March 26, 1998
Alan G. Shuler Financial Officer (Principal
Financial and Accounting Officer)
/s/ Thomas R. King Director and Secretary March 26, 1998
Thomas R. King
/s/ Terrence W. Glarner Director March 26, 1998
Terrence W. Glarner
/s/ Gary R. Holland Chairman of the Board of March 26, 1998
Gary R. Holland Directors
/s/ Eugene W. Courtney Director March 26, 1998
Eugene W. Courtney
/s/ John H. Underwood Director March 26, 1998
John H. Underwood
<PAGE>
INDEPENDENT AUDITOR'S REPORT
To the Stockholders
Datakey, Inc.
Burnsville, Minnesota
We have audited the accompanying consolidated balance sheets of Datakey, Inc.
and Subsidiary as of December 31, 1997 and 1996, and the related consolidated
statements of operations, stockholders' equity, and cash flows for each of the
three years in the period ended December 31, 1997. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Datakey, Inc. and
Subsidiary as of December 31, 1997 and 1996, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1997, in conformity with generally accepted accounting principles.
/S/ McGladrey & Pullen, LLP
McGLADREY & PULLEN, LLP
Minneapolis, Minnesota
February 3, 1998
<PAGE>
DATAKEY, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
December 31, 1997 and 1996
<TABLE>
<CAPTION>
ASSETS (Note 9) 1997 1996
---------- ----------
<S> <C> <C>
Current Assets
Cash and cash equivalents $1,305,392 $ 140,030
Investment in held-to-maturity securities (Note 2) -- 5,993,228
Trade receivables, less allowance for doubtful accounts of
$30,000 in 1997 and $45,000 in 1996 (Note 7) 634,267 634,538
Inventories (Note 3) 1,082,737 1,128,907
Prepaid expenses and other 53,360 46,962
---------- ----------
Total current assets 3,075,756 7,943,665
---------- ----------
Other Assets
Deferred taxes (Note 4) -- 325,000
Licenses and patents, less amortization--1997 $181,801;
1996 $105,531 (Note 8) 1,104,302 228,986
---------- ----------
1,104,302 553,986
---------- ----------
Equipment and Leasehold Improvements, at cost
Production tooling 1,215,012 1,179,021
Equipment 2,956,269 2,561,659
Furniture and fixtures 298,771 267,482
Leasehold improvements 281,956 234,452
---------- ----------
4,752,008 4,242,614
Less accumulated depreciation 3,278,760 2,840,909
---------- ----------
1,473,248 1,401,705
---------- ----------
$5,653,306 $9,899,356
========== ==========
</TABLE>
See Notes to Consolidated Financial Statements.
<PAGE>
<TABLE>
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY 1997 1996
----------- -----------
<S> <C> <C>
Current Liabilities
Accounts payable $ 184,103 $ 559,280
Accrued expenses:
Compensation 410,055 538,664
Other 91,774 108,885
License obligation (Note 8) 439,000 --
----------- -----------
Total current liabilities 1,124,932 1,206,829
----------- -----------
Commitments and Contingencies (Notes 5, 8, and 9)
Stockholders' Equity (Notes 5 and 6)
Convertible preferred stock, voting, stated value $2.50
per share; authorized 400,000 shares; issued and
outstanding 150,000 shares 375,000 375,000
Common stock, par value $0.05 per share; authorized
10,000,000 shares; issued and outstanding 2,887,235
shares in 1997 and 2,882,069 shares in 1996 144,361 144,103
Additional paid-in capital 4,089,283 4,070,815
Retained earnings (deficit) (80,270) 4,102,609
----------- -----------
4,528,374 8,692,527
----------- -----------
$ 5,653,306 $ 9,899,356
=========== ===========
</TABLE>
<PAGE>
DATAKEY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 1997, 1996, and 1995
<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
Net sales (Note 7) $ 5,977,464 $ 6,558,025 $ 7,219,308
------------ ------------ ------------
Costs and expenses:
Cost of goods sold 4,389,367 4,282,062 4,821,516
Research and development 3,185,894 2,262,920 703,816
Marketing and sales 1,716,343 1,311,663 1,123,781
General and administrative 713,308 1,156,270 669,954
------------ ------------ ------------
Total costs and expenses 10,004,912 9,012,915 7,319,067
------------ ------------ ------------
Operating loss (4,027,448) (2,454,890) (99,759)
Interest income 169,569 360,558 381,385
------------ ------------ ------------
Income (loss) before income taxes (3,857,879) (2,094,332) 281,626
Income tax expense (benefit) (Note 4) 325,000 (388,000) 106,000
------------ ------------ ------------
Net income (loss) $ (4,182,879) $ (1,706,332) $ 175,626
============ ============ ============
Basic and diluted income (loss) per share $ (1.45) $ (0.60) $ 0.06
============ ============ ============
</TABLE>
See Notes to Consolidated Financial Statements.
<PAGE>
DATAKEY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended December 31, 1997, 1996, and 1995
<TABLE>
<CAPTION>
Additional Retained
Convertible Preferred Stock Common Stock Paid-In Earnings
Shares Amount Shares Amount Capital (Deficit) Total
------- --------- --------- --------- ----------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1994 150,000 $ 375,000 2,829,570 $ 141,479 $ 3,865,631 $ 5,633,315 $ 10,015,425
Issuance of common stock
under stock options (Note 6) -- -- 5,666 283 20,256 -- 20,539
Net income -- -- -- -- -- 175,626 175,626
------- --------- --------- --------- ----------- ----------- ------------
Balance, December 31, 1995 150,000 375,000 2,835,236 141,762 3,885,887 5,808,941 10,211,590
Issuance of common stock
under stock options (Note 6) -- -- 46,833 2,341 184,928 -- 187,269
Net loss -- -- -- -- -- (1,706,332) (1,706,332)
------- --------- --------- --------- ----------- ----------- ------------
Balance, December 31, 1996 150,000 375,000 2,882,069 144,103 4,070,815 4,102,609 8,692,527
Issuance of common stock
under stock options (Note 6) -- -- 5,166 258 18,468 -- 18,726
Net loss -- -- -- -- -- (4,182,879) (4,182,879)
------- --------- --------- --------- ----------- ----------- ------------
Balance, December 31, 1997 150,000 $ 375,000 2,887,235 $ 144,361 $ 4,089,283 $ (80,270) $ 4,528,374
======= ========= ========= ========= =========== =========== ============
</TABLE>
See Notes to Consolidated Financial Statements.
<PAGE>
DATAKEY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 1997, 1996, and 1995
<TABLE>
<CAPTION>
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
Cash Flows From Operating Activities
Net income (loss) $(4,182,879) $(1,706,332) $ 175,626
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Depreciation 515,593 475,475 461,378
Amortization 127,723 134,041 133,253
Change in accrued interest on investment
securities 163,287 16,962 (44,399)
Deferred taxes 325,000 (374,000) 114,000
Changes in assets and liabilities:
Trade receivables 271 420,537 135,818
Inventories 46,170 94,031 126,047
Accounts payable (375,177) 49,597 (249,193)
Other (152,118) 400,734 85,049
----------- ----------- -----------
Net cash provided by (used in)
operating activities (3,532,130) (488,955) 937,579
----------- ----------- -----------
Cash Flows From Investing Activities
Purchase of equipment (587,136) (351,795) (262,892)
Purchase of held-to-maturity securities -- (5,829,941) (6,073,735)
Proceeds from maturity of held-to-maturity
securities 5,829,941 6,073,735 5,974,726
License and patent costs (234,789) (163,513) (55,526)
----------- ----------- -----------
Net cash provided by (used in)
investing activities 5,008,016 (271,514) (417,427)
----------- ----------- -----------
</TABLE>
(Continued)
<PAGE>
DATAKEY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) Years Ended December 31, 1997,
1996, and 1995
<TABLE>
<CAPTION>
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
Cash Flows From Financing Activities
Net proceeds from issuance of common stock 18,726 187,269 20,539
Payment on license obligation (329,250) -- --
Payments on noncompete obligation -- -- (82,500)
----------- ----------- -----------
Net cash provided by (used in)
financing activities (310,524) 187,269 (61,961)
----------- ----------- -----------
Increase (decrease) in cash and
cash equivalents 1,165,362 (573,200) 458,191
Cash and Cash Equivalents
Beginning 140,030 713,230 255,039
----------- ----------- -----------
Ending $ 1,305,392 $ 140,030 $ 713,230
=========== =========== ===========
Supplemental Disclosures of Cash Flow Information
Net cash refunds of income taxes $ -- $ 75,112 $ 63,038
=========== =========== ===========
Supplemental Schedule of Noncash Investing and
Financing Activity
License obligation to licensor (Note 8) $ 768,250 $ -- $ --
=========== =========== ===========
</TABLE>
See Notes to Consolidated Financial Statements.
<PAGE>
Note 1. Nature of Business and Significant Accounting Policies
Nature of business: Datakey, Inc. is an international supplier of electronic
products and services. The Company designs, manufactures, and markets products,
subsystems, and systems solutions to record, store, and transmit electronic
information. The Company is developing products and systems directed to the
information security market which will enable user identification and
authentication, secure data exchange, and information validation. The Company
also provides OEM products, consisting of proprietary memory keys, cards, and
other custom-shaped tokens, that serve as a convenient way to carry electronic
information and are packaged to survive in portable environments. The Company's
practice is to grant credit on an unsecured basis to customers who meet certain
financial criteria.
A summary of significant accounting policies follows:
Principles of consolidation: The consolidated financial statements include the
accounts of Datakey, Inc. and its wholly-owned subsidiary. All significant
intercompany accounts and transactions have been eliminated in consolidation.
Use of estimates: The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Cash and cash equivalents: For purposes of reporting the statements of cash
flows, the Company includes all cash accounts and all highly liquid debt
instruments purchased with an original maturity of three months or less as cash
and cash equivalents on the accompanying consolidated balance sheets.
The Company maintains its cash in bank deposit accounts which, at times, may
exceed federally insured limits. The Company has not experienced any losses in
such accounts.
Fair value of financial instruments: The Company's financial instruments consist
of cash and cash equivalents and short-term trade receivables and payables for
which current carrying amounts approximate fair market value.
Inventories: Inventories are stated at the lower of cost (first-in, first-out
method) or market.
Licenses and patents: Licenses and patents are stated at cost. Patents are being
amortized using the straight-line method over their economic useful lives which
has been estimated to be five years. The cost of the license agreements are
amortized to cost of goods sold as the products incorporating the licensed units
are sold (Note 8).
The Company periodically reviews the utilization of its licenses, patents, and
long-lived assets for impairment. To date, management has determined that no
impairment in the value of these assets has occurred.
<PAGE>
Note 1. Nature of Business and Significant Accounting Policies
(Continued)
Depreciation: Depreciation of equipment and leasehold improvements is computed
on the straight-line and accelerated methods over the following estimated useful
lives:
Years
Production tooling 2-5
Equipment 5-7
Furniture and fixtures 7
Leasehold improvements Life of lease
Warranty costs: The Company provides for estimated normal warranty costs at the
time of product sales to the customers and for other costs associated with
specific items at the time their existence and amounts are determinable.
Income taxes: Deferred taxes are provided on a liability method whereby deferred
tax assets are recognized for deductible temporary differences and operating
loss or tax credit carryforwards, and deferred tax liabilities are recognized
for taxable temporary differences. Temporary differences are the differences
between the amounts of assets and liabilities recorded for income tax and
financial reporting purposes. Deferred tax assets are reduced by a valuation
allowance when management determines that it is more likely than not that some
portion or all of the deferred tax assets will not be realized. Deferred tax
assets and liabilities are adjusted for the effects of changes in tax laws and
rates on the date of enactment.
Revenue recognition: The Company records sales revenue upon shipment to the
customer.
Research and development: Research and development costs are charged to expense
as incurred.
Advertising: Expenditures for advertising costs are expensed as
incurred.
Earnings (loss) per share: The Financial Accounting Standards Board has issued
Statement No. 128, Earnings Per Share, which supersedes APB Opinion No. 15.
Statement No. 128 requires the presentation of earnings per share by all
entities that have common stock or potential common stock, such as options,
warrants, and convertible securities, outstanding that trade in a public market.
Those entities that have only common stock outstanding are required to present
basic earnings per share amounts. Basic per share amounts are computed by
dividing net income (loss) (the numerator) by the weighted-average number of
common shares outstanding (the denominator). All other entities are required to
present basic and diluted per share amounts. Diluted per share amounts assume
the conversion, exercise, or issuance of all potential common stock instruments
unless the effect is to reduce the loss or increase the income per common share
from continuing operations.
The Company initially applied Statement No. 128 for the year ended December 31,
1997, and, as required by the statement, has restated all per share information
for the prior years to conform to the statement.
<PAGE>
Note 1. Nature of Business and Significant Accounting Policies
(Continued)
Following is information about the computation of the earnings per share data
for the years ended December 31, 1997, 1996, and 1995:
Numerator Denominator Net Income
(Loss)
Per Share
Year ended December 31, 1997:
Basic and diluted loss per share, loss
available to common stockholders $(4,182,879) 2,886,924 $ (1.45)
============ ========= =========
Year ended December 31, 1996:
Basic and diluted loss per share, loss
available to common stockholders $(1,706,332) 2,861,498 $ (0.60)
============ ========= =========
Year ended December 31, 1995:
Basic income per share, income available
to common stockholders $ 175,626 2,829,885 $ 0.06
=========
Effect of dilutive securities:
Convertible preferred stock -- 150,000
Stock options -- 65,289
------------ ---------
Dilutive income per share, income
available to common stockholders plus
assumed exercise of options $ 175,626 3,045,174 $ 0.06
============ ========= =========
The Company had outstanding options to purchase 701,333 and 517,167 shares of
common stock at an average price of $3.84 and $4.37 per share during the years
ended December 31, 1997 and 1996, respectively. The Company also has 150,000
shares of convertible preferred stock outstanding. Those options and the
preferred stock were not included in the computation of diluted loss per share
in 1997 and 1996 as they would be antidilutive.
Of the 452,334 options outstanding at December 31, 1995, a total of 125,000
options to purchase common stock at an average price of $5.60 per share were not
included in the computation of diluted income per share because the exercise
price of those options exceeded the average market price of the common shares in
1995.
Note 2. Investment in Held-to-Maturity Securities
The following is a summary of the Company's investment in held-to-maturity
securities as of December 31, 1996:
Gross Gross
Amortized Unrealized Unrealized
Cost Gains Losses Fair Value
U. S. government securities $5,993,228 $ 465 $ 6,445 $5,987,248
All securities matured in 1997.
<PAGE>
Note 3. Inventories
Inventories consist of the following components as of December 31, 1997 and
1996:
1997 1996
---------- ----------
Raw materials $ 766,955 $ 754,629
Work in process 63,007 87,453
Finished goods 252,775 286,825
---------- ----------
$1,082,737 $1,128,907
========== ==========
Note 4. Income Taxes
The income tax expense (benefit) consists of the following:
December 31
1997 1996 1995
--------- --------- ---------
Currently payable (refundable):
Federal $ -- $ (15,000) $ (9,000)
State -- 1,000 1,000
Deferred 325,000 (374,000) 114,000
--------- --------- ---------
$ 325,000 $(388,000) $ 106,000
========= ========= =========
The income tax expense (benefit) is different from that which would be computed
by applying the U. S. federal income tax rate (35 percent) to pretax income
(loss) as follows:
<TABLE>
<CAPTION>
December 31
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
Computed "expected" federal tax expense
(benefit) at statutory rates $(1,350,000) $ (733,000) $ 99,000
Effect of graduated tax rates -- 21,000 (3,000)
Effect of net operating loss carryforward, with
no current benefit 1,350,000 338,000 --
State income taxes, net of federal benefit -- 1,000 1,000
Change in valuation allowance 325,000 -- --
Other -- (15,000) 9,000
----------- ----------- -----------
Actual tax expense (benefit) $ 325,000 $ (388,000) $ 106,000
=========== =========== ===========
</TABLE>
<PAGE>
Note 4. Income Taxes (Continued)
Net deferred tax assets (liabilities) consist of the following components as of
December 31, 1997 and 1996:
1997 1996
----------- -----------
Deferred tax assets:
Allowance for doubtful accounts $ 11,000 $ 16,000
Inventory 239,000 86,000
Warranty reserve 18,000 18,000
Compensation and benefits 89,000 134,000
Net operating loss carryforward 1,940,000 698,000
Research and development tax credit 68,000 --
----------- -----------
Total gross deferred tax assets 2,365,000 952,000
Valuation allowance (2,206,000) (455,000)
----------- -----------
Net deferred tax assets 159,000 497,000
Deferred tax liability:
Depreciation (159,000) (172,000)
----------- -----------
Net deferred tax asset $ -- $ 325,000
=========== ===========
Realization of deferred tax assets is dependent upon the generation of
sufficient future taxable income. At December 31, 1996, the Company had
established a valuation allowance against a portion of the net deferred tax
assets in recognition of the risk that part of the loss carryforward may not be
realized. During 1997, management determined that sufficient uncertainty exists
regarding the realizability of the deferred tax assets, and accordingly, the
Company increased the valuation allowance to entirely reserve the net deferred
tax asset of the Company.
At December 31, 1997, the Company's net operating loss carryforward is
approximately $5,390,000 and expires as follows:
2011 $ 1,850,000
2012 3,540,000
Note 5. Preferred Stock
The preferred shares are convertible at the rate of one share of common stock
for each share of preferred stock, subject to certain antidilution adjustments.
Conversion is mandatory in the event of certain future public offerings of
corporate stock. The holders of the preferred stock have certain piggyback and
demand registration rights, have a liquidation preference of $2.50 per share,
and share in dividends paid on common stock.
<PAGE>
Note 6. Stock Options
The Company has reserved 800,000 common shares for issuance under qualified and
nonqualified stock options for its key employees and directors. The Company has
also reserved 50,000 common shares for issuance under nonqualified options to
various distributors, dealers, and consultants. Option prices are the fair
market value of the stock at the time the option was granted. Options become
exercisable as determined at the date of grant by a committee of the Board of
Directors. Options expire ten years after the date of grant unless an earlier
expiration date is set at the time of grant.
The Company has adopted the disclosure-only provisions of Statement of Financial
Accounting Standards No. 123, Accounting for Stock-Based Compensation.
Accordingly, no compensation cost has been recognized for the stock option
plans. Had compensation cost for the Company's stock option plans been
determined based on the fair value at the grant date for awards in 1997, 1996,
and 1995 consistent with the provisions of SFAS No. 123, the Company's net
income (loss) and basic and diluted income (loss) per share would have changed
to the pro forma amounts indicated below:
Years Ended December 31
1997 1996 1995
Net income (loss), as reported $ (4,182,879) $ (1,706,332) $ 175,626
Net income (loss), pro forma (4,391,620) (1,844,604) 112,348
Basic and diluted income (loss), per
share, as reported (1.45) (0.60) 0.06
Basic and diluted income (loss), per
share, pro forma (1.52) (0.64) 0.04
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in 1997, 1996, and 1995:
Years Ended December 31
1997 1996 1995
Expected dividend yield -- -- --
Expected stock price volatility 53.26% 48.39% 32.76%
Risk-free interest rate 6.17% 5.87% 6.71%
Expected life of options 3.6 years 3 years 3 years
Weighted-average fair value of options
granted during the year $ 1.39 $ 1.29 $ 1.15
The pro forma effect on net loss or net income in 1997, 1996, and 1995 is not
representative of the pro forma effect in future years because it does not take
into consideration pro forma compensation expense related to grants made prior
to 1995.
<PAGE>
Note 6. Stock Options (Continued)
Additional information relating to all outstanding options as of December 31,
1997, 1996, and 1995 is as follows:
<TABLE>
<CAPTION>
1997 1996 1995
------------------ ------------------ -------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------- ------- ------- ------- ------- --------
<S> <C> <C> <C> <C> <C> <C>
Options outstanding at
beginning of year 517,167 $ 4.37 452,334 $ 4.16 179,000 $ 5.17
Options exercised (5,166) 3.62 (46,833) 4.00 (5,666) 3.63
Options expired (80,668) 4.81 (27,334) 3.73 (33,000) 4.66
Options granted 270,000 3.12 139,000 4.80 312,000 3.62
------- ------- ------- ------- ------- --------
Options outstanding at
end of year 701,333 $ 3.84 517,167 $ 4.37 452,334 $ 4.16
======= ======= ======= ======= ======= ========
</TABLE>
The following table summarizes information about stock options outstanding at
December 31, 1997:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
-------------------------- ----------------------------
Weighted-
Average
Number Remaining Weighted- Number Weighted-
Range of Outstanding Contractual Average Exercisable Average
Exercise at December 31, Life Exercise at December 31, Exercise
Prices 1997 (Years) Price 1997 Price
- ------------- --------------- ----------- --------- --------------- ---------
<S> <C> <C> <C> <C> <C>
$2.25 - $3.38 187,500 9.5 $ 2.77 35,000 $ 2.88
$3.50 - $5.00 383,833 8.5 3.69 214,333 3.65
$5.38 - $8.00 130,000 5.5 5.84 130,000 5.84
- ------------- --------------- ----------- --------- --------------- ---------
$2.25 - $8.00 701,333 8.2 $ 3.84 379,333 $ 4.33
============= =============== =========== ========= =============== =========
</TABLE>
Note 7. Major Customers and International Sales
Major customers: Net sales for 1997, 1996, and 1995 include sales to the
following major customers:
<TABLE>
<CAPTION>
Amount of Net Sales Trade Receivables Balance
------------------------------------ -----------------------
1997 1996 1995 1997 1996
---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
U.S. government agencies $1,198,000 $ 889,000 $ 993,000 $ 70,000 $ 103,000
Customer A 616,000 1,161,000 2,158,000 1,000 104,000
Customer B -- 376,000 563,000 -- --
Customer C 638,000 471,000 530,000 95,000 14,000
---------- ---------- ---------- ---------- ----------
$2,452,000 $2,897,000 $4,244,000 $ 166,000 $ 221,000
========== ========== ========== ========== ==========
</TABLE>
International sales: Export sales to international customers for 1997, 1996, and
1995 were $1,800,000, $1,906,000, and $1,907,000, respectively.
<PAGE>
Note 8. Commitments and Contingencies
License agreement: In December 1996, the Company entered into a license
agreement with a software company to allow the Company to bundle the licensed
products into certain of the Company's products. Under the agreement, payments
to the software company for the licensed products are based upon the number of
units sold and the nature of the software bundled. In addition, the Company
agreed to purchase a minimum quantity of software units over a specified period
of time. The value of the minimum purchase is included in the initial license
agreement.
At December 31, 1996, the Company had paid $109,750 as the first payment for the
license agreement, with an additional $768,250 to be paid in seven quarterly
installments pending the successful delivery of a beta version of the licensed
product from the software company in 1997. Upon delivery of the product in 1997,
the Company recorded an additional liability of $768,250 and a corresponding
asset for prepaid license fees. Subsequently, the software company announced
that certain of the licensed software would be available at no cost to the
general public. As a result of this announcement, the Company has suspended
payments, with $439,000 remaining under the original agreement, and the Company
is seeking to renegotiate the agreement to reduce or eliminate the remaining
liability. Upon completion of any contract amendment, the prepaid license fee
and corresponding liability would be adjusted to reflect the new agreement.
Leases: The Company leases its office and warehouse facilities under
noncancelable operating leases which expire in May and June 1999. Minimum annual
cash commitments under this lease are approximately $156,000 and $75,000 for
1998 and 1999, respectively. Total rent expense under these leases totaled
$136,000 in 1997 and $97,000 in 1996 and 1995.
Note 9. Subsequent Event
In January 1998, the Company obtained a $1,000,000 line of credit from a bank
which bears interest at 1.25 percent above the prime rate and is secured by
substantially all assets of the Company. The line of credit expires in May 1998
and is subject to annual renewal.
<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)*
<PAGE>
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.
EMPLOYMENT AGREEMENT
This Employment Agreement made and entered into effective as of the
16th day of April 1997, by and between Datakey, Inc., a Minnesota corporation
(the "Company" or "Datakey") and Michael L. Sorensen ("Executive").
RECITALS
Michael L. Sorensen became the Vice President of Operations as of the
date hereof. The Company and the Executive are desirous that the Executive
serves the Company in this capacity under the following terms and conditions.
AGREEMENT
1. Employment
a. Datakey agrees to continue to employ Executive on a full-time basis
as the Vice President of Operations of Datakey.
b. Executive agrees that he will, at all times, faithfully,
industriously, and, to the best of his abilities, experience and talents,
continue to perform all the duties and responsibilities that may be required of
him as an officer of Datakey.
2. Term of Employment
a. Subject to the terms and conditions hereof, Executive shall be
employed for a term ("Employment Term") commencing on April 16, 1997 and
terminating on April 15, 1998, unless extended as set forth in Subsection 2b
below.
b. This Agreement will be renewed automatically after April 15, 1998
for additional one-year periods unless either party gives the other party
written notice 30 days before April 15, 1998 or 30 days before the end of any
one-year period thereafter of his or its intention to terminate the Agreement.
3. Base Monthly Compensation
As compensation for his services to Datakey, Executive shall be paid a
monthly salary of $7,500, payable in accordance with Datakey's periodic payment
periods.
<PAGE>
4. Bonus
Executive shall be eligible to participate in both the Annual Incentive
Plan (AIP) and the Long-Term Incentive Plan or any other approved bonus plan.
5. Other Benefits
a. Vacation. Executive will receive four weeks of vacation for every
twelve months of employment. Unused vacation may not be carried over from one
year to the next.
b. Automobile Allowance. During the term of this Agreement, Datakey
will pay Executive $400 per month to be applied toward his automobile expenses.
c. Miscellaneous. During the term of this Agreement, Executive will be
eligible to receive the other benefits described in the attached Exhibit A,
subject to such changes as Datakey may adopt from time to time for salaried
employees generally.
6. Termination
a. Notwithstanding Section 2 above, the Employment Term or any
extension thereof shall terminate upon the happening of any of the following
events:
(i) Mutual written agreement between the Board of
Directors of Datakey and Executive to terminate his
employment;
(ii) Executive's death;
(iii) Executive's disability defined as physically or
mentally unable to perform as Vice President of
Engineering for a period of six consecutive months;
or
(iv) For cause (as defined below) upon written notice from
the Board of Directors specifying the nature of the
cause.
b. For purposes of this Agreement, "cause" shall include commission of
any felony, misdemeanor, any act of fraud or dishonesty in connection with the
affairs of Datakey.
7. Payment Upon Termination of Employment for Cause or Voluntary
Resignation
If Executive is terminated for cause or voluntarily resigns, Executive
shall not be eligible to receive any severance benefits. The date of termination
under this Section 7 shall be on the day the notice of termination for cause is
given or 30 days from the date the notice of resignation is given. Executive
shall be entitled to no additional compensation past the date of a notice of
termination for cause or after 30 days from the notice of resignation.
<PAGE>
8. Payment Upon Termination of Employment Without Cause
a. If during the term of this Agreement Executive is terminated without
cause, and without cause shall include death, disability or mutual agreement,
Executive shall not be entitled to receive his agreed compensation for the
balance of the term of this Agreement but shall instead receive a severance
payment equal to his base monthly compensation payable for six months in
accordance with Datakey's payment periods beginning on the 10th day of the first
month following the last month of his employment term.
b. Base compensation shall be deemed to be no less than $7,500.00 per
month.
c. The payments provided for under this Section 8 shall, in the event
of Executive's death, continue and shall be payable to his wife if she survives
or, if not, to his estate.
d. The Company will continue to provide medical and health coverage,
under its plans as they currently exist or may hereafter be amended, at Company
subsidized rates during the six-month severance pay period. Thereafter,
Executive and his covered dependents will be entitled to elect to continue
coverage under COBRA to the extent it is available. Coverage by the Company or
under COBRA will end on the earlier of Executive's obtaining new employment,
which gives him the ability to provide medical and health insurance coverage for
himself and his family through his new employer, or the failure to pay any
premium when due.
9. Payment Upon Termination of Agreement by the Company on April 15, 1998
or at the End of Any One-Year Extension
a. If the Company decides to terminate the Employment Agreement on
April 15, 1998 or as of the end of any one-year extension, Executive shall
receive his base monthly compensation for six (6) months beginning on the 10th
of the first month following the last month of the Employment Term in accordance
with Datakey's payment periods.
b. The payments provided for under this Section 9 shall, in the event
of Executive's death, continue and shall be payable to his wife if she survives
or, if not, to his estate.
c. The Company will continue to provide medical and health coverage,
under its plans as they currently exist or may hereafter be amended, at Company
subsidized rates during the six-month severance pay period. Thereafter,
Executive and his covered dependents will be entitled to elect to continue
coverage under COBRA to the extent it is available. Coverage by the Company or
under COBRA will end on the earlier of Executive's obtaining new employment,
which gives him the ability to provide medical and health insurance coverage for
himself and his family through his new employer, or the failure to pay any
premium when due.
<PAGE>
10. Termination of Employment or Resignation Within Six Months of a Change
in Control
a. If Employee's employment is terminated within six months of a Change
of Control, or if Employee resigns within six months of a Change of Control
because of a diminution of either position responsibilities or remuneration,
notwithstanding such termination or resignation, Employee shall receive his base
monthly compensation for a period of six months. The severance payments shall be
made in six monthly installments beginning on the 10th day of the first month
following Employee's termination or resignation in accordance with the Company's
payroll periods.
b. A Change in Control shall be deemed to have occurred if: (a) any
person or entity becomes the beneficial owner of thirty-five percent (35%) or
more of the Company's outstanding securities other than any institution,
individual, individuals acting in concert, or entity owning thirty-five percent
(35%) or more of the Company's outstanding securities as of the date of this
Agreement; (b) the consummation of a merger or consolidation of the Company into
or with any other corporation; (c) the consummation of a plan of complete
liquidation of the Company; or (d) the consummation of the sale of substantially
all of the Company's assets.
c. The payments provided for under this Section 10 shall, in the event
of Employee's death, continue and be payable to his wife if she survives or, if
not, to his estate.
11. Nondisclosure
Except by written permission from Datakey, Executive shall never
disclose or use any trade secrets, sales projections, formulations, customer
lists or information, product specifications or information, credit information,
production know-how, research and development plans or other information not
generally known to the public ("Confidential Information") acquired or learned
by Executive during the course, and on account, of his employment, whether or
not developed by Executive, except as such disclosure or use may be required by
his duties to Datakey, and then only in strict accordance with his obligations
of service and loyalty thereto. Upon termination of employment, Executive agrees
to deliver to Datakey all Confidential Information.
12. Inventions
Any invention, discovery, improvement, or idea, whether patentable or
copyrightable or not, and whether or not shown or described in writing or
reduced to practice ("Invention") shall be promptly and fully disclosed by
Executive to the Company, and the Company will hold in trust for its sole right
and benefit, any Invention that Executive, during the period of employment, and
for one year thereafter, make, conceive, or reduce to practice or cause to be
made, conceived, or reduced to practice, either alone or in conjunction with
others, that:
a. Relates to any subject matter pertaining to Executive's
employment with the Company;
<PAGE>
b. Relates to or is directly or indirectly connected with the
Company's business, products, projects, or Confidential Information; or
c. Involves the use of any time, material, or facility of the
Company's.
Executive hereby assigns to the Company all of his right, title, and interest in
and to all such Inventions and, upon the Company's request, shall execute,
verify, and deliver to the Company such documents including, without limitation,
assignments and applications for Letters Patent, and shall perform such other
acts, including, without limitation, appearing as a witness in any action
brought in connection with this Employment Agreement that is necessary to enable
the Company to obtain the sole right, title, and benefit to all such Inventions.
13. Specific Performance
Executive acknowledges that a breach of this Employment Agreement would
cause Datakey irreparable injury and damage which could not be remedied or
adequately compensated by damages at law; therefore, Executive expressly agrees
that Datakey shall be entitled, in addition to any other remedies legally
available, to injunctive and/or other equitable relief to prevent a breach of
this Employment Agreement.
14. Noncompetition
a. For a period of six months from and after the end of the Employment
Term or any extension thereof or after termination of employment, Executive will
not, directly or indirectly, alone or in any capacity with another legal entity,
(i) engage in any activity that competes in any respect with Datakey, (ii)
contact or in any way interfere or attempt to interfere with the relationship of
Datakey with any current or potential customers of Datakey, or (iii) employ or
attempt to employ any employee of Datakey (other than a former employee thereof
after such employee has terminated employment with the Datakey), and
b. Executive acknowledges that Datakey markets products throughout the
United States and that Datakey would be harmed if Executive conducted any of the
activities described in this Section 14 anywhere in the United States.
Therefore, Executive agrees that the covenants contained in this Section 14
shall apply to all portions of, and throughout, the United States.
c. Executive acknowledges that if he fails to fulfill his obligations
under this Section 14, the damages to Datakey would be very difficult to
determine. Therefore, in addition to any other rights or remedies available to
Datakey at law, in equity, or by statute, Executive hereby consents to the
specific enforcement of the provisions of this Section 14 by Datakey through an
injunction or restraining order issued by the appropriate court.
<PAGE>
d. To the extent any provision of this Section 14 shall be invalid or
unenforceable, it shall be considered deleted herefrom and the remainder of such
provision and this Section 14 shall be unaffected and shall continue in full
force and effect. In furtherance to and not in limitation of the foregoing,
should the duration or geographical extent of, or business activities covered
by, any provision of this Section 14 be in excess of that which is valid and
enforceable under applicable law, then such provision shall be construed to
cover only that duration, extent or activities which are validly and enforceably
covered. Executive acknowledges the uncertainty of the law in this respect and
expressly stipulates that this Section 14 be given the construction which
renders its provisions valid and enforceable to the maximum extent (not
exceeding its expressed terms) possible under applicable laws.
15. Miscellaneous
a. Waiver by Datakey of a breach of any provision of this Agreement by
Executive shall not operate or be construed as a waiver of any subsequent breach
by Executive.
b. This Agreement shall be binding upon and inure to the benefit of
Datakey, its successors and assigns, and as to Executive, his heirs, personal
representatives, estate, legatees, and assigns.
c. This Agreement constitutes the entire agreement between the parties
hereto with respect to the subject matter hereof and supersedes all prior
agreements whether written or oral relating hereto.
d. This Agreement shall be governed by and construed under the laws of
the State of Minnesota.
IN WITNESS WHEREOF, the parties have hereto executed this Employment
Agreement effective as of the day and year first above written.
DATAKEY, INC.
By
Carl P. Boecher, President
Michael L. Sorensen, Executive
<PAGE>
EXHIBIT A
TO
EMPLOYMENT AGREEMENT DATED APRIL 16, 1997
EXECUTIVE BENEFITS
- -- Group health, dental, life and disability insurance, 401K plan, 125
plan and other benefits as provided to all employees
- -- Supplemental life insurance in the amount of $200,000 paid 100% by the
Company
- -- Supplemental long-term disability insurance paying $4,000 per month
paid 90% by the Company
- -- Auto allowance of $400 per month
- -- Four weeks of annual vacation, unused vacation cannot be carried over
- -- Sick leave as needed, up to 90 days at the discretion of the CEO
DATAKEY, INC.
1997 STOCK OPTION PLAN
SECTION 1.
DEFINITIONS
As used herein, the following terms shall have the meanings indicated
below:
(a) "Committee" shall mean a Committee of two or more directors who
shall be appointed by and serve at the pleasure of the Board. As long
as the Company's securities are registered pursuant to Section 12 of
the Securities Exchange Act of 1934, as amended, then, to the extent
necessary for compliance with Rule 16b-3, or any successor provision,
each of the members of the Committee shall be a "Non-Employee
Director." For purposes of this Section 1(a) "Non-Employee Director"
shall have the same meaning as set forth in Rule 16b-3, or any
successor provision, as then in effect, of the General Rules and
Regulations under the Securities Exchange Act of 1934, as amended.
(b) The "Company" shall mean Datakey, Inc., a Minnesota corporation.
(c) "Fair Market Value" shall mean (i) if such stock is reported by the
Nasdaq National Market or Nasdaq SmallCap Market or is listed upon an
established stock exchange or exchanges, the reported closing price of
such stock by the Nasdaq National Market or Nasdaq SmallCap Market or
on such stock exchange or exchanges on the date the option is granted
or, if no sale of such stock shall have occurred on that date, on the
next preceding day on which there was a sale of stock; (ii) if such
stock is not so reported by the Nasdaq National Market or Nasdaq
SmallCap Market or listed upon an established stock exchange, the
average of the closing "bid" and "asked" prices quoted by the National
Quotation Bureau, Inc. (or any comparable reporting service) on the
date the option is granted, or if there are no quoted "bid" and "asked"
prices on such date, on the next preceding date for which there are
such quotes; or (iii) if such stock is not publicly traded as of the
date the option is granted, the per share value as determined by the
Board, or the Committee, in its sole discretion by applying principles
of valuation with respect to all such options.
(d) The "Internal Revenue Code" is the Internal Revenue Code of 1986,
as amended from time to time.
(e) "Non-Employee Director" shall mean members of the Board who are not
employees of the Company or any subsidiary.
(f) "Option Stock" shall mean Common Stock of the Company (subject to
adjustment as described in Section 13) reserved for options pursuant to
this Plan.
<PAGE>
(g) The "Optionee" means an employee of the Company or any Subsidiary
to whom an incentive stock option has been granted pursuant to Section
9; a consultant or advisor to or director (including a Non-Employee
Director), employee or officer of the Company or any Subsidiary to whom
a nonqualified stock option has been granted pursuant to Section 10; or
a Non-Employee Director to whom a nonqualified stock option has been
granted pursuant to Section 11.
(h) "Parent" shall mean any corporation which owns, directly or
indirectly in an unbroken chain, fifty percent (50%) or more of the
total voting power of the Company's outstanding stock.
(i) The "Plan" means the Datakey, Inc. 1997 Stock Option Plan, as
amended hereafter from time to time, including the form of Option
Agreements as they may be modified by the Board from time to time.
(j) A "Subsidiary" shall mean any corporation of which fifty percent
(50%) or more of the total voting power of outstanding stock is owned,
directly or indirectly in an unbroken chain, by the Company.
SECTION 2.
PURPOSE
The purpose of the Plan is to promote the success of the Company and
its Subsidiaries by facilitating the retention of competent personnel and by
furnishing incentive to officers, directors, employees, consultants, and
advisors upon whose efforts the success of the Company and its Subsidiaries will
depend to a large degree.
It is the intention of the Company to carry out the Plan through the
granting of stock options which will qualify as "incentive stock options" under
the provisions of Section 422 of the Internal Revenue Code, or any successor
provision, pursuant to Section 9 of this Plan, and through the granting of
"nonqualified stock options" pursuant to Sections 10 and 11 of this Plan.
Adoption of this Plan shall be and is expressly subject to the condition of
approval by the shareholders of the Company within twelve (12) months before or
after the adoption of the Plan by the Board of Directors. Any incentive stock
options granted after adoption of the Plan by the Board of Directors shall be
treated as nonqualified stock options if shareholder approval is not obtained
within such twelve-month period.
SECTION 3.
EFFECTIVE DATE OF PLAN
The Plan shall be effective as of the date of adoption by the Board of
Directors, subject to approval by the shareholders of the Company as required in
Section 2.
<PAGE>
SECTION 4.
ADMINISTRATION
The Plan shall be administered by the Board of Directors of the Company
(hereinafter referred to as the "Board") or by a Committee which may be
appointed by the Board from time to time (collectively referred to as the
"Administrator"). The Administrator shall have all of the powers vested in it
under the provisions of the Plan, including but not limited to exclusive
authority (where applicable and within the limitations described herein) to
determine, in its sole discretion, whether an incentive stock option or
nonqualified stock option shall be granted, the individuals to whom, and the
time or times at which, options shall be granted, the number of shares subject
to each option and the option price and terms and conditions of each option. The
Administrator shall have full power and authority to administer and interpret
the Plan, to make and amend rules, regulations and guidelines for administering
the Plan, to prescribe the form and conditions of the respective stock option
agreements (which may vary from Optionee to Optionee) evidencing each option and
to make all other determinations necessary or advisable for the administration
of the Plan. The Administrator's interpretation of the Plan, and all actions
taken and determinations made by the Administrator pursuant to the power vested
in it hereunder, shall be conclusive and binding on all parties concerned.
No member of the Board or the Committee shall be liable for any action
taken or determination made in good faith in connection with the administration
of the Plan. In the event the Board appoints a Committee as provided hereunder,
any action of the Committee with respect to the administration of the Plan shall
be taken pursuant to a majority vote of the Committee members or pursuant to the
written resolution of all Committee members.
SECTION 5.
PARTICIPANTS
The Administrator shall from time to time, at its discretion and
without approval of the shareholders, designate those employees, officers,
directors (including Non-Employee Directors), consultants, and advisors of the
Company or of any Subsidiary to whom nonqualified stock options shall be granted
under this Plan; provided, however, that consultants or advisors shall not be
eligible to receive stock options hereunder unless such consultant or advisor
renders bona fide services to the Company or Subsidiary and such services are
not in connection with the offer or sale of securities in a capital raising
transaction; and, provided further, that Non-Employee Directors will be granted
options pursuant to Section 11 hereof without further action by the
Administrator. The Administrator shall, from time to time, at its discretion and
without approval of the shareholders, designate those employees of the Company
or any Subsidiary to whom incentive stock options shall be granted under this
Plan. The Administrator may grant additional incentive stock options or
nonqualified stock options under this Plan to some or all participants then
holding options or may grant options solely or partially to new participants. In
designating participants, the Administrator shall also determine the number of
shares to be optioned to each such participant. The Board may from time to time
designate individuals as being ineligible to participate in the Plan.
<PAGE>
SECTION 6.
STOCK
The Stock to be optioned under this Plan shall consist of authorized
but unissued shares of Option Stock. Five Hundred Thousand (500,000) shares of
Option Stock shall be reserved and available for options under the Plan;
provided, however, that the total number of shares of Option Stock reserved for
options under this Plan shall be subject to adjustment as provided in Section 13
of the Plan. In the event that any outstanding option under the Plan for any
reason expires or is terminated prior to the exercise thereof, the shares of
Option Stock allocable to the unexercised portion of such option shall continue
to be reserved for options under the Plan and may be optioned hereunder.
SECTION 7.
DURATION OF PLAN
Incentive stock options may be granted pursuant to the Plan from time
to time during a period of ten (10) years from the effective date as defined in
Section 3. Nonqualified stock options may be granted pursuant to the Plan from
time to time after the effective date of the Plan and until the Plan is
discontinued or terminated by the Board. Any incentive stock option granted
during such ten-year period and any nonqualified stock option granted prior to
the termination of the Plan by the Board shall remain in full force and effect
until the expiration of the option as specified in the written stock option
agreement and shall remain subject to the terms and conditions of this Plan.
SECTION 8.
PAYMENT
Optionees may pay for shares upon exercise of options granted pursuant
to this Plan with cash, personal check, certified check or, if approved by the
Administrator in its sole discretion, Common Stock of the Company valued at such
Stock's then Fair Market Value, or such other form of payment as may be
authorized by the Administrator. The Administrator may, in its sole discretion,
limit the forms of payment available to the Optionee and may exercise such
discretion any time prior to the termination of the option granted to the
Optionee or upon any exercise of the option by the Optionee.
With respect to payment in the form of Common Stock of the Company, the
Administrator may require advance approval or adopt such rules as it deems
necessary to assure compliance with Rule 16b-3, or any successor provision, as
then in effect, of the General Rules and Regulations under the Securities
Exchange Act of 1934, if applicable.
<PAGE>
SECTION 9.
TERMS AND CONDITIONS OF INCENTIVE STOCK OPTIONS
Each incentive stock option granted pursuant to this Section 9 shall be
evidenced by a written stock option agreement (the "Option Agreement"). The
Option Agreement shall be in such form as may be approved from time to time by
the Administrator and may vary from Optionee to Optionee; provided, however,
that each Optionee and each Option Agreement shall comply with and be subject to
the following terms and conditions:
(a) Number of Shares and Option Price. The Option Agreement shall state
the total number of shares covered by the incentive stock option. To
the extent required to qualify the Option as an incentive stock option
under Section 422 of the Internal Revenue Code, or any successor
provision, the option price per share shall not be less than one
hundred percent (100%) of the Fair Market Value of the Common Stock per
share on the date the Administrator grants the option; provided,
however, that if an Optionee owns stock possessing more than ten
percent (10%) of the total combined voting power of all classes of
stock of the Company or of its Parent or any Subsidiary, the option
price per share of an incentive stock option granted to such Optionee
shall not be less than one hundred ten percent (110%) of the Fair
Market Value of the Common Stock per share on the date of the grant of
the option. The Administrator shall have full authority and discretion
in establishing the option price and shall be fully protected in so
doing.
(b) Term and Exercisability of Incentive Stock Option. The term during
which any incentive stock option granted under the Plan may be
exercised shall be established in each case by the Administrator. To
the extent required to qualify the Option as an incentive stock option
under Section 422 of the Internal Revenue Code, or any successor
provision, in no event shall any incentive stock option be exercisable
during a term of more than ten (10) years after the date on which it is
granted; provided, however, that if an Optionee owns stock possessing
more than ten percent (10%) of the total combined voting power of all
classes of stock of the Company or of its parent or any Subsidiary, the
incentive stock option granted to such Optionee shall be exercisable
during a term of not more than five (5) years after the date on which
it is granted.
The Option Agreement shall state when the incentive stock option
becomes exercisable and shall also state the maximum term during which
the option may be exercised. In the event an incentive stock option is
exercisable immediately, the manner of exercise of the option in the
event it is not exercised in full immediately shall be specified in the
Option Agreement. The Administrator may accelerate the exercisability
of any incentive stock option granted hereunder which is not
immediately exercisable as of the date of grant.
<PAGE>
(c) Other Provisions. The Option Agreement authorized under this
Section 9 shall contain such other provisions as the Administrator
shall deem advisable. Any such Option Agreement shall contain such
limitations and restrictions upon the exercise of the option as shall
be necessary to ensure that such option will be considered an
"incentive stock option" as defined in Section 422 of the Internal
Revenue Code or to conform to any change therein.
SECTION 10.
TERMS AND CONDITIONS OF NONQUALIFIED STOCK OPTIONS
Each nonqualified stock option granted pursuant to this Section 10
shall be evidenced by a written Option Agreement. The Option Agreement shall be
in such form as may be approved from time to time by the Administrator and may
vary from Optionee to Optionee; provided, however, that each Optionee and each
Option Agreement shall comply with and be subject to the following terms and
conditions:
(a) Number of Shares and Option Price. The Option Agreement shall state
the total number of shares covered by the nonqualified stock option.
Unless otherwise determined by the Administrator, the option price per
share shall be one hundred percent (100%) of the Fair Market Value of
the Common Stock per share on the date the Administrator grants the
option.
(b) Term and Exercisability of Nonqualified Stock Option. The term
during which any nonqualified stock option granted under the Plan may
be exercised shall be established in each case by the Administrator.
The Option Agreement shall state when the nonqualified stock option
becomes exercisable and shall also state the maximum term during which
the option may be exercised. In the event a nonqualified stock option
is exercisable immediately, the manner of exercise of the option in the
event it is not exercised in full immediately shall be specified in the
stock option agreement. The Administrator may accelerate the
exercisability of any nonqualified stock option granted hereunder which
is not immediately exercisable as of the date of grant.
(c) Withholding. The Company or its Subsidiary shall be entitled to
withhold and deduct from future wages of the Optionee all legally
required amounts necessary to satisfy any and all withholding and
employment-related taxes attributable to the Optionee's exercise of a
nonqualified stock option. In the event the Optionee is required under
the Option Agreement to pay the Company, or make arrangements
satisfactory to the Company respecting payment of, such withholding and
employment-related taxes, the Administrator may, in its discretion and
pursuant to such rules as it may adopt, permit the Optionee to satisfy
such obligation, in whole or in part, by electing to have the Company
withhold shares of Common Stock otherwise issuable to the Optionee as a
result of the option's exercise equal to the amount required to be
withheld for tax purposes. Any stock elected to be withheld shall be
valued at its Fair Market Value, as of the date the amount of tax to be
withheld is determined under applicable tax law. The Optionee's
election to have shares withheld for this purpose shall be made on or
before the date the option is exercised or, if later, the date that the
amount of tax to be withheld is determined under applicable tax law.
Such election shall be approved by the Administrator and otherwise
comply with such rules as the Administrator may adopt to assure
compliance with Rule 16b-3, or any successor provision, as then in
effect, of the General Rules and Regulations under the Securities
Exchange Act of 1934, if applicable.
<PAGE>
(d) Other Provisions. The Option Agreement authorized under this
Section 10 shall contain such other provisions as the Administrator
shall deem advisable.
SECTION 11.
GRANTING OF OPTIONS TO NON-EMPLOYEE DIRECTORS
(a) Upon Joining Board. Each Non-Employee Director of the Company whose
initial election or appointment to the Board of Directors occurs on or
after the date this Plan is approved by the Company's shareholders
shall, as of the date of such election, automatically be granted an
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
such date. Options granted pursuant to this subsection (a) shall be
immediately exercisable to the extent of 3,000 shares subject to such
option and to the extent of an additional 3,000 shares on each of the
first, second, third and fourth anniversaries of the date of grant.
(b) Upon Re-election to Board. Each Non-Employee Director who, on and
after the date this Plan is approved by the Company's shareholders, 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 option to purchase 2,500 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. Options granted pursuant to this subsection (b)
shall be immediately exercisable in full.
(c) General. No director shall receive more than one option pursuant to
subsection (b) of this Section 11 in any one fiscal year. All options
granted pursuant to this Section 11 shall be designated as nonqualified
options and shall be subject to the same terms and provisions as are
then in effect with respect to granting of nonqualified options to
officers and employees of the Company, including Section 13 of the
Plan, except that the option 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 Section
11 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.
<PAGE>
SECTION 12.
TRANSFER OF OPTION
No incentive stock option shall be transferable, in whole or in part,
by the Optionee other than by will or by the laws of descent and distribution
and, during the Optionee's lifetime, the option may be exercised only by the
Optionee. If the Optionee shall attempt any transfer of any incentive stock
option granted under the Plan during the Optionee's lifetime, such transfer
shall be void and the incentive stock option, to the extent not fully exercised,
shall terminate.
The Administrator may, in its sole discretion, permit the Optionee to
transfer any or all nonqualified stock options to any member of the Optionee's
"immediate family" as such term is defined in Rule 16a-1(e) promulgated under
the Securities Exchange Act of 1934, or any successor provision, or to one or
more trusts whose beneficiaries are members of such Optionee's "immediate
family" or partnerships in which such family members are the only partners;
provided, however, that the Optionee receives no consideration for the transfer
and such transferred nonqualified stock option shall continue to be subject to
the same terms and conditions as were applicable to such nonqualified stock
option immediately prior to its transfer.
SECTION 13.
RECAPITALIZATION, SALE, MERGER, EXCHANGE
OR LIQUIDATION
In the event of an increase or decrease in the number of shares of
Common Stock resulting from a subdivision or consolidation of shares or the
payment of a stock dividend or any other increase or decrease in the number of
shares of Common Stock effected without receipt of consideration by the Company,
the number of shares of Option Stock reserved under Section 6 hereof and the
number of shares of Option Stock covered by each outstanding option and the
price per share thereof shall be adjusted by the Board to reflect such change.
Additional shares which may be credited pursuant to such adjustment shall be
subject to the same restrictions as are applicable to the shares with respect to
which the adjustment relates.
Unless otherwise provided in the stock option agreement, in the event
of
(i) an acquisition of the Company by a corporation, partnership,
trust or other entity not controlled by the Company through
(A) the sale of substantially all of the Company's assets and
the consequent discontinuance of its business or (B) through a
merger, consolidation, exchange, reorganization,
reclassification, extraordinary dividend, divestiture or
liquidation of the Company, other than a merger or
consolidation which would result in the voting securities of
the Company outstanding immediately prior thereto continuing
to represent (either by remaining outstanding or by being
converted into voting securities of the surviving entity) at
least 80% of the combined voting power of the voting
securities of the Company or such surviving entity outstanding
immediately after such merger or consolidation (collectively
referred to as a "transaction"), or
<PAGE>
(ii) a change of control such that (A) any individual, partnership,
trust or other entity becomes after the effective date of the
Plan the "beneficial owner" (as defined in Rule 13d-3 under
the Exchange Act), directly or indirectly, of 30% or more of
the combined voting power of the Company's outstanding
securities ordinarily having the right to vote at elections of
directors of the Company, or (B) individuals who constitute
the Board of Directors of the Company on the effective date of
the Plan cease for any reason to constitute at least a
majority thereof, provided that any person becoming a director
subsequent to the effective date of the Plan whose election,
or nomination for election by the Company's shareholders, was
approved by a vote of at least a majority of the directors
comprising the Board of Directors of the Company on the
effective date of the Plan (either by a specific vote or by
approval of the proxy statement of the Company in which such
person is named as a nominee for director, without objection
to such nomination) shall be, for purposes of this clause (B)
considered as though such person were a member of the Board of
Directors of the Company on the effective date of the Plan
(collectively referred to as a "change of control"),
all outstanding options shall become immediately exercisable, whether or not
such options had become exercisable prior to the transaction or change of
control; provided, however, that if the acquiring party seeks to have the
transaction accounted for on a "pooling of interests" basis and, in the opinion
of the Company's independent certified public accountants, accelerating the
exercisability of such options would preclude a pooling of interests under
generally accepted accounting principles, the exercisability of such options
shall not accelerate. In addition to the foregoing, in the event of such a
transaction or change of control, the Board may provide for one or more of the
following:
(a) the complete termination of this Plan and cancellation of
outstanding options not exercised prior to a date specified by the
Board (which date shall give Optionees a reasonable period of time in
which to exercise the options prior to the effectiveness of such
transaction);
(b) that Optionees holding outstanding incentive or nonqualified
options shall receive, with respect to each share of Option Stock
subject to such options, as of the effective date of any such
transaction, cash in an amount equal to the excess of the Fair Market
Value of such Option Stock on the date immediately preceding the
effective date of such transaction over the option price per share of
such options; provided that the Board may, in lieu of such cash
payment, distribute to such Optionees shares of stock of the Company or
shares of stock of any corporation succeeding the Company by reason of
such transaction, such shares having a value equal to the cash payment
herein; or
(c) the continuance of the Plan with respect to the exercise of options
which were outstanding as of the date of adoption by the Board of such
plan for such transaction and provide to Optionees holding such options
the right to exercise their respective options as to an equivalent
number of shares of stock of the corporation succeeding the Company by
reason of such transaction.
<PAGE>
The Board may restrict the rights of or the applicability of this Section 13 to
the extent necessary to comply with Section 16(b) of the Securities Exchange Act
of 1934, the Internal Revenue Code or any other applicable law or regulation.
The grant of an option pursuant to the Plan shall not limit in any way the right
or power of the Company to make adjustments, reclassifications, reorganizations
or changes of its capital or business structure or to merge, exchange or
consolidate or to dissolve, liquidate, sell or transfer all or any part of its
business or assets.
SECTION 14.
SECURITIES LAW COMPLIANCE
No shares of Common Stock shall be issued pursuant to the Plan unless
and until there has been compliance, in the opinion of Company's counsel, with
all applicable legal requirements, including without limitation, those relating
to securities laws and stock exchange listing requirements. As a condition to
the issuance of Option Stock to Optionee, the Administrator may require Optionee
to (i) represent that the shares of Option Stock are being acquired for
investment and not resale and to make such other representations as the
Administrator shall deem necessary or appropriate to qualify the issuance of the
shares as exempt from the Securities Act of 1933 and any other applicable
securities laws, and (ii) represent that Optionee shall not dispose of the
shares of Option Stock in violation of the Securities Act of 1933 or any other
applicable securities laws.
As a further condition to the grant of any incentive or nonqualified
stock option or the issuance of Option Stock to Optionee, Optionee agrees to the
following:
(a) In the event the Company advises Optionee that it plans an
underwritten public offering of its Common Stock in compliance with the
Securities Act of 1933, as amended, and the underwriter(s) seek to
impose restrictions under which certain shareholders may not sell or
contract to sell or grant any option to buy or otherwise dispose of
part or all of their stock purchase rights of the underlying Common
Stock, Optionee will not, for a period not to exceed 180 days from the
prospectus, sell or contract to sell or grant an option to buy or
otherwise dispose of any incentive or nonqualified stock option granted
to Optionee pursuant to the Plan or any of the underlying shares of
Common Stock without the prior written consent of the underwriter(s) or
its representative(s).
(b) In the event the Company makes any public offering of its
securities and determines in its sole discretion that it is necessary
to reduce the number of issued but unexercised stock purchase rights so
as to comply with any states securities or Blue Sky law limitations
with respect thereto, the Board of Directors of the Company shall have
the right (i) to accelerate the exercisability of any incentive or
nonqualified stock option and the date on which such option must be
exercised, provided that the Company gives Optionee prior written
notice of such acceleration, and (ii) to cancel any options or portions
thereof which Optionee does not exercise prior to or contemporaneously
with such public offering.
<PAGE>
(c) In the event of a transaction (as defined in Section 13 of the
Plan) which is treated as a "pooling of interests" under generally
accepted accounting principles, Optionee will comply with Rule 145 of
the Securities Act of 1933 and any other restrictions imposed under
other applicable legal or accounting principles if Optionee is an
"affiliate" (as defined in such applicable legal and accounting
principles) at the time of the transaction, and Optionee will execute
any documents necessary to ensure compliance with such rules.
The Company reserves the right to place a legend on any stock
certificate issued upon exercise of an option granted pursuant to the Plan to
assure compliance with this Section 14.
SECTION 15.
RIGHTS AS A SHAREHOLDER
An Optionee (or the Optionee's successor or successors) shall have no
rights as a shareholder with respect to any shares covered by an option until
the date of the issuance of a stock certificate evidencing such shares. No
adjustment shall be made for dividends (ordinary or extraordinary, whether in
cash, securities or other property), distributions or other rights for which the
record date is prior to the date such stock certificate is actually issued
(except as otherwise provided in Section 13 of the Plan).
SECTION 16.
AMENDMENT OF THE PLAN
The Board may from time to time, insofar as permitted by law, suspend
or discontinue the Plan or revise or amend it in any respect; provided, however,
that no such revision or amendment, except as is authorized in Section 13, shall
impair the terms and conditions of any option which is outstanding on the date
of such revision or amendment to the material detriment of the Optionee without
the consent of the Optionee. Notwithstanding the foregoing, no such revision or
amendment shall (i) materially increase the number of shares subject to the Plan
except as provided in Section 13 hereof, (ii) change the designation of the
class of employees eligible to receive options, (iii) decrease the price at
which options may be granted, or (iv) materially increase the benefits accruing
to Optionees under the Plan without the approval of the shareholders of the
Company if such approval is required for compliance with the requirements of any
applicable law or regulation. Furthermore, the Plan may not, without the
approval of the shareholders, be amended in any manner that will cause incentive
stock options to fail to meet the requirements of Section 422 of the Internal
Revenue Code.
SECTION 17.
NO OBLIGATION TO EXERCISE OPTION
The granting of an option shall impose no obligation upon the Optionee
to exercise such option. Further, the granting of an option hereunder shall not
impose upon the Company or any Subsidiary any obligation to retain the Optionee
in its employ for any period.
DATAKEY, INC.
INCENTIVE STOCK OPTION AGREEMENT
THIS AGREEMENT, made effective as of this _____ day of _______________,
199___, by and between DATAKEY, INC., a Minnesota corporation (the "Company"),
and __________________ ("Optionee").
W I T N E S S E T H:
WHEREAS, Optionee on the date hereof is a key employee of the Company
or one of its Subsidiaries; and
WHEREAS, the Company wishes to grant an incentive stock option to
Optionee to purchase shares of the Company's Common Stock pursuant to the
Company's 1997 Stock Option Plan (the "Plan"); and
WHEREAS, the Administrator of the Plan has authorized the grant of an
incentive stock option to Optionee and has determined that, as of the effective
date of this Agreement, the fair market value of the Company's Common Stock is
$_______ per share;
NOW, THEREFORE, in consideration of the premises and of the mutual
covenants herein contained, the parties hereto agree as follows:
1. Grant of Option. The Company hereby grants to Optionee on the date
set forth above (the "Date of Grant"), the right and option (the "Option") to
purchase all or portions of an aggregate of _____________________ (______)
shares of Common Stock at a per share price of $________ on the terms and
conditions set forth herein, subject to adjustment pursuant to Section 13 of the
Plan. Except as otherwise provided in Paragraph 2(c), this Option is intended to
be an incentive stock option within the meaning of Section 422, or any successor
provision, of the Internal Revenue Code of 1986, as amended (the "Code"), and
the regulations thereunder.
2. Duration and Exercisability.
a. The term during which this Option may be exercised shall
terminate at the close of business on ________, 20___, except as otherwise
provided in Paragraphs 2(b) through 2(e) below. This Option shall become
exercisable according to the following schedule:
Vesting Date Percentage/Number of Shares
<PAGE>
Once the Option becomes exercisable to the extent of one hundred percent (100%)
of the aggregate number of shares specified in Paragraph 1, Optionee may
continue to exercise this Option under the terms and conditions of this
Agreement until the termination of the Option as provided herein. If Optionee
does not purchase upon an exercise of this Option the full number of shares
which Optionee is then entitled to purchase, Optionee may purchase upon any
subsequent exercise prior to this Option's termination such previously
unpurchased shares in addition to those Optionee is otherwise entitled to
purchase.
b. Termination of Employment (other than Change of Control,
Disability or Death). If Optionee's employment with the Company or any
Subsidiary is terminated for any reason other than because of a "transaction" or
"change of control" as described in Paragraph 2(c) or because of disability or
death, this Option shall completely terminate on the earlier of (i) the close of
business on the three-month anniversary date of such termination of employment,
and (ii) the expiration date of this Option stated in Paragraph 2 above.
In such period following the termination of Optionee's
employment, this Option shall be exercisable only to the extent the Option was
exercisable on the vesting date immediately preceding such termination of
employment but had not previously been exercised. To the extent this Option was
not exercisable upon such termination of employment or if Optionee does not
exercise the Option within the time specified in this Paragraph 2(b), all rights
of Optionee under this Option shall be forfeited.
c. Change of Control. If (i) Optionee's employment with the
Company or any Subsidiary is terminated because of a "transaction" or "change of
control transaction" (as those terms are defined in Section 13 of the Plan),
(ii) such transaction is treated as a "pooling of interests" under generally
accepted accounting principles, and (iii) Optionee is an "affiliate" of the
Company or Subsidiary under applicable legal and accounting principles, this
Option shall completely terminate on the later of (A) the close of business on
the three-month anniversary date of such termination of employment or (B) the
close of business on the date that is 60 days after the date on which affiliates
are no longer restricted from selling, transferring or otherwise disposing of
the shares of stock received in the change of control transaction.
In such period following the termination of Optionee's
employment because of a "transaction" or "change of control", this Option shall
become immediately exercisable unless the acceleration of the exercisability of
this Option has been prevented as provided in Section 13 of the Plan, in which
case, this Option shall be exercisable only to the extent the Option was
exercisable on the vesting date immediately preceding such termination of
employment, but had not previously been exercised. To the extent this Option was
not exercisable upon such termination of employment, or if Optionee does not
exercise the Option within the time specified in this Paragraph 2(c), all rights
of Optionee under this Option shall be forfeited. If Optionee exercises this
Option on a date that is after the three-month anniversary of the termination of
Optionee's employment or on a date that is more than ten years (or five years,
if applicable) after the Date of Grant, this Option shall not be treated as an
incentive stock option within the meaning of Code Section 422.
<PAGE>
d. Disability. If Optionee ceases to be an employee of the
Company or any Subsidiary due to disability (as such term is defined in Code
Section 22(e)(3), or any successor provision), this Option shall completely
terminate on the earlier of (i) the close of business on the twelve-month
anniversary date of such termination of employment, and (ii) the expiration date
under this Option stated in Paragraph 2(a) above. In such period following such
termination of employment, this Option shall be exercisable only to the extent
the Option was exercisable on the vesting date immediately preceding the date of
Optionee's termination of employment. If Optionee does not exercise the Option
within the time specified in this Paragraph 2(d), all rights of Optionee under
this Option shall be forfeited.
e. Death. In the event of Optionee's death, this Option shall
terminate on the earlier of (i) the close of business on the twelve-month
anniversary date of the date of Optionee's death, and (ii) the expiration date
of this Option stated in Paragraph 2(a) above. In such period following
Optionee's death, this Option shall be exercisable by the person or persons to
whom Optionee's rights under this Option shall have passed by Optionee's will or
by the laws of descent and distribution only to the extent the Option was
exercisable on the vesting date immediately preceding the date of Optionee's
death. If such person or persons do not exercise this Option within the time
specified in this Paragraph 2(e), all rights under this Option shall be
forfeited.
3. Manner of Exercise.
a. General. The Option may be exercised only by Optionee (or
other proper party in the event of death or incapacity), subject to the
conditions of the Plan and subject to such other administrative rules as the
Administrator may deem advisable, by delivering within the Option Period written
notice of exercise to the Company at its principal office. The notice shall
state the number of shares as to which the Option is being exercised and shall
be accompanied by payment in full of the Option price for all shares designated
in the notice. The exercise of the Option shall be deemed effective upon receipt
of such notice by the Company and upon payment that complies with the terms of
the Plan and this Agreement. The Option may be exercised with respect to any
number or all of the shares as to which it can then be exercised and, if
partially exercised, may be so exercised as to the unexercised shares any number
of times during the Option period as provided herein.
b. Form of Payment. Payment of the Option price by Optionee
shall be in the form of cash, personal check, certified check or previously
acquired shares of Common Stock of the Company, or any combination thereof. Any
stock so tendered as part of such payment shall be valued at its Fair Market
Value as provided in the Plan. For purposes of this Agreement, "previously
acquired shares of Common Stock" shall include shares of Common Stock that are
already owned by Optionee at the time of exercise.
c. Stock Transfer Records. As soon as practicable after the
effective exercise of all or any part of the Option, Optionee shall be recorded
on the stock transfer books of the Company as the owner of the shares purchased,
and the Company shall deliver to Optionee one or more duly issued stock
certificates evidencing such ownership. All requisite original issue or transfer
documentary stamp taxes shall be paid by the Company.
<PAGE>
4. Miscellaneous.
a. Employment; Rights as Shareholder. This Agreement shall not
confer on Optionee any right with respect to continuance of employment by the
Company or any of its Subsidiaries, nor will it interfere in any way with the
right of the Company to terminate such employment. Optionee shall have no rights
as a shareholder with respect to shares subject to this Option until such shares
have been issued to Optionee upon exercise of this Option. No adjustment shall
be made for dividends (ordinary or extraordinary, whether in cash, securities or
other property), distributions or other rights for which the record date is
prior to the date such shares are issued, except as provided in Section 13 of
the Plan.
b. Securities Law Compliance. The exercise of all or any parts
of this Option shall only be effective at such time as counsel to the Company
shall have determined that the issuance and delivery of Common Stock pursuant to
such exercise will not violate any state or federal securities or other laws.
Optionee may be required by the Company, as a condition of the effectiveness of
any exercise of this Option, to agree in writing that all Common Stock to be
acquired pursuant to such exercise shall be held, until such time that such
Common Stock is registered and freely tradable under applicable state and
federal securities laws, for Optionee's own account without a view to any
further distribution thereof, that the certificates for such shares shall bear
an appropriate legend to that effect and that such shares will not be
transferred or disposed of except in compliance with applicable state and
federal securities laws.
c. Mergers, Recapitalizations, Stock Splits, Etc. Pursuant and
subject to Section 13 of the Plan, certain changes in the number or character of
the Common Stock of the Company (through sale, merger, consolidation, exchange,
reorganization, divestiture (including a spin-off), liquidation,
recapitalization, stock split, stock dividend or otherwise) shall result in an
adjustment, reduction or enlargement, as appropriate, in Optionee's rights with
respect to any unexercised portion of the Option (i.e., Optionee shall have such
"anti-dilution" rights under the Option with respect to such events, but shall
not have "preemptive" rights).
d. Withholding Taxes on Disqualifying Disposition. In the
event of a disqualifying disposition of the shares acquired through the exercise
of this Option, Optionee hereby agrees to inform the Company of such
disposition. Upon notice of a disqualifying disposition, the Company may take
such action as it deems appropriate to insure that, if necessary to comply with
all applicable federal or state income tax laws or regulations, all applicable
federal and state payroll, income or other taxes are withheld from any amounts
payable by the Company to Optionee. If the Company is unable to withhold such
federal and state taxes, for whatever reason, Optionee hereby agrees to pay to
the Company an amount equal to the amount the Company would otherwise be
required to withhold under federal or state law. Optionee may, subject to the
approval and discretion of the Administrator or such administrative rules it may
deem advisable, elect to have all or a portion of such tax withholding
obligations satisfied by delivering shares of the Company's Common Stock having
a fair market value equal to such obligations.
<PAGE>
e. Nontransferability. During the lifetime of Optionee, the
accrued Option shall be exercisable only by Optionee or by the Optionee's
guardian or other legal representative, and shall not be assignable or
transferable by Optionee, in whole or in part, other than by will or by the laws
of descent and distribution.
f. 1997 Stock Option Plan. The Option evidenced by this
Agreement is granted pursuant to the Plan, a copy of which Plan has been made
available to Optionee and is hereby incorporated into this Agreement. This
Agreement is subject to and in all respects limited and conditioned as provided
in the Plan. The Plan governs this Option and, in the event of any questions as
to the construction of this Agreement or in the event of a conflict between the
Plan and this Agreement, the Plan shall govern, except as the Plan otherwise
provides.
g. Lockup Period Limitation. Optionee agrees that in the event
the Company advises Optionee that it plans an underwritten public offering of
its Common Stock in compliance with the Securities Act of 1933, as amended, and
that the underwriter(s) seek to impose restrictions under which certain
shareholders may not sell or contract to sell or grant any option to buy or
otherwise dispose of part or all of their stock purchase rights of the
underlying Common Stock, Optionee hereby agrees that for a period not to exceed
180 days from the date of the prospectus, Optionee will not sell or contract to
sell or grant an option to buy or otherwise dispose of this option or any of the
underlying shares of Common Stock without the prior written consent of the
underwriter(s) or its representative(s).
h. Blue Sky Limitation. Notwithstanding anything in this
Agreement to the contrary, in the event the Company makes any public offering of
its securities and determines in its sole discretion that it is necessary to
reduce the number of issued but unexercised stock purchase rights so as to
comply with any state securities or Blue Sky law limitations with respect
thereto, the Board of Directors of the Company shall have the right (i) to
accelerate the exercisability of this Option and the date on which this Option
must be exercised, provided that the Company gives Optionee 15 days' prior
written notice of such acceleration, and (ii) to cancel any portion of this
Option or any other option granted to Optionee pursuant to the Plan which is not
exercised prior to or contemporaneously with such public offering. Notice shall
be deemed given when delivered personally or when deposited in the United States
mail, first class postage prepaid and addressed to Optionee at the address of
Optionee on file with the Company.
i. Accounting Compliance. Optionee agrees that, in the event a
"change of control transaction" (as defined in Paragraph 2(c) above) is treated
as a "pooling of interests" under generally accepted accounting principles and
Optionee is an "affiliate" of the Company or any Subsidiary (as defined in
applicable legal and accounting principles) at the time of such change of
control transaction, Optionee will comply with all requirements of Rule 145 of
the Securities Act of 1933, as amended, and the requirements of such other legal
or accounting principles, and will execute any documents necessary to ensure
such compliance.
j. Stock Legend. If applicable, the Company may put an
appropriate legend on the certificates for any shares of Common Stock purchased
by Optionee (or, in the case of death, Optionee's successors) to reflect the
restrictions of Paragraphs 4(b), 4(g), 4(h) and 4(i) of this Agreement.
<PAGE>
k. Scope of Agreement. This Agreement shall bind and inure to
the benefit of the Company and its successors and assigns and Optionee and any
successor or successors of Optionee permitted by Paragraph 4(e) above.
l. Arbitration. Any dispute arising out of or relating to this
Agreement or the alleged breach of it, or the making of this Agreement,
including claims of fraud in the inducement, shall be discussed between the
disputing parties in a good faith effort to arrive at a mutual settlement of any
such controversy. If, notwithstanding, such dispute cannot be resolved, such
dispute shall be settled by binding arbitration. Judgment upon the award
rendered by the arbitrator may be entered in any court having jurisdiction
thereof. The arbitrator shall be a retired state or federal judge or an attorney
who has practiced securities or business litigation for at least ten years. If
the parties cannot agree on an arbitrator within 20 days, any party may request
that the chief judge of the District Court for Hennepin County, Minnesota,
select an arbitrator. Arbitration will be conducted pursuant to the provisions
of this Agreement, and the commercial arbitration rules of the American
Arbitration Association, unless such rules are inconsistent with the provisions
of this Agreement. Limited civil discovery shall be permitted for the production
of documents and taking of depositions. Unresolved discovery disputes may be
brought to the attention of the arbitrator who may dispose of such dispute. The
arbitrator shall have the authority to award any remedy or relief that a court
of this state could order or grant; provided, however, that punitive or
exemplary damages shall not be awarded. The arbitrator may award to the
prevailing party, if any, as determined by the arbitrator, all of its costs and
fees, including the arbitrator's fees, administrative fees, travel expenses,
out-of-pocket expenses and reasonable attorneys' fees. Unless otherwise agreed
by the parties, the place of any arbitration proceedings shall be Hennepin
County, Minnesota.
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be
executed on the day and year first above written.
DATAKEY, INC.
By:__________________________________________
Its:
COMPANY
_____________________________________________
OPTIONEE
<PAGE>
DATAKEY, INC.
NONQUALIFIED STOCK OPTION AGREEMENT
THIS AGREEMENT, made effective as of this _____ day of ______________,
199__, by and between DATAKEY, INC., a Minnesota corporation (the "Company"),
and _____________________________ ("Optionee").
W I T N E S S E T H:
WHEREAS, Optionee on the date hereof is a key employee, officer,
director, consultant or advisor of the Company or one of its Subsidiaries; and
WHEREAS, the Company wishes to grant a nonqualified stock option to
Optionee to purchase shares of the Company's Common Stock pursuant to the
Company's 1997 Stock Option Plan (the "Plan"); and
WHEREAS, the Administrator has authorized the grant of a nonqualified
stock option to Optionee and has determined that, as of the effective date of
this Agreement, the fair market value of the Company's Common Stock is $ per
share;
NOW, THEREFORE, in consideration of the premises and of the mutual
covenants herein contained, the parties hereto agree as follows:
1. Grant of Option. The Company hereby grants to Optionee on the date
set forth above (the "Date of Grant"), the right and option (the "Option") to
purchase all or portions of an aggregate of ____________ (____) shares of Common
Stock at a per share price of $______ on the terms and conditions set forth
herein, subject to adjustment pursuant to Section 13 of the Plan. This Option is
a nonqualified stock option and will not be treated as an incentive stock
option, as defined under Section 422, or any successor provision, of the
Internal Revenue Code of 1986, as amended (the "Code"), and the regulations
thereunder.
2. Duration and Exercisability.
a. The term during which this Option may be exercised shall
terminate on _______________, 20__, except as otherwise provided in Paragraphs
2(b) through 2(e) below. This Option shall become exercisable according to the
following schedule:
Vesting Date Percentage/Number of Shares
<PAGE>
Once the Option becomes exercisable to the extent of one hundred percent (100%)
of the aggregate number of shares specified in Paragraph 1, Optionee may
continue to exercise this Option under the terms and conditions of this
Agreement until the termination of the Option as provided herein. If Optionee
does not purchase upon an exercise of this Option the full number of shares
which Optionee is then entitled to purchase, Optionee may purchase upon any
subsequent exercise prior to this Option's termination such previously
unpurchased shares in addition to those Optionee is otherwise entitled to
purchase.
b. Termination of Relationship (other than Change of Control,
Disability or Death). If Optionee ceases to be an employee, director, consultant
or an advisor of the Company or any Subsidiary for any reason other than because
of a "transaction" or "change of control transaction" as described in Paragraph
2(c) or because of disability or death, this Option shall completely terminate
on the earlier of (i) the close of business on the three-month anniversary date
of the termination of all such relationships, and (ii) the expiration date of
this Option stated in Paragraph 2(a) above. In such period following such
termination, this Option shall be exercisable only to the extent the Option was
exercisable on the vesting date immediately preceding the date on which all of
Optionee's relationships with the Company or Subsidiary have terminated, but had
not previously been exercised. To the extent this Option was not exercisable
upon the termination of such relationship, or if Optionee does not exercise the
Option within the time specified in this Paragraph 2(b), all rights of Optionee
under this Option shall be forfeited.
c. Change of Control. If (i) Optionee ceases to be an
employee, director, consultant or advisor of the Company or any Subsidiary
because of a "transaction" or "change of control transaction" (as those terms
are defined in Section 13 of the Plan), (ii) such transaction is treated as a
"pooling of interests" under generally accepted accounting principles, and (iii)
Optionee is an "affiliate" of the Company or Subsidiary under applicable legal
and accounting principles, this Option shall completely terminate on the later
of (A) the close of business on the three-month anniversary date of the
termination of all such relationships with the Company or any Subsidiary, and
(B) the close of business on the date that is 60 days after the date on which
affiliates are no longer restricted from selling, transferring or otherwise
disposing of the shares of stock received in the change of control transaction.
In such period following such termination, this Option shall become immediately
exercisable unless the acceleration of the exercisability of this Option has
been prevented as provided in Section 13 of the Plan, in which case, this Option
shall be exercisable only to the extent the Option was exercisable on the
vesting date immediately preceding such termination of Optionee's relationships
with the Company or Subsidiary, but had not previously been exercised. To the
extent this Option was not exercisable upon such termination of such
relationships, or if Optionee does not exercise the Option within the time
specified in this Paragraph 2(c), all rights of Optionee under this Option shall
be forfeited.
d. Disability. If Optionee ceases to be an employee, director,
consultant or advisor of the Company or any Subsidiary because of disability (as
such term is defined in Code Section 22(e)(3), or any successor provision), this
Option shall completely terminate on the earlier of (i) the close of business on
the twelve-month anniversary date of the termination of all such relationships
with the Company or any Subsidiary, and (ii) the expiration date under this
Option stated in Paragraph 2(a) above. In such period following such
termination, this Option shall be exercisable only to the extent the Option was
exercisable on the vesting date immediately preceding the termination of all of
Optionee's relationships. If Optionee does not exercise the Option within the
time specified in this Paragraph 2(d), all rights of Optionee under this Option
shall be forfeited.
<PAGE>
e. Death. In the event of Optionee's death, this Option shall
terminate on the earlier of (i) the close of business on the twelve-month
anniversary date of the date of Optionee's death, and (ii) the expiration date
of this Option stated in Paragraph 2(a) above. In such period following
Optionee's death, this Option may be exercised by the person or persons to whom
Optionee's rights under this Option shall have passed by Optionee's will or by
the laws of descent and distribution only to the extent the Option was
exercisable on the vesting date immediately preceding the date of Optionee's
death. If such person or persons fail to exercise this Option within the time
specified in this Paragraph 2(e), all rights under this Option shall be
forfeited.
3. Manner of Exercise.
a. General. The Option may be exercised only by Optionee (or
other proper party in the event of death or incapacity), subject to the
conditions of the Plan and subject to such other administrative rules as the
Administrator may deem advisable, by delivering within the option period written
notice of exercise to the Company at its principal office. The notice shall
state the number of shares as to which the Option is being exercised and shall
be accompanied by payment in full of the option price for all shares designated
in the notice. The exercise of the Option shall be deemed effective upon receipt
of such notice by the Company and upon payment that complies with the terms of
the Plan and this Agreement. The Option may be exercised with respect to any
number or all of the shares as to which it can then be exercised and, if
partially exercised, may be exercised as to the unexercised shares any number of
times during the option period as provided herein.
b. Form of Payment. Payment of the option price by Optionee
shall be in the form of cash, personal check, certified check or previously
acquired shares of Common Stock of the Company, or any combination thereof. Any
stock so tendered as part of such payment shall be valued at its Fair Market
Value as provided in the Plan. For purposes of this Agreement, "previously
acquired shares of Common Stock" shall include shares of Common Stock that are
already owned by Optionee at the time of exercise.
c. Stock Transfer Records. As soon as practicable after the
effective exercise of all or any part of the Option, Optionee shall be recorded
on the stock transfer books of the Company as the owner of the shares purchased,
and the Company shall deliver to Optionee one or more duly issued stock
certificates evidencing such ownership. All requisite original issue or transfer
documentary stamp taxes shall be paid by the Company.
<PAGE>
4. Miscellaneous.
a. Rights as Shareholder. This Agreement shall not confer on
Optionee any right with respect to the continuance of any relationship with the
Company or any of its Subsidiaries, nor will it interfere in any way with the
right of the Company to terminate any such relationship. Optionee shall have no
rights as a shareholder with respect to shares subject to this Option until such
shares have been issued to Optionee upon exercise of this Option. No adjustment
shall be made for dividends (ordinary or extraordinary, whether in cash,
securities or other property), distributions or other rights for which the
record date is prior to the date such shares are issued, except as provided in
Section 13 of the Plan.
b. Securities Law Compliance. The exercise of all or any parts
of this Option shall only be effective at such time as counsel to the Company
shall have determined that the issuance and delivery of Common Stock pursuant to
such exercise will not violate any state or federal securities or other laws.
Optionee may be required by the Company, as a condition of the effectiveness of
any exercise of this Option, to agree in writing that all Common Stock to be
acquired pursuant to such exercise shall be held, until such time that such
Common Stock is registered and freely tradable under applicable state and
federal securities laws, for Optionee's own account without a view to any
further distribution thereof and that such shares will be not transferred or
disposed of except in compliance with applicable state and federal securities
laws.
c. Mergers, Recapitalizations, Stock Splits, Etc. Pursuant and
subject to Section 13 of the Plan, certain changes in the number or character of
the Common Stock of the Company (through sale, merger, consolidation, exchange,
reorganization, divestiture (including a spin-off), liquidation,
recapitalization, stock split, stock dividend or otherwise) shall result in an
adjustment, reduction or enlargement, as appropriate, in Optionee's rights with
respect to any unexercised portion of the Option (i.e., Optionee shall have such
"anti-dilution" rights under the Option with respect to such events, but shall
not have "preemptive" rights).
d. Withholding Taxes. In order to permit the Company to comply
with all applicable federal or state income tax laws or regulations, the Company
may take such action as it deems appropriate to insure that, if necessary, all
applicable federal or state payroll, income or other taxes are withheld from any
amounts payable by the Company to Optionee. If the Company is unable to withhold
such federal and state taxes, for whatever reason, Optionee hereby agrees to pay
to the Company an amount equal to the amount the Company would otherwise be
required to withhold under federal or state law. Optionee may, subject to the
approval and discretion of the Administrator or such administrative rules it may
deem advisable, elect to have all or a portion of such tax withholding
obligations satisfied by delivering shares of the Company's Common Stock having
a fair market value equal to such obligations.
e. Nontransferability. During the lifetime of Optionee, the
accrued Option shall be exercisable only by Optionee or by the Optionee's
guardian or other legal representative, and shall not be assignable or
transferable by Optionee, in whole or in part, other than by will or by the laws
of descent and distribution.
<PAGE>
f. 1997 Stock Option Plan. The Option evidenced by this
Agreement is granted pursuant to the Plan, a copy of which Plan has been made
available to Optionee and is hereby incorporated into this Agreement. This
Agreement is subject to and in all respects limited and conditioned as provided
in the Plan. The Plan governs this Option and, in the event of any questions as
to the construction of this Agreement or in the event of a conflict between the
Plan and this Agreement, the Plan shall govern, except as the Plan otherwise
provides.
g. Lockup Period Limitation. Optionee agrees that in the event
the Company advises Optionee that it plans an underwritten public offering of
its Common Stock in compliance with the Securities Act of 1933, as amended, and
that the underwriter(s) seek to impose restrictions under which certain
shareholders may not sell or contract to sell or grant any option to buy or
otherwise dispose of part or all of their stock purchase rights of the
underlying Common Stock, Optionee hereby agrees that for a period not to exceed
180 days from the date of prospectus, Optionee will not sell or contract to sell
or grant an option to buy or otherwise dispose of this option or any of the
underlying shares of Common Stock without the prior written consent of the
underwriter(s) or its representative(s).
h. Blue Sky Limitation. Notwithstanding anything in this
Agreement to the contrary, in the event the Company makes any public offering of
its securities and determines in its sole discretion that it is necessary to
reduce the number of issued but unexercised stock purchase rights so as to
comply with any state securities or Blue Sky law limitations with respect
thereto, the Board of Directors of the Company shall have the right (i) to
accelerate the exercisability of this Option and the date on which this Option
must be exercised, provided that the Company gives Optionee 15 days' prior
written notice of such acceleration, and (ii) to cancel any portion of this
Option or any other option granted to Optionee pursuant to the Plan which is not
exercised prior to or contemporaneously with such public offering. Notice shall
be deemed given when delivered personally or when deposited in the United States
mail, first class postage prepaid and addressed to Optionee at the address of
Optionee on file with the Company.
i. Accounting Compliance. Optionee agrees that, in the event a
"change of control transaction" (as defined in Paragraph 2(c) above) is treated
as a "pooling of interests" under generally accepted accounting principles and
Optionee is an "affiliate" of the Company or any Subsidiary (as defined in
applicable legal and accounting principles) at the time of such change of
control transaction, Optionee will comply with all requirements of Rule 145 of
the Securities Act of 1933, as amended, and the requirements of such other legal
or accounting principles, and will execute any documents necessary to ensure
such compliance.
j. Stock Legend. If applicable, the Company may put an
appropriate legend on the certificates for any shares of Common Stock purchased
by Optionee (or, in the case of death, Optionee's successors) to reflect the
restrictions of Paragraphs 4(b), 4(h), 4(i) and 4(j) of this Agreement.
<PAGE>
k. Scope of Agreement. This Agreement shall bind and inure to
the benefit of the Company and its successors and assigns and Optionee and any
successor or successors of Optionee permitted by Paragraph 4(e) above.
l. Arbitration. Any dispute arising out of or relating to this
Agreement or the alleged breach of it, or the making of this Agreement,
including claims of fraud in the inducement, shall be discussed between the
disputing parties in a good faith effort to arrive at a mutual settlement of any
such controversy. If, notwithstanding, such dispute cannot be resolved, such
dispute shall be settled by binding arbitration. Judgment upon the award
rendered by the arbitrator may be entered in any court having jurisdiction
thereof. The arbitrator shall be a retired state or federal judge or an attorney
who has practiced securities or business litigation for at least ten years. If
the parties cannot agree on an arbitrator within 20 days, any party may request
that the chief judge of the District Court for Hennepin County, Minnesota,
select an arbitrator. Arbitration will be conducted pursuant to the provisions
of this Agreement, and the commercial arbitration rules of the American
Arbitration Association, unless such rules are inconsistent with the provisions
of this Agreement. Limited civil discovery shall be permitted for the production
of documents and taking of depositions. Unresolved discovery disputes may be
brought to the attention of the arbitrator who may dispose of such dispute. The
arbitrator shall have the authority to award any remedy or relief that a court
of this state could order or grant; provided, however, that punitive or
exemplary damages shall not be awarded. The arbitrator may award to the
prevailing party, if any, as determined by the arbitrator, all of its costs and
fees, including the arbitrator's fees, administrative fees, travel expenses,
out-of-pocket expenses and reasonable attorneys' fees. Unless otherwise agreed
by the parties, the place of any arbitration proceedings shall be Hennepin
County, Minnesota.
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be
executed on the day and year first above written.
DATAKEY, INC.
By:__________________________________________
Its:
COMPANY
_____________________________________________
OPTIONEE
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
$822,000 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.
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements on
Forms S-8 No. 33-14144, No. 33-47068, No. 33-67280, No. 333-11405, No. 33-80894,
and No. 333-43937 of our report dated February 3, 1998, with respect to the
financial statements of Datakey, Inc., which appear in Item 7 of the annual
report on Form 10-KSB for the year ended December 31, 1997.
/s/ McGLADREY & PULLEN, LLP
Minneapolis, Minnesota
March 25, 1998
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0
375,000
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</TABLE>
