10KSB

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, 2002

Commission file No. 0-11447

DATAKEY, INC.

(Name of small business issuer in its charter)

MINNESOTA
(State of incorporation or organization) 41-1291472
(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:    (952) 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

Series B Preferred Stock Purchase Rights Pursuant to Rights Agreement

(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  o

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: $8,127,000, which represents $7,257,000 for continuing operations and $870,000 for discontinued operations.

The aggregate market value of the Issuer’s Common Stock held by non-affiliates was approximately $6,924,582 based upon the closing sale price of the Issuer’s Common Stock on March 21, 2003.

As of March 21, 2003, there were 10,125,032 shares of the Issuer’s Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

     Portions of the Company’s definitive Proxy Statement for its Annual Meeting of Shareholders to be held on May 28, 2003 are incorporated by reference pursuant to Rule 12b-23 into Items 9, 10, 11 and 12 of Part III.

     Transitional Small Business Disclosure Format (check one)    YES  o    NO  x

TABLE OF CONTENTS

PART I
	ITEM 1. DESCRIPTION OF BUSINESS
	ITEM 2. DESCRIPTION OF PROPERTY
	ITEM 3. LEGAL PROCEEDINGS
	ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
PART II
	ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
	ITEM 6. MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
	ITEM 7. FINANCIAL STATEMENTS
	ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
PART III
	ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS, COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
	ITEM 10. EXECUTIVE COMPENSATION
	ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
	ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
	ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
	ITEM 14. CONTROLS AND PROCEDURES
SIGNATURES
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
EXHIBIT INDEX
EX-3.1 Restated Articles of Incorporation
EX-3.2 Restated Bylaws
EX-10.18 2003 Executive Incentive Plan
EX-10.19 Employment Agreement
EX-23.1 Consent of Independent Accountant
EX-99.1 Certification of Chief Executive Officer
EX-99.1 Certification of Chief Financial Officer

PART I

ITEM 1. DESCRIPTION OF BUSINESS

General

Datakey Inc. was founded in 1976 as a manufacturer of rugged memory keys and tokens to reliably store and transfer electronic data. For more than two decades, the Company’s unique, easy-to-use “Data Keys” were integrated into a wide range of industrial and commercial applications throughout the world to help businesses run their equipment and control their operations with electronic information. One notable application for Datakey tokens was for accessing a cryptographic telephone used to protect private and sensitive communications between high-ranking government officials. Datakey delivered more than 1 million tokens to operate these cryptographic telephones.

     Recognizing the growing need to secure access to computer networks and to protect electronic data – Datakey memory key technology was revised and re-engineered to develop a prototype secure token for computer workstation authentication in 1989. Based on this secure token, Datakey pioneered the first cryptographic smart card used for digital signatures in 1991.

     During the 1990s, Datakey continued to refine and set the standards for cryptographic smart card technology, drawing upon its existing memory key technology to form the basis of its new smart card product line. With the divestiture of the company’s traditional Electronics Products (memory key) business unit in August 2001, Datakey today dedicates all its resources to delivering smart card technology for access and identity management.

Interoperable Smart Card Solutions for Access and Identity Management Datakey focuses on delivering complete smart card-based solutions that simplify access and identity management throughout the enterprise. We believe our solutions make it easier to administer digital identities and to manage access to corporate resources. In turn, it’s more convenient and secure for users to login to company resources by consolidating all credentials onto one smart card and automating access through a single smart card sign-on. The core components of Datakey’s solution set – its Management Center software, smart cards and card management system – enable enterprises to identity users and open doors in both the physical and online worlds.

     A strict adherence to industry standards allows Datakey technology to “plug and play” with more authentication/security software products than any other technology. Customers and partners alike rely on Datakey’s interoperable technology as the foundation for securing a wide range of their existing applications and environments.

Product Applications

Customers use Datakey smart cards and software for a diverse range of applications:

• Smart ID Badge
Datakey smart cards, when combined with building access control technologies, function as both an employee’s physical ID as well as digital ID. The same smart card that is used for network and computer security can be personalized and printed with ID pictures to function as an employee’s ID badge, and fitted with a magnetic stripe or RF proximity technology for door access systems.

• Password Management/Consolidation of Credentials
Datakey smart cards offer a medium for storing all of a user’s access credentials, including passwords, digital certificates, VPN/dial-up credentials or biometric templates. Instead of having to remember multiple passwords or maintain many certificates to access corporate applications and protected web sites, the user only has to remember one PIN to activate their smart card.

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• Network Authentication
Datakey smart card technology is used to enable secure network logon. Windows 2000, XP and later versions of Windows support smart card logon. In addition, digital certificate/PKI products can be deployed together with Datakey smart cards to enable secure network authentication and logon based on PKI.

Datakey smart card technology also works with dynamic password products to enable an enterprise to use one-time authentication codes for network access or application authentication. Datakey smart cards integrate seamlessly with one-time password and authentication server products.

• Single Sign On
Datakey’s smart card solution enables Single Sign-On to company applications and resources. When the user logs into the network by inserting their smart card, they only enter their PIN one time for authentication. In doing so, the user gains access not only to the network, but also to company applications (accounting system, CRM, e-mail, etc.).

• Secure E-mail
Microsoft Outlook and Outlook Express, and Netscape Messenger, support Datakey smart cards for digitally signing and encrypting e-mail messages. A user generates/stores their digital certificate and public/private key pair on their smart card, and through the built-in support in Outlook and Messenger, have the capability of digitally signing their e-mail message or encrypting an e-mail message when they possess a valid certificate from another user.

• Computer Security
Datakey smart card technology protects access to an employee’s desktop/laptop computer, as well as protects the data that resides on that computer. Datakey smart cards can be used for pre-boot authentication, file/folder encryption and computer lock-down functions.

• Secure VPN access
VPN technology gives remote or traveling users the ability to connect to the corporate network through a secure, encrypted tunnel. Many enterprises are using Datakey smart cards as part of their VPN solution to enable greater security for user authentication. A user’s credentials (whether password-based or a digital certificate) are stored on a Datakey smart card for greater flexibility, portability and security. These credentials travel with the user anywhere they carry their smart card.

• Digital signature applications
Datakey smart cards have been integrated with a range of applications for digitally signing XML-based forms, Adobe .pdf files and other documents.

Product Descriptions

Datakey CIP (Cryptographic Interface Provider). 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 often insufficient for public networks with connections, such as extranets and the Internet, outside of the organization. Datakey’s CIP allows enterprise users 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. CIP provides token add-ons to Cryptoki (PKCS-11) standard information security interface applications and for applications that incorporate Microsoft’s CryptoAPI (CAPI). It offers “load, plug and play” convenience for strong information security. CIP includes three elements:

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• A user-unique smart card or smart key “token” that holds critical information and performs the cryptographic functions necessary for information security.

• A companion reader that plugs into a computer’s serial port, PCMCIA port or USB port.

• Software that is installed in the workstation and interfaces to the application program.

Datakey CIP Thin. During 2001, Datakey introduced a “server-based” version of the “client based” CIP. CIP Thin contains all the features and functionality of CIP but is installed on the server instead of on each individual workstation.

Datakey DTK (Developers Tool Kit). DTK is a turnkey package to assist software developers in integration of Datakey hardware tokens and a public key infrastructure (PKI) into their applications. DTK is available in several configurations ranging from a token with a reader/writer and integration software, to the full PKI configuration that issues and manages hardware tokens and digital certificates. This product flexibility allows developers who utilize DTK to integrate just what is needed for their application.

Datakey CMS (Card Management System) CMS is a web-based smart card and digital credential management solution for enterprises – used to issue, manage and support Datakey cryptographic smart cards throughout the organization for identity-based applications. Datakey CMS gives enterprise customers a powerful, secure system that reduces the cost of deploying and supporting smart cards. Through innovative, policy-based enrollment features, Datakey CMS significantly reduces the time an enterprise must spend issuing and managing smart cards for geographically distributed users. Datakey CMS makes it easier to perform a wide range of critical digital credential management activities – everything from requesting or renewing a user’s digital credentials to revoking or re-issuing these credentials.

Datakey CIP Desktop CIP Desktop is a suite of complementary applications that work seamlessly with Datakey’s field-tested CIP software to extend the usability of Datakey smart cards with functions like password management, data storage and smart card configuration. CIP Desktop effectively extends the flexibility, functionality and power of smart cards for desktop security while continuing to enable the two-factor security and strong user authentication increasingly required in enterprise network environments.

     NEW PRODUCT FOR 2003

Datakey Axis. Axis is a smart card-based solution that simplifies access control and identity management throughout the enterprise. Datakey Axis makes it much more convenient and secure for users to login to company resources by consolidating all credentials/user identities onto one smart card and automating access through a Single Sign-On. With this product, we are primarily targeting enterprises that do not currently intend to install a PKI.

For the administrator, Datakey Axis Rapid Deploy Technology™ automates policy, credential and desktop management through a single, powerful Management Center. It makes it much easier to configure and deploy smart cards for access to a complete range of corporate resources – without requiring any changes to the existing infrastructure.

We plan to have this production ready during the second quarter of 2003. Success of this new product depends upon our demonstration that it does, indeed, make management of multiple passwords very easy for the administrator to maintain, that the smart card’s convenience far outweighs the cost, and that passwords in combination with smart cards are far more secure than passwords alone.

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Large and medium-sized enterprises benefit from rapid return on investment (ROI) through an increase in productivity and a reduction in administrator workload.

OEM Private Label Products. Datakey also provides its family of information security products to OEM’s under their own private label.

OEM Technology Licensing. In addition to selling products, Datakey licenses its smart card operating system and CIP software to OEM’s for incorporation into their products. Licenses are sold on a per seat basis with revenue recognized at time of delivery to the customer, provided that Datakey has no significant cost or obligation beyond the original authorization to the silicon supplier.

Manufacturing

As a result of selling the Electronic Products business unit in August 2001, the Company no longer maintains an internal manufacturing capability. We do, however, control the manufacturing process for our cards with several outside assembly operations, and we buy our readers, with an imprinted Datakey logo, from several smart card reader companies.

Sources of Supply

The Company purchases a microprocessor, with its proprietary operating system masked into the chip, from a single source supplier. The Company is currently qualifying other suppliers of the microprocessor to reduce the dependency on one supplier.

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 interchangeable with another. Should the present source of supply become inadequate or inferior to other offerings in the future or should its secondary suppliers be inadequate, the Company would be required to incur a significant cost and possibly experience a gap in supply to switch to a new supplier.

The Company continues to offer a Smart Key version of the smart card offering. Although this product has not received broad acceptance, several customers have expressed interest in it as an alternative to the card. If we receive orders for this product, the company that purchased our former EP business will be our sole source of supply.

Significant Customers

Sales to a group of the Company’s customers, representing agencies of the Canadian Government, totaled approximately $2,127,000, or 29% of net sales, during the year ended December 31, 2002, with one agency representing approximately $1,300,000, or 18% of net sales. Export sales to international customers, including Canada, from continuing operations, for 2002 and 2001 were approximately $4,168,000 and $5,206,000, or 57% and 67% of total sales, respectively. Direct and indirect sales to U.S. government agencies from continuing operations were approximately $1,756,000 and $1,250,000, or 24% and 16% of total sales, in 2002 and 2001, respectively.

Markets Served

Datakey smart card technology represents a strong solution for many organizations that face increasing challenges in the areas of access and identity management. Whether a company relies on usernames/passwords or digital certificates and PKI, Datakey smart card technology simplifies the experience for the administrator and end-user by consolidating all credentials on one smart card for complete corporate access. Datakey technology also continues to be ideally suited for those organizations

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that require the highest practical level of security for users accessing physical and logical resources like buildings, the corporate network and applications.

Datakey’s target customer base includes large and medium-size businesses worldwide. We sell our products principally through value-added resellers (VARs) and system integrators. Within the large enterprise segment, Datakey partners with system integrators to more specifically target Global 2000 corporations, government organizations and financial institutions. Expanding our base of VAR partners is critical to reaching the medium-size business market where demand for information security products is growing rapidly.

We team with the top information security companies in the industry, including Baltimore Technologies, Check Point Software, Computer Associates, Citrix, Entrust, Nortel, Precise Biometrics, RSA Security, Secure Computing, VASCO and VeriSign. We believe Datakey has earned the trust of these leading companies because our solutions work immediately and effectively with their security applications and software.

Customers

Currently, more than 800,000 users at more than 1,500 organizations worldwide take advantage of Datakey smart card technology. Our established history and widespread exposure to such a large number of demanding customer environments has allowed us to maintain our technology lead, providing better products and more responsive service than any other smart card developer.

The list of organizations using Datakey smart card technology speaks for itself. Included among the customers that Datakey is allowed to publicly identify are:

•	Bank of England	•	Siemens
•	Canadian Department of National Defence	•	U.S. Bureau of Labor Statistics
•	Federal Deposit Insurance Corporation (FDIC)	•	U.S. Department of Energy
•	ING Barings	•	U.S. Department of State
•	Rabobank	•	Wells Fargo Bank

In addition, industry-leaders such as Datacard, Rainbow Technologies (iKey 2000 series), SafeNet (SafeNet/Smart VPN), Clearstream and SWIFT rely on the strength of Datakey’s core technology and have integrated it as central components of their own product lines.

Sales in North America are generally conducted through direct sales representatives and value-added resellers. The Company has a number of resellers in Europe, South America and Asia/Pacific and plans to add more international resellers as appropriate to serve those markets. In 2002 and 2001, sales to domestic customers and the corresponding percentage of total revenue, were approximately $3,089,000 (43%) and $2,609,000 (33%), respectively. Sales to international customers, including Canada, and the corresponding percentage of revenue, were approximately $4,168,000 (57%) and $5,206,000 (67%), respectively, in 2002 and 2001.

Backlog

As of March 21, 2003, the Company had an order backlog from continuing operations totaling approximately $352,000. Although the orders generally 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.

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Competition

Information Security Solutions. Datakey currently offers token-based (smart card, smart key and iKey) information security solutions which are primarily utilized for electronic mail privacy, remote network authentication private and secure file transfer and digital signatures for electronic document authentication. The Company is continuing a significant product development effort to expand the applications and ease-of-use of its products and systems. See “Products—Information Security 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, smart key or iKey and utilize passwords, encryption and digital signatures. They also include extensive software to make the system user-friendly and seamless with common desktop software packages. 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, pilot programs and initial deployments of production programs have been progressing very well, although the worldwide economic slowdown has hindered this progress. There are no assurances, however, that the existing and future products will, in the long term, be accepted in the marketplace.

The technology involved in information security systems is 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.

Research and Development, Engineering and Technical Support

In 2002 and 2001, research and development, engineering and technical support expenses (RDETS) were $2,314,000 and $2,325,000, respectively. The Company expects that RDETS expenses in 2003 will decrease by about nine percent (9%) as the Company plans to continue new product development and technical support at a reduced rate in light of current economic conditions.

Employees

As of March 21, 2003, the Company employs 33 full-time employees, 3 in procurement and materials handling, 3 in technical support, 11 in engineering, 10 in marketing/sales and 6 in general and administrative areas. The Company’s employees are not subject to a collective bargaining agreement, and the Company believes that its employee relations are good.

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ITEM 2. DESCRIPTION OF PROPERTY

     The Company’s corporate offices and shipping/warehouse facility, located at 407 West Travelers Trail, Burnsville, Minnesota, consist of approximately 25,000 square feet including approximately 13,000 square feet that is currently under a sublease between the Company and Datakey Electronics. Of the space not subleased, approximately one-third of the space is used for shipping and warehousing, and the balance for present and future office space. All of this space is rented under a lease that extends through June 2004. The annualized rent expense for the space currently occupied is $178,000, plus a portion of the operating expenses and real estate taxes. Sublease payments are approximately $100,000 per year.

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 2002.

PART II

ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS

The Company’s common stock is currently traded on the Nasdaq SmallCap Market 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 2002 and 2001.

On March 21, 2003, the Company had approximately 4,300 shareholders, including approximately 4,000 beneficial owners. The Company has never paid dividends on its common stock and does not plan to in the foreseeable future.

		Sale Prices
		High		Low
2002
	1st Quarter	$	6.99	$	3.65
	2nd Quarter	$	5.05	$	2.50
	3rd Quarter	$	3.60	$	2.01
	4th Quarter	$	2.50	$	1.35
2001
	1st Quarter	$	4.75	$	2.00
	2nd Quarter	$	3.77	$	1.63
	3rd Quarter	$	3.46	$	1.58
	4th Quarter	$	6.35	$	2.90

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ITEM 6. MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION

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 from continuing operations for each of the past two years. Inflation has not been a significant factor in Datakey’s operations to date.

		Percentage of Total Revenue
Year Ended December 31,		2002			2001
Revenue			100	%		100	%
Cost and Expenses Cost of goods sold			50			43
Research and development, engineering and technical support			31			30
Marketing and sales			46			44
General and administrative			10			10
	Total cost and expenses		137			127
Operating loss			(37	)		(27	)
Interest income			0			1
Loss before income taxes			(37	)		(26	)
Income taxes			—			—
Net loss from continuing operations			(37	)%		(26	)%

Comparison of 2002 with 2001

Continuing Operations

Total revenue: Total revenue was $7,257,000 in 2002 compared to $7,815,000 in 2001. This decline in revenue was attributable primarily to a general reduction in information technology spending as a result of the international economic slowdown and a related delay in adoption of Public Key Infrastructure (PKI) with which the Company’s products have primarily been designed to work. There is no assurance that the economy will improve materially or that potential customers will be willing to invest in PKI, even if the economy improves. The Company has not yet been able to prove that its products will ever achieve sufficient market acceptance to attain profitability.

Gross margins: The gross profit margin decreased to 50 percent in 2002 from 57 percent in 2001 principally due to delivery of about $1.3 million of USB tokens in the first quarter of 2002 for which the Company acts as a reseller and which carry significantly lower margins than the Company’s standard products.

Research and development, engineering and technical support (RDETS): Research and development, engineering and technical support expense decreased by one percent to $2,314,000 in 2002 from $2,325,000 in 2001. Such expenses represented 31 and 30 percent of sales in 2002 and 2001, respectively. RDETS decreased only slightly during 2002 as the Company continued the development and support of its information security products in spite of the slow economy.

Marketing and sales, General and administrative: Marketing and sales expense decreased three percent to $3,347,000 in 2002 from $3,461,000 in 2001. As a percentage of revenue these expenses increased from 44 to 46 percent. The decrease in 2002 marketing and sales expense primarily resulted from lower commissions paid on the lower level of sales.

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General and administrative expenses decreased five percent to $707,000 in 2002 from $744,000 in 2001 primarily as a result of a reduction in payroll related expenses.

Interest income: Interest income, net of interest expense, decreased to $45,000 in 2002 from $79,000 in 2001, primarily due to a significant reduction in the market rate of interest on interest bearing accounts and reduced account in such balances due to use of cash to fund operating losses.

Income tax expense: As a result of the cumulative net operating loss carryovers of approximately $20,129,000 at December 31, 2002, and $17,936,000 at December 31, 2001, the Company recorded no income tax expense in either year.

Net loss. Net loss from continuing operations in 2002 was $2,668,000 compared to $2,006,000 in 2001, primarily due to the decrease in revenue and gross margin. Based on anticipated first quarter and 2003 revenues and profit margins, the Company believes that it will record a loss for the year comparable to the loss sustained in 2002.

Discontinued Operations

The Company announced in February 2001 that it planned to phase down or divest its EP business segment. Subsequently, the operations were sold in August 2001. As a result, the gain of $351,000, which was the result of the completion of the final contract, in 2002 and loss of $487,000 in 2001 were reflected as discontinued operations.

Comparison of 2001 with 2000

Continuing Operations

Total revenue: Total revenue was $7,815,000 in 2001 compared to $3,608,000 in 2000. The substantial increase in revenue was due to increasing acceptance and demand for our information security solutions’ products.

Gross margins: The gross profit margin increased to 57 percent in 2001 from 47 percent in 2000 primarily due to a significant reduction in the costs of materials used in cards and readers without a corresponding reduction in the selling price.

Research and development, engineering and technical support (RDETS): Research and development, engineering and technical support expense increased by 16 percent to $2,325,000 in 2001 from $2,003,000 in 2000. Such expenses represented 30 and 56 percent of sales in 2001 and 2000, respectively. RDETS expense increased during 2001 as the Company continued the development and support activities of its information security products.

Marketing and sales, General and administrative: Marketing and sales expense increased 56 percent to $3,461,000 in 2001 from $2,216,000 in 2000. As a percentage of revenue these expenses decreased from 61 to 44 percent. The increase in 2001 marketing and sales expense resulted from additions to the sales staff, increased commissions due to higher revenue and continuing promotional activities to promote the Company’s information security products. General and administrative expenses increased 28 percent to $744,000 in 2001 from $582,000 in 2000 primarily as a result of increases in legal, audit, insurance and employment related expenses.

Interest income: Interest income, net of interest expense, decreased to $79,000 in 2001 from $145,000 in 2000, primarily due to a significant reduction in the market rate of interest on interest bearing accounts.

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Income tax expense: As a result of the cumulative net operating loss carryovers of approximately $17,936,000 at December 31, 2001, and $13,514,000 at December 31, 2000, the Company recorded no income tax expense in either year.

Net loss. Net loss in 2001 was $2,006,000 compared to $2,953,000 in 2000, primarily due to the substantial increase in revenue and gross margin that more than offset the increase in expenses.

Liquidity and Capital Resources

Cash as of December 31, 2002, was $2,563,000 as compared to $4,112,000 as of December 31, 2001. The Company had a $1,550,000 use of cash in 2002 as compared to a $2,580,000 increase in cash in 2001. The 2001 increase was due to proceeds from the sale of common stock during the year of $4,752,000, offset by the net loss of $2,493,000. The 2002 reduction in cash was primarily due to the $2,317,000 net loss. The net loss was due, in part, to significant expenditures totaling $5,661,000 in research, development, engineering, technical support, and sales and marketing which were related to the Company’s information security products. The Company invested $317,000 in equipment, licenses and patents in 2002 compared to $307,000 in 2001. Based on the Company’s projected quarterly burn rate, the Company will be able to fund its operations in 2003. Its ability to fund its operations in 2003 and thereafter will depend on its revenue, profitability and cash flow trends which significantly influence its need for and ability to obtain needed debt or equity financing. There is no assurance that such financing will be available when required.

Datakey’s balance sheet reflected $3,953,000 in working capital and a current assets to current liabilities ratio of 3.9 to 1 as of December 31, 2002.

Contractual Cash Obligations
The Company presently has no long-term debt outstanding and its only contractual cash obligations are those from operating lease obligations. These lease obligations total $429,000 over the next three years as shown in Note 7 to the financial statements.

We believe that our cash balance, along with moderate increases in revenue and tight control over expenditures, will fund our operations through at least the next 12 months.

Critical Accounting Policies
Our significant accounting policies are summarized in the notes to our financial statements. Some of the most critical policies are also discussed below.

Revenue Recognition and Deferred Revenue: The revenue from products and systems sold is recognized upon shipment to the customer as we have no future obligation for support, upgrades or other services. If the customer purchases an extended maintenance contract, revenue from the contract is deferred and recognized over the term of the contract.

Shipping and handling charges to customers are included in net sales. Shipping and handling costs incurred by us are included in cost of goods sold.

Software Development Costs: Our policy on software development costs is to charge to expense those costs of software development incurred until the point of technical feasibility is attained, at which time such costs are capitalized.

Technical feasibility for our current products was attained several years ago, before we were able to ascertain the market acceptance of the products. As a result, we charged these costs to operations, as the net realizable value was not determinable at that time. Costs in recent years have been comprised primarily of maintenance and customer support, which have been charged to operations. New product

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development and/or significant product enhancements in the future may result in an increased level of capitalized software costs.

Reserves and Review for Impairment: As a matter of policy, we review our major assets for impairment. Our major operating assets are accounts receivable, inventory, license agreements and equipment and leasehold improvements. We have not experienced significant bad debts expense and our reserve for doubtful accounts of $55,000 should be adequate for any exposure to loss in our December 31, 2002 accounts receivable. We have also established reserves for slow moving and obsolete inventories and believe the reserve of $165,000 is adequate. We have also reserved $7,870,000, at December 31, 2002, for our deferred tax assets as realization is uncertain until we have sustained profitable operations.

We depreciate our property and equipment and license agreements over their estimated useful lives, and we have not identified any items that are impaired except for one license agreement for which we wrote off $49,000 in 2002 and $45,000 in 2001.

Recently Issued Accounting Pronouncements
In June 2002, the Financial Accounting Standards Board (“FASB”) issued Statement No. 146, Accounting for Costs Associated With Exit or Disposal Activities. This statement requires the recognition of a liability for a cost associated with an exit or disposal activity when the liability is incurred versus the date the Company commits to an exit plan. In addition, this statement states the liability should be initially measured at fair value. The statement is effective for exit or disposal activities that are initiated after December 31, 2002. The Company does not believe that the adoption of this pronouncement will have a material effect on its financial statements.

In January 2003, the FASB issued Statement No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure. This statement provides alternative methods of transition for a voluntary change to the fair value-based method of accounting for stock-based employee compensation. In addition, this statement also amends the disclosure requirements of SFAS No. 123 to require more prominent and frequent disclosures in the financial statements about the effects of stock-based compensation. The transitional guidance and annual disclosure provisions of this statement are effective for the December 31, 2002, financial statements. The interim reporting disclosure requirements will be effective for the Company’s Form 10-QSB for the quarter ending March 31, 2003. Because the Company continues to account for employee stock-based compensation under APB Opinion No. 25, the transitional guidance of Statement No. 148 had no effect on the Company’s financial statements. However, the December 31, 2002, financial statements have incorporated the enhanced disclosure requirements of Statement No. 148.

In January 2003, the FASB issued Interpretation No. 45 (“FIN 45”), Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. FIN 45 clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing certain guarantees. It also elaborates on the disclosures in FASB Statement No. 5, Accounting for Contingencies, which are to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued, even when the likelihood of making any payments under the guarantees is remote. The Company does not believe that the adoption of this pronouncement will have a material effect on its financial statements. The December 31, 2002 financial statements have incorporated the enhanced disclosure requirements of FIN 45, as discussed in Note 1 to the financial statements under the caption “product warranty.”

In January 2003, the FASB issued Interpretation No. 46 (“FIN 46”), Consolidation of Variable Interest Entities. This interpretation establishes standards for identifying a variable interest entity and for determining under what circumstances a variable interest entity should be consolidated with its primary beneficiary. Until now, a company generally has included another entity in its consolidated financial statements only if it controlled the entity through voting interests. FIN 46 changes that by requiring a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk

-12-

of loss from the variable interest entity’s activities or is entitled to receive a majority of the entity’s residual returns or both. The disclosure requirements of FIN 46 currently apply to the Company and the balance of the requirements will apply to the Company as of the 3rd Quarter of 2003. The Company does not believe that the adoption of this pronouncement will have a material effect on its consolidated financial statements.

Outlook & Risks

Certain statements in this Annual Report are forward looking, are based upon current expectations and actual results may differ materially due to certain risks and uncertainties, including those set forth below.

Revenue: Revenue in the first quarter of 2003 is expected to be down significantly from the $2,500,000 in the first quarter of 2002, but is expected to increase gradually during the year. Revenue increases depend on customer acceptance and demand of the Company’s existing products as well as the new Axis product, the effectiveness of the Company’s marketing and sales organization, as well as general business, economic and competitive conditions.

If a well-established company with much greater resources develops or begins to aggressively market a competitive product, if new technology emerges that surpasses that of the Company, or if similar technology is offered at a significantly lower price, the Company could face significant competition obstacles that would further negatively impact the Company’s ability to meet its revenue goals. Based on anticipated first quarter revenues, there is no assurance that the Company will achieve its revenue plan.

Gross margins: A gradual improvement in gross profit margins during 2003 is expected through effective material purchasing and additional contribution from software applications being developed. Such an increase in gross margin depends on achievement of the expected purchasing prices, realization of the revenue increases, a continuation of improvement in manufacturing processes and general market conditions.

The Company’s gross profit margin will continue to be negatively impacted due to the resale of certain products for which we do not act as a principal supplier. Revenue, if any, from technology licensing fees would positively impact revenue because they carry a very high margin. Less than 5 percent of revenue in 2002 and 2001 arose from technology licensing fees.

On balance, therefore, the gross profit margin in 2003 may increase or decrease depending on how significant revenue from resale of products becomes in relation to technology licensing fees, and the extent to which we are successful in achieving additional reductions in material costs.

Research and development, engineering and technical support: The Company intends to reduce, by about 9 percent, funding for product development and support activities in 2003 compared to the level in 2002. The ability to maintain such funding depends in significant part on the Company’s ability to meet its 2003 revenue plan.

Marketing and sales, General and administrative: Marketing and sales expenses are expected to decrease by about 7 percent in 2003 to bring overall expenses in line with expected revenue and to conserve cash.

General and administrative expenses in 2003 are expected to decrease about 30 percent reflecting significant reductions in outside services, payroll and employee benefits expenses.

Profit unlikely: The Company’s goal is to gradually increase revenue and tightly control expenses during the year so that there is a higher likelihood of approaching profitability by year end, but the ability to achieve this goal depends on significantly improved revenues in the remaining three quarters and there is no assurance this will occur.

-13-

Financial resources. In 2003, the Company plans to maintain expenditures for product development, marketing activities and inventory levels to support anticipated revenue growth. The Company’s current plan estimates annual revenue will increase modestly over the 2002 level. The Company believes its working capital will be sufficient to fund its planned operations and product development and promotional activities in 2003. If the Company’s cash burn rate is increased significantly as a result of a continued decrease in revenue, the Company may be required to seek debt or equity financing prior to the end of 2003. In this circumstance, the Company’s ability to obtain financing of any kind could be problematic, and its ability to fund its operations could be materially adversely affected.

Change to Use of Calendar Quarters. During 2003, the Company has changed its quarterly reporting cycle from 13-week intervals, more commonly employed by manufacturing companies, to calendar quarters. The Company does not believe the change in reported results will be material to quarterly results and will not affect comparisons to results in previous quarters.

ITEM 7. FINANCIAL STATEMENTS

     The following financial statements of the Company are included herein following the signature page of this Report on the pages set forth:

Independent Auditor’s Report	F-1
Balance Sheets as of December 31, 2002 and 2001	F-2
Statements of Operations for Years Ended December 31, 2002 and 2001	F-4
Statements of Stockholders’ Equity for Years Ended December 31, 2002 and 2001	F-5
Statements of Cash Flows for Years Ended December 31, 2002 and 2001	F-6
Notes to Financial Statements	F-7

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 2003 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 2003 Annual Meeting of Shareholders under the caption “Section 16(a) Beneficial Ownership Compliance.”

ITEM 10. EXECUTIVE COMPENSATION

     The information required by Item 10 is incorporated by reference to the Company’s proxy statement for its 2003 Annual Meeting of Shareholders under the caption “Executive Compensation.”

-14-

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT

     The information required by Item 11 with respect to security ownership of certain individuals is incorporated by reference to the Company’s proxy statement for its 2003 Annual Meeting of Shareholders under the caption “Security Ownership of Management and Certain Beneficial Owners.”

     The following table provides information concerning the Company’s equity compensation plans as of December 31, 2002.

					Number of securities
	Number of securities				remaining available for
	to be issued upon		Weighted average		future issuance under
	exercise of		exercise price of		equity compensation
	outstanding		outstanding		plans
	options, warrants and		options, warrants		(excluding securities
Plan Category	rights		and rights		reflected in column (a))
	(a)		(b)		(c)
Equity compensation plans approved by security holders		1,403,515	$	3.51		416,173	(2)
Equity compensation plans not approved by security holders(1)		35,000	$	3.63		50,000
TOTAL		1,438,515	$	3.51		466,173

(1) The only plan not approved by the Company’s shareholders is the 1994 Consultant Stock Option Plan (the “Plan”) adopted in 1994. The Plan provides for the granting of stock options to distributors, consultants, sales agents and dealers who are not employees of the Company, which options can be granted with such terms as determined by the Board of Directors. The only outstanding option under the Plan was granted at the fair market value on the date of grant, became exercisable in three annual increments and expires on October 31, 2005. No options have been granted pursuant to the Plan since November 1995.

(2) Includes 56,121 shares available for issuance under the Company's 1998 Employee Stock Purchase Plan.

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     The information required by Item 12 is incorporated by reference to the Company’s proxy statement for its 2003 Annual Meeting of Shareholders under the caption “Certain Relationships and Related Transactions.”

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.

     Datakey filed no reports on Form 8-K during the fourth quarter of 2002, but it did file a Form 8-K dated March 3, 2003 announcing the resignation of Carl Boecher as its President and Chief Executive Officer and the appointment of Tim Russell as President and Chief Executive Officer.

-15-

ITEM 14. CONTROLS AND PROCEDURES

     Within 90 days prior to the date of this report, we carried out an evaluation, under the supervision and participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based upon the evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information required to be included in our periodic SEC filings. No significant change has occurred in the Company’s internal controls since the date of the evaluation that could significantly affect these controls subsequent to the date of the evaluation.

-16-

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, 2003	DATAKEY, INC.
	BY:	/s/ Timothy L. Russell Timothy L. Russell Chief Executive Officer (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 Timothy L Russell and Alan G. Shuler as his true and lawful attorneys-in-fact and agents, each acting alone, with full power of substitution and re-substitution, 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/ Timothy L. Russell Timothy L. Russell	Chief Executive Officer (Principal Executive Officer)	March 26, 2003
/s/ Alan G. Shuler Alan G. Shuler	Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)	March 26, 2003
/s/ Thomas R. King Thomas R. King	Director and Secretary	March 26, 2003
/s/ Terrence W. Glarner Terrence W. Glarner	Director	March 26, 2003
/s/ Carl P. Boecher Carl P. Boecher	Vice Chairman of the Board of Directors	March 20, 2003
/s/ Gary R. Holland Gary R. Holland	Chairman of the Board of Directors	March 20, 2003
/s/ Eugene W. Courtney Eugene W. Courtney	Director	March 26, 2003

2747866-6

-17-

CERTIFICATION OF CHIEF EXECUTIVE OFFICER

     In connection with this Annual Report of Datakey, Inc. Inc. (the “Company”) on Form 10-KSB for the year ended December 31, 2002 as filed with the Securities and Exchange Commission (the “Report”), I, Timothy L. Russell, Chief Executive Officer of the Company, certify, pursuant to §302(a) of the Sarbanes-Oxley Act of 2002 and related rules, that:

1.	I have reviewed this annual report on Form 10-KSB of Datakey, Inc. for the period ended December 31, 2002;
2.	Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3.	Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the Company as of, and for, the periods presented in this annual report;
4.	The Company’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d -14) for the Company and have:
	a) designed such disclosure controls and procedures to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
	b) evaluated the effectiveness of the Company’s disclosure controls and procedures as of a date within 90 days prior to the filing date of the annual report (the “Evaluation Date”);
	c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5.	The Company’s other certifying officer and I have disclosed, based on our most recent evaluation, to the Company’s auditors and the audit committee of the Company’s board of directors:
	a) all significant deficiencies in the design or operation of internal controls which could adversely affect the Company’s ability to record, process, summarize and report financial data and have identified for the Company’s auditors any material weaknesses in internal controls; and
	b) any fraud, whether or not material, that involves management or other employees which have a significant role in the Company’s internal controls; and
6.	The Company’s other certifying officer and I have indicated in this annual report whether there were significant changes in the internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: March 26, 2003 Signature: /s/ Timothy L. Russell
Timothy L. Russell
Chief Executive Officer

-18-

CERTIFICATION OF CHIEF FINANCIAL OFFICER

     In connection with this Annual Report of Datakey, Inc. Inc. (the “Company”) on Form 10-KSB for the year ended December 31, 2002 as filed with the Securities and Exchange Commission (the “Report”), I, Alan G. Shuler, Chief Financial Officer of the Company, certify, pursuant to §302(a) of the Sarbanes-Oxley Act of 2002 and related rules, that:

1.	I have reviewed this annual report on Form 10-KSB of Datakey, Inc. for the period ended December 31, 2002;
2.	Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3.	Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the Company as of, and for, the periods presented in this annual report;
4.	The Company’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d -14) for the Company and have:
	a) designed such disclosure controls and procedures to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
	b) evaluated the effectiveness of the Company’s disclosure controls and procedures as of a date within 90 days prior to the filing date of the annual report (the “Evaluation Date”);
	c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5.	The Company’s other certifying officer and I have disclosed, based on our most recent evaluation, to the Company’s auditors and the audit committee of the Company’s board of directors:
	a) all significant deficiencies in the design or operation of internal controls which could adversely affect the Company’s ability to record, process, summarize and report financial data and have identified for the Company’s auditors any material weaknesses in internal controls; and
	b) any fraud, whether or not material, that involves management or other employees which have a significant role in the Company’s internal controls; and
6.	The Company’s other certifying officer and I have indicated in this annual report whether there were significant changes in the internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: March 26, 2003 Signature: /s/ Alan G. Shuler
Alan G. Shuler
Chief Financial Officer

-19-

INDEPENDENT AUDITOR’S REPORT

To the Stockholders
Datakey, Inc.
Burnsville, Minnesota

We have audited the accompanying balance sheets of Datakey, Inc. as of December 31, 2002 and 2001, and the related statements of operations, stockholders’ equity and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the 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 financial statements referred to above present fairly, in all material respects, the financial position of Datakey, Inc. as of December 31, 2002 and 2001, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

/s/  McGladrey & Pullen, LLP

Minneapolis, Minnesota
January 31, 2003

McGladrey & Pullen, LLP is an independent member firm of
RSM International, an affiliation of independent accounting
and consulting firms.

F-1

DATAKEY, INC.

BALANCE SHEETS
December 31, 2002 and 2001

ASSETS			2002		2001
Current Assets
	Cash and cash equivalents		$	2,562,611	$	4,112,264
	Trade receivables, less allowance for doubtful accounts of $55,000 in 2002 and $28,000 in 2001 (Note 6)			1,700,434		2,154,723
	Inventories (Note 2)			996,532		926,028
	Prepaid expenses and other			65,259		84,433
	Net assets of discontinued operations (Note 9)			—		82,077
		Total current assets		5,324,836		7,359,525
Other Assets
	Licenses, less accumulated amortization (Note 10)			236,817		191,839
Equipment and Leasehold Improvements, at cost
	Production tooling			23,650		209,752
	Equipment			735,916		671,221
	Furniture and fixtures			166,520		166,520
	Leasehold improvements			310,912		146,812
				1,236,998		1,194,305
	Less accumulated depreciation			927,844		803,548
				309,154		390,757
			$	5,870,807	$	7,942,121

See Notes to Financial Statements.

F-2

LIABILITIES AND STOCKHOLDERS' EQUITY				2002			2001
Current Liabilities
	Accounts payable			$	574,266		$	566,345
	Accrued expenses:
		Compensation			287,718			313,098
		Other			154,267			118,119
	Deferred revenue				355,338			474,897
			Total current liabilities		1,371,589			1,472,459
Commitments and Contingencies (Notes 7, 9 and 10)
Stockholders’ Equity (Notes 4 and 5)
	Convertible preferred stock, voting, liquidation 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 20,000,000 shares; issued and outstanding 10,082,750 shares in 2002 and 9,974,012 shares in 2001				504,138			498,701
	Additional paid-in capital				18,921,150			18,580,288
	Accumulated deficit				(15,301,070	)		(12,984,327	)
					4,499,218			6,469,662
				$	5,870,807		$	7,942,121

F-3

DATAKEY, INC.

STATEMENTS OF OPERATIONS
Years Ended December 31, 2002 and 2001

			2002			2001
Net sales (Note 6)			$	7,257,109		$	7,814,850
Costs and expenses:
	Cost of goods sold			3,601,347			3,369,483
	Research and development, engineering and technical support			2,314,391			2,325,037
	Marketing and sales			3,346,501			3,460,675
	General and administrative			707,296			744,335
		Total costs and expenses		9,969,535			9,899,530
		Operating loss		(2,712,426	)		(2,084,680	)
Interest income				44,637			109,028
Interest expense				—			(30,096	)
		Loss from continuing operations before income taxes		(2,667,789	)		(2,005,748	)
Income tax expense (Note 3)				—			—
		Net loss from continuing operations		(2,667,789	)		(2,005,748	)
Discontinued operations (Note 9):
	Gain (loss) on disposal of discontinued segment			351,046			(487,045	)
		Gain (loss) from discontinued operations		351,046			(487,045	)
		Net loss	$	(2,316,743	)	$	(2,492,793	)
Loss per share:
	Basic and diluted loss from continuing operations		$	(0.26	)	$	(0.21	)
	Basic and diluted gain (loss) from discontinued operations			0.03			(0.05	)
		Basic and diluted loss per common share	$	(0.23	)	$	(0.26	)
Weighted-average common shares:
	Basic and diluted			10,074,871			9,714,002

See Notes to Financial Statements.

F-4

DATAKEY, INC.

STATEMENTS OF STOCKHOLDERS’ EQUITY
Years Ended December 31, 2002 and 2001

		Convertible
		Preferred Stock				Common Stock				Additional
										Paid-In		Accumulated
		Shares		Amount		Shares		Amount		Capital		Deficit			Total
Balance, December 31, 2000			150,000	$	375,000		8,269,173	$	413,459	$	13,906,744	$	(10,491,534	)	$	4,203,669
	Issuance of common stock (net of offering expenses of $297,066)		—		—		1,601,633		80,082		4,414,505		—			4,494,587
	Exercise of stock options		—		—		87,840		4,392		210,916		—			215,308
	Issuance of common stock in accordance with employee stock purchase plan (Note 5)		—		—		15,366		768		40,874		—			41,642
	Compensation expense from stock options		—		—		—		—		7,249		—			7,249
	Net loss		—		—		—		—		—		(2,492,793	)		(2,492,793	)
Balance, December 31, 2001			150,000		375,000		9,974,012		498,701		18,580,288		(12,984,327	)		6,469,662
	Exercise of stock options		—		—		6,667		333		9,667		—			10,000
	Exercise of warrants		—		—		80,268		4,014		272,109		—			276,123
	Issuance of common stock in accordance with employee stock purchase plan (Note 5)		—		—		21,803		1,090		59,086		—			60,176
	Net loss		—		—		—		—		—		(2,316,743	)		(2,316,743	)
Balance, December 31, 2002			150,000	$	375,000		10,082,750	$	504,138	$	18,921,150	$	(15,301,070	)	$	4,499,218

See Notes to Financial Statements.

F-5

DATAKEY, INC.

STATEMENTS OF CASH FLOWS
Years Ended December 31, 2002 and 2001

					2002			2001
Cash Flows From Operating Activities
	Net loss				$	(2,316,743	)	$	(2,492,793	)
	Adjustments to reconcile net loss to net cash used in operating activities:
		Depreciation				170,528			233,403
		Amortization				182,847			415,934
		Utilization of reserve for loss of discontinued segment				—			(1,281,000	)
		Loss on disposal of equipment				682			144,146
		Noncash compensation from stock options				—			7,249
		Changes in assets and liabilities:
			Trade receivables			536,366			(749,499	)
			Inventories			(70,504	)		1,035,306
			Prepaid expenses			19,174			28,743
			Accounts payable			7,921			(177,808	)
			Deferred revenue			(119,559	)		411,100
			Other			10,768			7,048
				Net cash used in operating activities		(1,578,520	)		(2,418,171	)
Cash Flows From Investing Activities
	Purchases of equipment					(89,607	)		(271,390	)
	Proceeds on sale of segment					—			550,000
	Proceeds on sale of equipment					—			3,730
	Purchased licenses					(227,825	)		(36,000	)
				Net cash provided by (used in) investing activities		(317,432	)		246,340
Cash Flows From Financing Activities
	Net proceeds from issuance of common stock					346,299			4,751,537
				Increase (decrease) in cash and cash equivalents		(1,549,653	)		2,579,706
Cash and Cash Equivalents
	Beginning					4,112,264			1,532,558
	Ending				$	2,562,611		$	4,112,264
Supplemental Disclosures of Noncash Items
	Cash paid for interest				$	—		$	30,096

See Notes to Financial Statements.

F-6

DATAKEY, INC.

NOTES TO FINANCIAL STATEMENTS

Note 1. Nature of Business and Significant Accounting Policies

Nature of business: Datakey, Inc. provides products and systems directed to the information security market, which enables user identification and authentication, secure data exchange and information validation. The Company discontinued a segment (Note 9) which provided electronic products, consisting of proprietary memory keys, cards and other custom-shaped tokens, that served as a convenient way to carry electronic information and were packaged to survive in portable environments. The Company has a wholly owned subsidiary which is inactive.

A summary of significant accounting policies follows:

Use of estimates: The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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 in 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 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.

Trade receivables: Trade receivables are carried at original invoice amount less an estimate made for doubtful receivables based on a review of all outstanding amounts on a quarterly basis. Management determines the allowance for doubtful accounts by identifying troubled accounts and by using historical experience applied to an aging of accounts. Trade receivables are written off when deemed uncollectible. Recoveries of trade receivables previously written off are recorded when received.

A trade receivable is considered to be past due if any portion of the receivable balance is outstanding for more than 60 days.

Inventories: Inventories are stated at the lower of cost (first-in, first-out method) or market.

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		3-7
Furniture and fixtures		7
Leasehold improvements	Life of lease

F-7

DATAKEY, INC.

NOTES TO FINANCIAL STATEMENTS

Note 1. Nature of Business and Significant Accounting Policies (Continued)

Income taxes: Deferred taxes are provided on an asset and 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 and deferred revenue: The revenue from products and systems sold by the information security business segment is recognized upon shipment to the customer, as the Company has no future obligation for support, upgrades or other services. If the customer purchases an extended maintenance contract, revenue from the contract is deferred and recognized over the term of the contract.

The revenue from products sold by the electronic products business segment is recognized upon shipment, FOB shipping point. This segment, now discontinued, fulfilled its last contract in 2002.

Shipping and handling charges to customers are included in net sales. Shipping and handling costs incurred by the Company are included in cost of goods sold.

Software development costs: The Company’s policy is to charge to expense those costs of software development incurred until the point of technical feasibility is attained, at which time such costs are capitalized.

Technical feasibility for the Company’s current products was attained several years ago, before the Company was able to ascertain the market acceptance of the products. As a result, the Company charged these costs to operations, as the net realizable value was not determinable at that time. Costs in recent years have been comprised primarily of maintenance and customer support, which have been charged to operations. Company plans for new product development and/or significant product enhancements in the future may result in an increased level of capitalized software costs.

Research and development, engineering and technical support: Research and development costs, engineering and technical support are charged to expense as incurred and consist primarily of engineering expenses related to product development. Engineering and technical support consist primarily of maintenance of the Company’s products and systems. Research and development costs were approximately $1,903,000 and $1,972,000 during 2002 and 2001, respectively.

Advertising: Expenditures for advertising costs are expensed as incurred. Advertising and product promotion expense was approximately $106,000 and $83,000 during 2002 and 2001, respectively.

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 value.

Loss per share: The Company computes basic and diluted net loss per share based upon the weighted-average number of common shares outstanding during each year. Potential common shares, such as options and warrants, were not included in the computation of diluted loss per common share since their effect would be anti-dilutive. Due to the losses from continuing operations in 2002 and 2001, basic and diluted loss per share were the same for both years.

F-8

DATAKEY, INC.

NOTES TO FINANCIAL STATEMENTS

Note 1. Nature of Business and Significant Accounting Policies (Continued)

Recent accounting pronouncements: In April 2002, the FASB issued Statement No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendments of FASB Statement No. 13, and Technical Corrections. The Company does not believe that the adoption of the pronouncement will have a material effect on its financial statements.

In June 2002, the FASB issued Statement No. 146, Accounting for Costs Associated With Exit or Disposal Activities. This statement requires the recognition of a liability for a cost associated with an exit or disposal activity when the liability is incurred versus the date the Company commits to an exit plan. In addition, this statement states the liability should be initially measured at fair value. The statement is effective for exit or disposal activities that are initiated after December 31, 2002. The Company does not believe that the adoption of this pronouncement will have a material effect on its financial statements.

In January 2003, the FASB issued Statement No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure. This statement provides alternative methods of transition for a voluntary change to the fair value-based method of accounting for stock-based employee compensation. In addition, this statement also amends the disclosure requirements of Statement No. 123 to require more prominent and frequent disclosures in the financial statements about the effects of stock-based compensation. The transitional guidance and annual disclosure provisions of the statement is effective for the December 31, 2002, financial statements. The interim reporting disclosure requirements will be effective for the Company’s March 31, 2003, 10-QSB. Because the Company continues to account for employee stock-based compensation under APB Opinion No. 25, the transitional guidance of Statement No. 148 has no effect on the financial statements at this time. However, the December 31, 2002, financial statements have incorporated the enhanced disclosure requirements of Statement No. 148, as presented below under the caption “Stock-based compensation.”

In January 2003, the Financial Accounting Standards Board issued Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. FASB Interpretation No. 45 clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing certain guarantees. The December 31, 2002, financial statements have incorporated the enhanced disclosure requirements of Interpretation No. 45, as presented in Note 1 to the financial statements under the caption “Product warranty.” The Company does not anticipate that this interpretation will have other effects on the financial statements.

In January 2003, the Financial Accounting Standards Board issued Interpretation No. 46, Consolidation of Variable Interest Entities. This interpretation establishes standards for identifying a variable interest entity and for determining under what circumstances a variable interest entity should be consolidated with its primary beneficiary and where additional disclosures about such entities should be made. Until now, a company generally has included another entity in its consolidated financial statements only if it controlled the entity through voting interests. Interpretation No. 46 changes that by requiring a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or is entitled to receive a majority of the entity’s residual returns or both. The requirements of Interpretation No. 46 will apply to the Company for its quarter ending September 30, 2003. The Company does not believe that the adoption of this pronouncement will have a material effect on its financial statements.

F-9

DATAKEY, INC.

NOTES TO FINANCIAL STATEMENTS

Note 1. Nature of Business and Significant Accounting Policies (Continued)

Stock-based compensation: The Company regularly grants options to its employees under various plans as described below. As permitted under accounting principles generally accepted in the United States of America, these grants are accounted for following APB Opinion No. 25 and related interpretations. Accordingly, compensation cost has been recognized for those grants whose exercise price is less than the fair market value of the stock on the date of grant. There was no compensation expense recorded for employee grants for the year ended December 31, 2002. Compensation expense recorded for employee grants for the year ended December 31, 2001, was $7,249.

The Company also grants options and warrants to nonemployees for goods and services and in conjunction with certain agreements. These grants are accounted for under FASB Statement No. 123 based on the grant date fair values.

Had compensation cost for all of the stock-based compensation grants and warrants issued been determined based on the fair values at the grant date consistent with the provisions of Statement No. 123, the Company’s net loss and net loss per basic and diluted common share would have been as indicated below.

	Years Ended December 31
	2002			2001
Net loss, as reported	$	(2,316,743	)	$	(2,492,793	)
Deduct total stock-based employee compensation expense determined under the fair value-based method for all awards		(747,322	)		(699,141	)
Net loss, pro forma	$	(3,064,065	)		(3,191,934	)
Basic and diluted loss per share, as reported	$	(0.23	)	$	(0.26	)
Basic and diluted loss per share, pro forma		(0.30	)		(0.33	)

The above pro forma effects on net loss and net loss per basic and diluted common share are not likely to be representative of the effects on reported net loss or net loss per common share for future years because options vest over several years and additional awards generally are made each year.

Product warranty: The Company provides a limited 90-day warranty for the replacement of defective products. The Company’s standard warranty policy requires the Company to repair or replace defective products at no cost to its customers. The Company estimates the costs that may be incurred under its basic limited warranty and records a liability in the amount of such costs at the time product revenue is recognized. Factors that affect the Company’s warranty liability include the number of units sold, historical and anticipated rates of warranty claims, and cost per claim. The Company periodically assesses the adequacy of its recorded warranty liabilities and adjusts the amounts as necessary. The Company utilizes historical trends and information received from its customers to assist in determining the appropriate loss reserve levels.

F-10

DATAKEY, INC.

NOTES TO FINANCIAL STATEMENTS

Note 1. Nature of Business and Significant Accounting Policies (Continued)

Changes in the Company’s warranty liability are as follows:

		Years Ended December 31
		2002			2001
Balance, beginning		$	26,894		$	27,872
	Reduction of accrual to estimated required amount based upon current experience		(20,000	)		—
	Payments made		(2,719	)		(978	)
Balance, ending		$	4,175		$	26,894

Note 2. Inventories

Inventories consist of the following components as of December 31, 2002 and 2001:

	2002			2001
Raw materials	$	585,743		$	764,249
Work in process		22,024			19,193
Finished goods		553,417			327,873
Inventory obsolescence reserve		(164,652	)		(185,287	)
	$	996,532		$	926,028

Note 3. Income Taxes

The income tax benefit is different from that which would be computed by applying the U.S. federal income tax rate (35 percent) to pretax loss as follows:

	December 31
	2002			2001
Computed “expected” federal tax benefit at statutory rates	$	(811,000	)	$	(872,000	)
Effect of net operating loss with no current benefit		811,000			872,000
Actual tax benefit	$	—		$	—

F-11

DATAKEY, INC.

NOTES TO FINANCIAL STATEMENTS

Note 3. Income Taxes (Continued)

Deferred taxes consist of the following components as of December 31, 2002 and 2001:

		2002			2001
Deferred tax assets:
	Net operating loss carryforwards	$	7,247,000		$	6,456,000
	Research and development tax credit		415,000			349,000
	Allowance for doubtful accounts		20,000			10,000
	Inventory		59,000			58,000
	Accrued expenses and deferred revenue		91,000			59,000
	Contributions carryforward		7,000			7,000
	Depreciation		31,000			20,000
Total gross deferred tax assets			7,870,000			6,959,000
Valuation allowance			(7,870,000	)		(6,959,000	)
Net deferred taxes		$	—		$	—

Realization of deferred tax assets is dependent upon the generation of sufficient future taxable income. Management has determined that significant uncertainty exists regarding the realizability of the net deferred tax assets and, accordingly, has provided a valuation allowance against them.

At December 31, 2002, the Company’s net operating loss and tax credit carryforwards expire as follows:

			Research and
			Development
	Operating Loss		Tax Credit
	Carryforward		Carryforward
2011	$	1,850,000	$	—
2012		3,540,000		113,000
2018		2,560,000		59,000
2019		2,450,000		67,000
2020		3,114,000		40,000
2021		4,422,000		70,000
2022		2,193,000		66,000
	$	20,129,000	$	415,000

The use of the federal net operating losses will be limited to $5.5 million per year under the provisions of the Internal Revenue Code, Section 382, which relates to a 50 percent change in control over a three-year period. Further changes of control may result in additional limitations of the remaining carryforward. Utilization of the carryforwards is dependent upon the Company attaining profitable operations in the future.

F-12

DATAKEY, INC.

NOTES TO FINANCIAL STATEMENTS

Note 4. Stockholders’ Equity

Convertible preferred stock: The preferred stock is convertible at the rate of one share of common stock for each share of preferred stock, subject to certain anti-dilution 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, voting rights and a liquidation preference of $2.50 per share, and share in dividends paid on common stock.

Series B Preferred Stock: The Board of Directors has designated 120,000 shares of previously undesignated stock as Series B Preferred Stock. The shares have a par value of $0.05 per share and a liquidation value equal to the greater of $100 or 100 times the aggregate amount to be distributed per share to holders of common stock. Shares of Series B Preferred Stock are not convertible into shares of the Company’s common stock. Each share of Series B Preferred Stock will be entitled to a minimum preferential quarterly dividend payment of $1 per share but will be entitled to an aggregate dividend of 100 times the dividend declared per share of common stock. Each share of Series B Preferred Stock has 100 votes. In the event of any merger, consolidation or other transaction in which common stock is exchanged, each share of Series B Preferred Stock will be entitled to receive 100 times the amount received per share of common stock. There are no shares of Series B Preferred Stock outstanding.

Shareholder Rights Plan: On October 19, 2001, the Company’s Board of Directors adopted a Shareholder Rights Plan, which took effect on October 26, 2001. Under the plan, rights were constructively distributed as a dividend at the rate of one right for each share of common stock or convertible preferred stock of the Company held by the shareholders of record as of the close of business on November 9, 2001. The Board further authorized the issuance of one right (subject to adjustment) with each share of common stock or convertible preferred stock issued subsequent to November 9, 2001, but prior to the expiration date. Each right entitles its holder to purchase one-hundredth of a share of Series B Preferred Stock at an exercise price of $60, subject to adjustment. The rights will only be exercisable if a person or group acquires, has the right to acquire, or has commenced a tender offer for 15 percent or more of the outstanding common stock. The rights are nonvoting, pay no dividends, expire on November 9, 2011, and may be redeemed by the Company for $0.001 per right at any time before the tenth day (subject to adjustment) after a 15 percent position is acquired. The rights have no effect on earnings per share until they become exercisable.

After the rights are exercisable, if the Company is acquired in a merger or other business combination, or if 50 percent or more of the Company’s assets are sold, each right will entitle its holder (other than the acquiring person or group) to purchase, at the then current exercise price, common stock of the acquiring entity having a value of twice the exercise price.

Undesignated stock: The Company has 9,480,000 shares of undesignated capital stock.

F-13

DATAKEY, INC.

NOTES TO FINANCIAL STATEMENTS

Note 5. Stock Options and Warrants

As discussed in Note 1 to the financial statements, the Company accounts for employee stock-based compensation under APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. The pro forma fair value of each option grant as presented in Note 1 to the financial statements is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants in 2002 and 2001:

	Years Ended December 31
	2002		2001
Expected dividend yield		—		—
Expected stock price volatility		99.17%		101.45%
Risk-free interest rate		2.54%		5.01%
Expected life of options		5.00 years		4.50 years
Weighted-average fair value of options granted during the year	$	2.42	$	2.03

The Company has reserved 1,800,000 common shares for issuance as qualified and nonqualified stock options for its key employees and directors. The Company has also reserved 100,000 common shares for issuance as nonqualified options to various distributors, dealers and consultants. Option prices are generally at the fair market value of the stock at the time an option is granted. Options become exercisable as determined at the date of grant by a committee of the Board of Directors. Options expire 10 years after the date of grant, unless an earlier expiration date is set at the time of grant.

Additional information relating to all outstanding options as of December 31, 2002 and 2001, is as follows:

		2002					2001
					Weighted-					Weighted-
					Average					Average
					Exercise					Exercise
		Shares			Price		Shares			Price
Options outstanding at beginning of year			1,146,053		$	3.66		1,059,423		$	3.84
	Options exercised		(6,667	)		1.50		(87,840	)		2.31
	Options forfeited		(73,833	)		4.47		(185,933	)		3.46
	Options granted		372,962			3.22		360,403			2.81
Options outstanding at end of year			1,438,515		$	3.51		1,146,053		$	3.66

F-14

DATAKEY, INC.

NOTES TO FINANCIAL STATEMENTS

Note 5. Stock Options and Warrants (Continued)

The following table summarizes information about stock options outstanding at December 31, 2002:

	Options Outstanding						Options Exercisable
			Weighted-
			Average
	Number		Remaining		Weighted-		Number		Weighted-
	Outstanding		Contractual		Average		Exercisable		Average
Range of	at December 31,		Life		Exercise		at December 31,		Exercise
Exercise Prices	2002		(Years)		Price		2002		Price
$0.01		7,354		7.84	$	0.01		7,354	$	0.01
$1.42 - $2.40		304,458		8.19		1.78		161,525		1.84
$2.50 - $3.625		539,861		6.37		3.07		298,906		3.15
$3.74 - $5.25		447,342		7.84		4.18		174,942		4.48
$5.38 - $7.563		79,500		7.26		6.23		56,334		6.29
$8.00 - $8.38		60,000		7.29		8.11		41,668		8.10
$0.01 - $8.38		1,438,515		7.31	$	3.51		740,729	$	3.67

At December 31, 2001, there were 542,154 options exercisable at a weighted-average exercise price of $3.81.

Employee stock purchase plan: Under its 1998 employee stock purchase plan, which became effective for the plan year beginning January 1, 1999, the Company is authorized to issue up to 100,000 shares of common stock to its full-time employees, nearly all of whom are eligible to participate. Employees can choose each year to have up to 10 percent of their earnings withheld to purchase the Company’s stock at a price that is 85 percent of the lower of its beginning-of-year or end-of-year fair market value. During 2002 and 2001, 21,803 and 15,366 shares, respectively, were issued under the plan.

Warrants: The Company has issued warrants to purchase shares of common stock at prices between $1.25 and $6.60 per share. All warrants are currently exercisable. The following tables summarize information about warrants outstanding at December 31, 2002 and 2001:

		2002					2001
					Weighted-				Weighted-
					Average				Average
					Exercise				Exercise
		Shares			Price		Shares		Price
Warrants outstanding at beginning of year			3,075,511		$	3.44		1,395,243	$	3.93
	Warrants exercised		(80,268	)		3.44		—		—
	Warrants granted		—			—		1,680,268		3.04
Warrants outstanding at end of year			2,995,243		$	3.44		3,075,511	$	3.44

F-15

DATAKEY, INC.

NOTES TO FINANCIAL STATEMENTS

Note 5. Stock Options and Warrants (Continued)

Warrants outstanding at December 31, 2002, expire as follows:

2003	$	97,353
2004		10,000
2005		880,000
2006		1,600,000
2008		37,890
2009		370,000
	$	2,995,243

Note 6. Major Customers and International Sales

Major customers: Direct and indirect sales to U.S. government agencies from continuing operations were approximately $1,756,000 and $1,250,000, or 24 and 16 percent of total sales, in 2002 and 2001, respectively. Accounts receivable from U.S. government agencies were approximately $669,000 and $844,000 at December 31, 2002 and 2001, respectively. In addition, sales to agencies of the Canadian government were approximately $2,127,000, or 29 percent of net sales from continuing operations, during the year ended December 31, 2002. Accounts receivable from these customers were approximately $66,000 at December 31, 2002. Sales to these customers were approximately $4,152,000, or 53 percent of total sales, during the year ended December 31, 2001. Accounts receivable from these customers were approximately $511,000 at December 31, 2001. Sales to another customer (not a government agency) were approximately $1,159,000, or 16 percent of net sales from continuing operations, during the year ended December 31, 2002. Accounts receivable from this customer were approximately $182,000 at December 31, 2002.

International sales: Export sales to international customers, including Canada, from continuing operations, for 2002 and 2001 were approximately $4,168,000 and $5,206,000, or 57 and 67 percent of total sales, respectively. Accounts receivable from international customers were approximately $721,000 and $982,000 at December 31, 2002 and 2001, respectively. Sales to customers in Canada accounted for approximately $2,401,000, or 33 percent of sales, and sales to customers in Germany accounted for approximately $768,000, or 11 percent of sales, in 2002. No other individual country accounted for more than 10 percent of sales in 2002. Sales to customers in Canada, including agencies of the Canadian government, accounted for approximately $4,450,000, or 57 percent of sales in 2001. No other individual country accounted for more than 10 percent of sales in 2001.

Note 7. Commitments and Contingencies

The Company leases its office and warehouse facilities under a noncancelable operating lease, which expires in June 2004. In addition, certain items of equipment are leased under noncancelable operating leases through February 2007.

F-16

DATAKEY, INC.

NOTES TO FINANCIAL STATEMENTS

Note 7. Commitments and Contingencies (Continued)

Future lease commitments are as follows:

2003	$	278,000
2004		138,000
2005		13,000
2006		6,000
2007		1,000
	$	436,000

Rent expense totaled approximately $343,000 and $240,000 in 2002 and 2001, respectively.

In connection with the transaction described in Note 9, the Company is subleasing a portion of its office space. The Company will receive monthly rentals of $8,834 through June 2004. Sublease income during 2002 and 2001 was approximately $106,000 and $46,000, respectively.

Employee benefits: The Company maintains a voluntary 401(k) plan in effect for its employees. The Company offers a match of 25 percent of the employees’ contributions, up to 6 percent. The Company’s match was approximately $39,000 and $45,000 in 2002 and 2001, respectively. In addition, a discretionary contribution may be authorized by the Board of Directors. There were no discretionary contributions authorized in 2002 and 2001.

Note 8. Operating Segments

The Company had two reportable segments: ISS Information Security Solutions (ISS) and Electronic Products (EP). The ISS Information Security Solutions segment produces and markets products for the information security market, which enable user identification and authentication, secure data exchange and information validation. EP produced proprietary memory keys, cards and other custom-shaped tokens that serve as a convenient way to carry electronic information.

The accounting policies of the segments are the same as those described in the summary of significant accounting policies. There are no inter-segment transactions. The Company evaluates performance based on operating earnings of the respective segments. The following tables present information by segment. As further discussed in Note 9, the revenues and expenses of EP are reflected in the statements of operations on a net basis as loss from operations of discontinued segment.

	2002
	ISS			EP		Unallocated		Total
Revenue	$	7,257,000		$	870,000	$	—	$	8,127,000
Depreciation and amortization		313,000			40,000		—		353,000
Segment profit (loss)		(2,712,000	)		351,000		45,000		(2,316,000	)

F-17

DATAKEY, INC.

NOTES TO FINANCIAL STATEMENTS

Note 8. Operating Segments (Continued)

	2001
	ISS			EP			Unallocated		Total
Revenue	$	7,815,000		$	2,425,000		$	—	$	10,240,000
Depreciation and amortization		479,000			170,000			—		649,000
Segment profit (loss)		(2,085,000	)		(487,000	)		79,000		(2,493,000	)

Note 9. Discontinued Operations

In February 2001, the Company’s Board of Directors approved management’s plan to discontinue the operations of the EP segment. The Company’s plan anticipated the phasedown of operations through December 31, 2001, and the 2000 financial statements were prepared as if the operation would be phased down. In August 2001, certain assets of the EP segment were sold to an unrelated party for $550,000. One customer contract was retained by the Company with final delivery taking place in 2002.

In 2000, an estimated loss of $1,281,000 on the phasedown of the EP segment was recognized and included the write-off of inventory, patents and equipment anticipated to remain at the date of closedown and expenses associated with the phasedown, net of estimated operating income through closedown. The loss from disposal of the discontinued segment in 2001 of $487,045 was the amount in excess of the loss estimated at December 2000, net of sales proceeds of $550,000. The Company fulfilled its final sales contract during 2002, and the gain on disposal of the discontinued segment was the profit realized on the contract in excess of the amounts previously estimated. The disposal of the segment is being accounted for as discontinued operations and, accordingly, its net assets have been segregated from continuing operations in the accompanying balance sheets, and the results of its operations have been excluded from continuing operations for all periods presented. There are no assets or liabilities remaining from the EP segment as of December 31, 2002. Net assets of $82,077 at December 31, 2001, represent accounts receivable which were collected in 2002.

The EP segment had total revenues of $870,052 and $2,425,299 in 2002 and 2001, respectively.

Note 10. Licenses

Licenses are stated at cost. The costs of the license agreements are amortized to cost of goods sold as the products incorporating the licensed units are sold or over the life of the agreement. Under these agreements, the Company generally agrees to purchase a minimum quantity of software units over a specified period of time.

		December 31
		2002			2001
Licenses:
	Gross carrying amount	$	546,000		$	641,000
	Accumulated amortization		(309,183	)		(449,161	)
Net carrying amount		$	236,817		$	191,839

F-18

DATAKEY, INC.

NOTES TO FINANCIAL STATEMENTS

Note 10. Licenses (Continued)

Aggregate amortization expense in 2002 was $182,847 and in 2001 was $343,122. The Company expects that the remainder of the December 31, 2002, carrying amount of the license agreements will be charged to amortization in 2003 based upon the expected sales of its products which incorporate the licenses. In 2002, the Company entered into a license agreement under which it purchased 15,000 licenses for $195,000 and agreed to a minimum future purchase of 70,000 licenses for $910,000 by March 2004. The Company presently expects to acquire and utilize the minimum number of licenses under the agreement by March 2004.

The Company reviews its license costs for impairment and records impairment charges if sales of products incorporating the licenses are less than expected. As a result, the Company recognized impairment expense of $48,667 in 2002 and $45,000 in 2001 to reduce the carrying amount of certain license costs to the amount required based on sales levels. These impairment charges are included in the caption “cost of goods sold” in the accompanying income statement.

F-19

DATAKEY, INC.

EXHIBIT INDEX TO ANNUAL REPORT
ON FORM 10-KSB
For the Fiscal Year Ended December 31, 2002

Exhibit No.	Description
3.1*	Restated Articles of Incorporation, as amended
3.2*	Restated Bylaws
4.1	Rights Agreement dated October 26, 2001 between the Company and Wells Fargo Bank, as Rights Agent, including Statement of Designation of Series B Preferred Stock, Summary of Rights to Purchase Shares of Series B Preferred Stock and Form of Rights Certificate included as exhibits (incorporated by reference to Exhibit to the Company’s Registration Statement on Form 8-A, Reg. No. 0-11447)
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	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)
10.5	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)
10.6	Employment Agreement between Alan G. Shuler and the Company dated January 1, 1999 (Incorporated by reference to Exhibit 10.2 to Form 10-QSB for fiscal quarter ended April 3, 1999)**
10.7	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)**
10.8	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)
10.9	1997 Stock Option Plan (Incorporated by reference to Exhibit 10.15 to Form 10-KSB for fiscal year ended December 31, 1997)**
10.10	Forms of Incentive and Nonqualified Stock Option Agreements under 1997 Stock Option Plan (Incorporated by reference to Exhibit 10.16 to Form 10-KSB for fiscal year ended December 31, 1997)**
10.11	Lease Extension and Expansion Agreement between the Company and Kraus-Anderson, Incorporated dated April 19, 1999 (Incorporated by reference to Exhibit 10.14 to Form 10-KSB for fiscal year ended December 31, 1999)

E-1

Exhibit No.	Description
10.12	Employment Agreement between Timothy Russell and the Company dated August 16, 1999 (Incorporated by reference to Exhibit 10.15 to Form 10-KSB for fiscal year ended December 31, 1999)**
10.13	Employment Agreement between Colleen M. Kulhanek and the Company dated April 1, 2000 (Incorporated by reference to Exhibit 10.1 to Form 10-QSB for fiscal quarter ended April 1, 2000)**
10.14	2001 Executive Incentive Plan (Incorporated by reference to Exhibit 10.17 to Form 10-KSB for the year ended December 31, 2000)**
10.15	Loan Agreement dated January 23, 2001 between the Company and Ray Lipkin and Unsecured Promissory Note dated January 26, 2001 in the amount of $500,000 (Incorporated by reference to Exhibit 10.18 to Form 10-KSB for the year ended December 31, 2000)
10.16	Asset Acquisition Agreement dated August 3, 2001 between Datakey, Inc. and Datakey Electronics, Inc. (Incorporated by reference to Exhibit 2.1 of Form 8-K dated August 3, 2001)
10.17	2002 Executive Incentive Plan (Incorporated by reference to Exhibit 10.18 to Form 10-KSB for the year ended December 31, 2002)
10.18*	2003 Executive Incentive Plan**
10.19*	Employment Agreement between Carl P. Boecher and the Company effective March 1, 2003**
23.1*	Consent of Independent Accountant
24.1*	Power of attorney for Timothy L. Russell, Alan G. Shuler, Carl P. Boecher, Thomas R. King, Terrence W. Glarner, Gary R. Holland, Eugene W. Courtney (included on the signature page of this Form 10-KSB)
99.1*	Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes Oxley Act of 2002
99.2*	Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes Oxley Act of 2002

*	Filed herewith.
**	Designates a management contract or compensatory plan or arrangement.

2747866-6

E-2 EX-3.1 3 c75665exv3w1.txt EX-3.1 RESTATED ARTICLES OF INCORPORATION EXHIBIT 3.1 CERTIFICATE OF RESTATED ARTICLES OF INCORPORATION OF DATAKEY, INC. We the undersigned William P. Flies and Thomas R. King, respectively the president and secretary of Datakey, Inc., a corporation subject to the provisions of the Minnesota Business Corporations Act, do hereby certify that, pursuant to action taken by the directors of the Corporation at a regularly scheduled meeting thereof and a majority vote of the outstanding shares of the Corporation present in person or by proxy at an annual meeting thereof, the Corporation effective as of May 24, 1982 elected to become governed by Minnesota Statutes Ch. 302A and, in addition, approved and adopted the following Restated Articles of Incorporation to supercede and take place of the existing Articles of Incorporation. ARTICLE I The name of the Corporation is Datakey, Inc. ARTICLE II The registered office of this Corporation is located at 12281 Nicollet Avenue South, Burnsville, Minnesota, 55337. ARTICLE III 3.01 The aggregate number of shares of stock which this Corporation shall have the authority to issue is 5,000,000. All common stock issued by the Corporation shall have a par value of $.05 per share. 3.02. The board of directors may from time to time establish by resolution different classes or series of shares and may fix the rights and preferences of said shares in any class or series. 3.03. No shareholder of the Corporation shall have any preemptive rights. 3.04. No shareholder shall be entitled to any cumulative voting rights. 3.05. The shareholders shall take action by the affirmative vote of the holders of a majority of the voting power of all voting shares outstanding, except where a larger proportion is required by law, these articles or a shareholder control agreement. ARTICLE IV The name and address of the original incorporator of this Corporation is: William P. Flies, 12808 Woodview Lane, Burnsville, Minnesota, 55337. ARTICLE V The names and addresses of the present board of directors are: William P. Flies Richard A. Walter 12281 Nicollet Avenue 10101 E. Bren Road Burnsville, MN 55337 Minnetonka, MN 55343 Thomas R. King Timothy P. Stepanek 600 Midwest Plaza Bldg. 1730 Midwest Plaza Bldg. Minneapolis, MN 55402 Minneapolis, MN 55402 IN WITNESS WHEREOF, we have hereunto set our hands this 24th day of May, 1982. /s/ William P. Flies ------------------------------ William P. Flies, President /s/ Thomas R. King ------------------------------ Thomas R. King, Secretary STATE OF MINNESOTA ) ) ss. COUNTY OF HENNEPIN ) William P. Flies and Thomas R. King, being duly sworn on oath, depose and say that they are, respectively, the president and secretary of Datakey, Inc., the corporation named in the foregoing certificate; that said certificate contains a true statement of the action of the shareholders and board of directors of said corporation; that said certificate is executed on behalf of said corporation by its express authority; and that they further acknowledge the same to be their free act and deed and the free act, and deed of said corporation. /s/ William Flies ---------------------------------- /s/ Thomas R. King ---------------------------------- Subscribed and sworn to before me this 24th day of May, 1982. /s/ Elizabeth A. Forehand Notary Public - Minnesota Hennepin County My commission expires 3-13-87 OFFICERS' CERTIFICATE OF DATAKEY, INC. We, the undersigned, John H. Underwood and Thomas R. King, the respective President and Secretary of Datakey, Inc., a corporation subject to the provisions of Minnesota Statutes, Chapter 302A, do hereby certify that the Minutes of Action Without Meeting of the Board of Directors of the corporation dated December 23, 1985, a copy of which is attached hereto and incorporated herein by reference, in which the Board of Directors authorized the issuance of Preferred Stock, were unanimously adopted and approved by such Board of Directors. IN WITNESS WHEREOF, we have subscribed our names this 23rd day of December, 1985. /s/ John H. Underwood ------------------------------------ John H. Underwood President /s/ Thomas R. King ------------------------------------ Thomas R. King Secretary STATE OF MINNESOTA ) ) ss. COUNTY OF HENNEPIN ) On this 23rd day of December, 1985, before a Notary Public within and for said County, personally appeared John H. Underwood and Thomas R. King, to me personally known, being by me duly sworn, and did say that they are the President and Secretary, respectively, of the corporation named above and that the said instrument was signed on behalf of the corporation and the persons who signed said instrument acknowledged it to be the free act and deed of said corporation. /s/ Diane M. Dossetto Notary Public - Minnesota Ramsey County My commission expires 7-10-90 MINUTES OF ACTION WITHOUT MEETING OF THE BOARD OF DIRECTORS OF DATAKEY, INC. The undersigned, being all of the members of the Board of Directors of Datakey, Inc., hereby adopt, by action without meeting, the following resolutions to be effective as of December 23, 1985, to-wit: RESOLVED: That the Preferred Stock authorizing resolutions, which resolutions are attached hereto as Exhibit A and which resolutions establish a class of Convertible Preferred Stock be and they hereby are adopted. FURTHER RESOLVED: That the officers of the corporation be, and they hereby are, authorized and directed to take whatever action is necessary to effect the foregoing resolutions. /s/ John H. Underwood John H. Underwood /s/ William P. Flies William P. Flies /s/ Timothy A. Stepanek Timothy A. Stepanek /s/ Thomas R. King Thomas R. King EXHIBIT A MINUTES OF ACTION WITHOUT MEETING OF THE BOARD OF DIRECTORS OF DATAKEY, INC. The undersigned, being all of the members of the Board of Directors of Datakey, Inc., hereby adopt, by action without meeting, the following resolution to be effective as of December 23, 1985, to-wit: WHEREAS, the Articles of Incorporation of Datakey, Inc., a Minnesota corporation, authorize the corporation to issue an aggregate of 5,000,000 shares of capital stock and empower the corporation's Board of Directors to establish from time to time by resolution different classes or series of shares and to fix the rights and preferences of said shares in any class or series; and WHEREAS, there currently are outstanding 2,979,750 shares of Common Stock, the remaining 2,020,250 authorized shares of capital stock being undesignated; and WHEREAS, the corporation's Board of Directors deems it to be in the best interests of the corporation and its shareholders to establish a second class of capital stock, Convertible Preferred Stock, having certain rights and preferences; NOW, THEREFORE, BE IT RESOLVED, that the 5,000,000 shares of capital stock authorized by the Articles of Incorporation of this corporation be, and they hereby are, designated as belonging to the following classes having the relative rights and preferences set forth below: Section 1. Shares and Classes Authorized. Of the 5,000,000 shares which the corporation is authorized to issue, 4,000,000 shares shall be designated Common Stock, par value $.05, 400,000 shares shall be designated Convertible Preferred Stock and 600,000 shares shall be undesignated capital stock. Section 2. Right and Preferences of Convertible Preferred Stock. The rights and preferences of the 400,000 shares of Convertible Preferred Stock shall be as set forth in Exhibit 1 which is attached hereto and made a part hereof. /s/ William P. Flies William P. Flies /s/ John H. Underwood John H. Underwood /s/ Timothy A. Stepanek Timothy A. Stepanek /s/ Thomas R. King Thomas R. King EXHIBIT 1 CERTIFICATE OF RIGHTS AND PREFERENCES OF CONVERTIBLE PREFERRED STOCK OF DATAKEY, INC. (A). Classification of Undesignated Shares. Of the 1,000,000 undesignated shares which the corporation is authorized to issue under its Articles of Incorporation, 400,000 of such shares shall all be classified as shares of Convertible Preferred Stock of the corporation (the "Preferred Stock"). Such shares of Preferred Stock, together with the 4,000,000 authorized shares of Common Stock of the corporation (the "Common Stock") and the balance of the undesignated shares of the corporation, are sometimes hereinafter collectively referred to as the "capital stock". (B). Voting Privileges. (a) General. Each holder of Preferred Stock shall have that number of votes on all matters submitted to the stockholders that is equal to the number of shares of Common Stock into which such holder's shares of Preferred Stock are then convertible, as hereinafter provided. Except as otherwise provided in subparagraph (b) below, and except as otherwise required by agreement or law, the shares of capital stock of the corporation shall vote as a single class on all matters submitted to the stockholders. (b) Without the affirmative vote of the holders (acting together as a class) of at least a majority (with respect to (1) below) or at least 90% (with respect to (2) below) of the shares of Preferred Stock at the time outstanding, the corporation shall not: (1) authorize or issue any shares of stock having a priority over Preferred Stock or ranking on a parity therewith as to the payment or distribution of assets upon the liquidation or dissolution, voluntary or involuntary, of the corporation; or (2) amend the Articles of Incorporation of the corporation so as to alter any existing provision relating to Preferred Stock. (c) No Cumulative Voting. No holder of shares of capital stock shall have any cumulative voting rights. (C). No Preemptive Rights. No holder of shares of any class of capital stock shall be entitled as such, as a matter of right, to subscribe for, purchase or receive any part of any new or additional issue of stock of any class whatsoever, or of securities convertible into or exchangeable for any stock of any class whatsoever, whether now or hereafter authorized and whether issued for cash or other consideration or by way of dividend. (D). Cash Dividends. Any dividend declared must be payable with respect to all outstanding shares of capital stock of the corporation. In the event any dividend is declared with respect to the capital stock, each holder of Preferred Stock shall be paid such cash dividend on the basis of the number of shares of Common Stock into which such holder's shares of Preferred Stock are then convertible, as hereinafter provided. (E). Other Terms of the Preferred Stock. (a) Liquidation Preference. In the event of either an involuntary or a voluntary liquidation or dissolution of the corporation, the holders of shares of Preferred Stock shall be entitled to receive out of the assets of the corporation an amount equal to $2.50 per share. In the event of either an involuntary or voluntary liquidation or dissolution of the corporation, payment shall be made to the holders of the Preferred Stock in the amounts herein fixed before any payment shall be made or any assets distributed to the holders of the Common Stock or any other class of shares of the corporation ranking junior to the Preferred Stock with respect to payment of dividends or upon dissolution or liquidation of the corporation. If upon any such liquidation or dissolution of the corporation the assets available for distribution 'shall be insufficient to pay the holders of all outstanding shares of Preferred Stock the full amounts to which they respectively shall be entitled, the holders of such shares shall share pro rata in any such distribution. The merger or consolidation of the corporation into or with another corporation or the merger or consolidation of any other corporation into or with the corporation (in which consolidation or merger the stockholders of the corporation receive distribution of cash or securities or other property as a result of such consolidation or merger), or the sale, transfer or other disposition of all or substantially all of the assets of the corporation, shall be deemed, for purposes of determining the amounts to be received by the holders of the Preferred Stock in such merger, consolidation, sale, transfer or other disposition, to be a liquidation or dissolution of the corporation for purposes of this subparagraph (a) if the holders of a majority of the outstanding shares of Preferred Stock so elect by giving written notice thereof to the corporation at least two days before the effective date of such event. If no such notice is given, the provisions of subparagraph (c)(7) hereof shall apply. Nothing hereinabove set forth shall affect in any way the right of each holder of shares of Preferred Stock to convert such shares at any time and from time to time in accordance with subparagraph (c) below. (b) Redemptions. Redemptions of shares of Preferred Stock by the corporation without the consent of the holders thereof are not permitted. Mandatory redemptions of shares of Preferred Stock by the corporation are not required. (c) Conversion Right; Mandatory Conversion. At the option of the holders thereof, the shares of Preferred Stock shall be convertible, at the office of the corporation (or at such other office or offices, if any, as the Board of Directors may designate), into fully paid and nonassessable shares (calculated as to each conversion to the nearest 1/100th of a share) of Common Stock of the corporation, at the conversion price, determined as hereinafter provided, in effect at the time of conversion, each share of the Preferred Stock being taken at $2.50 for the purpose of such conversion. The price at which shares of Common Stock shall be delivered upon conversion (herein called the "conversion price") shall be initially $2.50 per share of Common Stock (i.e., at an initial conversion rate of one share of Common Stock for each share of Preferred Stock), provided, however, that such initial conversion price shall be subject to adjustment from time to time in certain instances as hereinafter provided. The following provisions shall govern such right of conversion: (1) In order to convert shares of Preferred Stock into shares of Common Stock of the corporation, the holder thereof shall surrender at any office hereinabove mentioned the certificate or certificates therefor, duly endorsed to the corporation or in blank, and give written notice to the corporation at such office that such holder elects to convert such shares. Shares of Preferred Stock shall be deemed to have been converted immediately prior to the close of business on the day of the surrender of such shares for conversion as herein provided, and the person entitled to receive the shares of Common Stock of the corporation issuable upon such conversion shall be treated for all purposes as the record holder of such shares of Common Stock at such time. As promptly as practicable on or after the conversion date, the corporation shall issue and deliver or cause to be issued and delivered at such office a certificate or certificates for the number of shares of Common Stock of the corporation issuable upon such conversion. (2) The conversion price shall be subject to adjustment from time to time as hereinafter provided. Upon each adjustment of the conversion price each holder of shares of Preferred Stock shall thereafter be entitled to receive the number of shares of Common Stock of the corporation obtained by multiplying the conversion price in effect immediately prior to such adjustment by the number of shares issuable pursuant to conversion immediately prior to such adjustment and dividing the product thereof by the conversion price resulting from such adjustment. (3) Except for the issuance of Conversion Stock and Warrant Stock (as those terms are defined in the Preferred Stock Purchase Agreement dated December 16, 1985 among the corporation and the Purchasers named therein) (a) if and whenever on or prior to June 30, 1987 the corporation shall issue or sell any shares of its Common Stock for a consideration per share less than the conversion price in effect immediately prior to the time of such issue or sale, then forthwith upon such issue or sale the conversion price shall be reduced to such lesser price, and (b) if and whenever after June 30, 1987 the corporation shall issue or sell any shares of its Common Stock for a consideration per share less than the conversion price in effect immediately prior to the time of such issue or sale, and/or the corporation shall issue or sell any shares of Common Stock for a consideration per share less than the market price on the date of such issue or sale, then forthwith upon such issue or sale the conversion price shall be reduced to the price (calculated to the nearest cent) determined by dividing (1) an amount equal to the sum of (aa) the number of shares of Common Stock outstanding immediately prior to such issue or sale multiplied by the then existing conversion price, and (bb) the consideration, if any, received by the corporation upon such issue or sale, by (2) an amount equal to the sum of (aa) the number of shares of Common Stock outstanding immediately prior to such issue or sale and (bb) the number of shares of Common Stock thus issued or sold. For the purposes of this subparagraph (3), the following provisions (i) to (vii), inclusive, shall also be applicable: (i) In case at any time the corporation shall grant (whether directly or by assumption in a merger or otherwise) any rights to subscribe for or to purchase, or any options for the purchase of, (a) Common Stock or (b) any obligations or any shares of stock of the corporation which are convertible into, or exchangeable for, Common Stock (any of such obligations or shares of stock being hereinafter called "Convertible Securities") whether or not such rights or options or the right to convert or exchange any such Convertible Securities are immediately exercisable, and the price per share for which Common Stock is issuable upon the exercise of such rights or options or upon conversion or exchange of such Convertible Securities (determined by dividing (x) the total amount, if any, received or receivable by the corporation as consideration for the granting of such rights or options, plus the minimum aggregate amount of additional consideration payable to the, corporation upon the exercise of such rights or options, plus, in the case of such Convertible Securities, the minimum aggregate amount of additional consideration, if any, payable upon the issue of such Convertible Securities and upon the conversion or exchange thereof, by (y) the total maximum number of shares of Common Stock issuable upon the exercise of such rights or options or upon the conversion or exchange of all such Convertible Securities issuable upon the exercise of such rights or options) shall be less than the conversion price in effect immediately prior to the time of the granting of such rights or options, then the total maximum number of shares of Common Stock issuable upon the exercise of such rights or options or upon conversion or exchange of the total maximum amount of such Convertible Securities issuable upon the exercise of such rights or options shall (as of the date of granting of such rights or options) be deemed to have been issued for such price per share. Except as provided in subparagraph (6) below, no further adjustments of the conversion price shall be made upon the actual issue of such Common Stock or of such Convertible Securities upon exercise of such rights or options or upon the actual issue of such Common Stock upon conversion or exchange of such Convertible Securities. (ii) In case the corporation shall issue or sell (whether directly or by assumption in a merger or otherwise) any Convertible Securities, whether or not the rights to exchange or convert thereunder are immediately exercisable, and the price per share for which Common Stock is issuable upon such conversion or exchange (determined by dividing (x) the total amount received or receivable by the corporation as consideration for the issue or sale of such Convertible Securities, plus the minimum aggregate amount of additional consideration, if any, payable to the corporation upon the conversion or exchange thereof, by (y) the total maximum number of shares of Common Stock issuable upon the conversion or exchange of all such Convertible Securities) shall be less than the conversion price in effect immediately prior to the time of such issue or sale, then the total maximum number of shares of Common Stock issuable upon conversion or exchange of all such Convertible Securities shall (as of the date of the issue or sale of such Convertible Securities) be deemed to be outstanding and to have been issued for such price per share, provided that (a) except as provided in subparagraph (6) below, no further adjustments of the conversion price shall be made upon the actual issue of such Common Stock upon conversion or exchange of such Convertible Securities, and (b) if any such issue or sale of such Convertible Securities is made upon exercise of any rights to subscribe for or to purchase or any option to purchase any such Convertible Securities for which adjustments of the conversion price have been or are to be made pursuant to other provisions of this subparagraph (3), no further adjustment of the conversion price shall be made by reason of such issue or sale. (iii) In case the corporation shall, after June 30, 1987, declare a dividend or make any other distribution upon any capital stock of the corporation payable in Common Stock or Convertible Securities, or in any rights or options to purchase any Common Stock or Convertible Securities, any Common Stock or Convertible Securities, or any such rights or options, as the case may be, issuable in payment of such dividend or distribution shall be deemed to have been issued or sold without consideration. (iv) In case any shares of Common Stock or Convertible Securities or any rights or options to purchase any such Common Stock or Convertible Securities shall be issued or sold for cash, the consideration received therefor shall be deemed to be the amount received by the corporation therefor, without deducting therefrom any expenses incurred or any underwriting commissions or concessions paid or allowed by the corporation in connection therewith. In case any shares of Common Stock or Convertible Securities or any rights or options to purchase any such Common Stock or Convertible Securities shall be issued or sold for a consideration other than cash, the amount of the consideration other than cash received by the corporation shall be deemed to be the fair value of such consideration as determined by the Board of Directors of the corporation, without deducting therefrom any expenses incurred or any underwriting commissions or concessions paid or allowed by the corporation in connection therewith. In case any shares of Common Stock or Convertible Securities or any rights or options to purchase such Common Stock or Convertible Securities shall be issued in connection with any merger or consolidation in which the corporation is the surviving corporation, the amount of consideration therefor shall be deemed to be the fair value as determined by the Board of Directors of the corporation of such portion of the assets and business of the non-surviving corporation or corporations as such Board shall determine to be attributable to such Common Stock, Convertible Securities, rights or options, as the case may be. In the event of any consolidation or merger of the corporation in which the corporation is not the surviving corporation or in the event of any sale of all or substantially all of the assets of the corporation for stock or other securities of any other corporation, the corporation shall be deemed to have issued a number of shares of its Common Stock for stock or securities of the other corporation computed on the basis of the actual exchange ratio on which the transaction was predicated and for a consideration equal to the fair market value on the date of such transaction of such stock or securities of the other corporation, and if any such calculation results in adjustment of the conversion price, the determination of the number of shares of Common Stock issuable upon conversion immediately prior to such merger, conversion or sale, for purposes of subparagraph (7) below, shall be made after giving effect to such adjustment of the conversion price. (v) In case the corporation shall take a record of the holders of its Common Stock for the purpose of entitling them (a) to receive a dividend or other distribution payable in Common Stock or in Convertible Securities, or in any rights or options to purchase any Common Stock or Convertible Securities, or (b) to subscribe for or purchase Common Stock or Convertible Securities, then the date of such record shall be deemed to be the date of the issue or sale of the shares of Common Stock deemed to have been issued or sold upon the declaration of such dividend or the making of such other distribution or the date of the granting of such rights of subscription or purchase, as the case may be. (vi) The number of shares of Common Stock outstanding at any given time shall not include shares owned or held by or for the account of the corporation, and the disposition of any such shares shall be considered an issue or sale of Common Stock for the purpose of this subparagraph (3). (vii) "Market price" shall mean the average of the high and low prices of the Common Stock sales on all exchanges on which the Common Stock may at the time be listed, or, if there shall have been no sales on any such exchange on any such day, the average of the bid and asked prices at the end of such day, or, if the Common Stock shall not be so listed, the average of the bid and asked prices at the end of the day in the over-the-counter market, in each case averaged over a period of 20 consecutive business days prior to the date as of which "market price" is being determined. If at any time the Common Stock is not listed on any exchange or quoted in the over-the-counter market, the "market price" shall be deemed to be the higher of (i) the book value thereof as determined by any firm of independent public accountants of recognized standing selected by the Board of Directors of the corporation as of the last day of any month ending within 60 days preceding the date as of which the determination is to be made, or (ii) the fair value thereof determined in good faith by the Board of Directors of the corporation as of a date which is within 15 days of the date as of which the determination is to be made. (4) In case the corporation shall declare a dividend or make a distribution upon the Common Stock payable otherwise than out of earnings or earned surplus (including dividends or distributions in Common Stock or Convertible Securities, or in any rights or options to purchase any Common Stock or Convertible Securities), then thereafter each holder of shares of Preferred Stock upon the conversion thereof will be entitled to receive the number of shares of Common Stock into which such shares of Preferred Stock have been converted, and, in addition and without payment therefor, the cash, stock or other securities and other property which such holder would have received by way of dividends (otherwise than out of such earnings or surplus) if continuously since such holder became the record holder of such shares of Preferred Stock such holder (i) had been the record holder of the number of shares of Common Stock then received, and (ii) had retained all dividends or distributions in stock or securities (including Common Stock or Convertible Securities, or in any rights or options to purchase any Common Stock or Convertible Securities) payable in respect of such Common Stock or in respect of any stock or securities paid as dividends or distributions and originating directly or indirectly from such Common Stock. For the purposes of the foregoing a dividend or distribution other than in cash shall be considered payable out of earnings or earned surplus only to the extent that such earnings or surplus are charged an amount equal to the fair value of such dividend or distribution as determined by the Board of Directors of the corporation. (5) In case the corporation shall at any time subdivide its outstanding shares of Common Stock into a greater number of shares, the conversion price in effect immediately prior to such subdivision shall be proportionately reduced, and conversely, in case the outstanding shares of Common Stock of the corporation shall be combined into a smaller number of shares, the conversion price in effect immediately prior to such combination shall be proportionately increased. (6) If (i) the purchase price provided for in any right or option referred to in clause (i) of subparagraph (3), or (ii) the additional consideration, if any, payable upon the conversion or exchange of Convertible Securities referred to in clause (i) or clause (ii) of subparagraph (3), or (iii) the rate at which any Convertible Securities referred to in clause (i) or clause (ii) of subparagraph (3) are convertible into or exchangeable for Common Stock, shall change at any time (other than under or by reason of provisions designed to protect against dilution), the conversion price then in effect hereunder shall forthwith be increased or decreased to such conversion price as would have obtained had the adjustments made upon the issuance of such rights, options or Convertible Securities been made upon the basis of (a) the issuance of the number of shares of Common Stock theretofore actually delivered upon the exercise of such options or rights or upon the conversion or exchange of such Convertible Securities, and the total consideration received therefor, and (b) the issuance at the time of such change of any such options, rights, or Convertible Securities then still outstanding for the consideration, if any, received by the corporation therefor and to be received on the basis of such changed price; and on the expiration of any such option or right or the termination of any such right to convert or exchange such Convertible Securities, the conversion price then in effect hereunder shall forthwith be increased to such conversion price as would have obtained had the adjustments made upon the issuance of such rights or options or Convertible Securities been made upon the basis of the issuance o the shares of Common Stock theretofore actually delivered (and the total consideration received therefor) upon the exercise of such rights or options or upon the conversion or exchange of such Convertible Securities. If the purchase price provided for in any right or option referred to in clause (i) of subparagraph (3), or the rate at which any Convertible Securities referred to in clause (i) or clause (ii) of subparagraph (3) are convertible into or exchangeable for Common Stock, shall decrease at any time under or by reason of provisions with respect thereto designed to protect against dilution, then in case of the delivery of Common Stock upon the exercise of any such right or option or upon conversion or exchange of any such Convertible Security, the conversion price then in effect hereunder shall forthwith be decreased to such conversion price as would have obtained had the adjustments made upon the issuance of such right, option or Convertible Security been made upon the basis of the issuance of (and the total consideration received for) the shares of Common Stock delivered as aforesaid. (7) If any capital reorganization or reclassification of the capital stock of the corporation, or consolidation or merger of the corporation with another corporation, or the sale of all or substantially all of its assets to another corporation shall be effected in such a way that holders of Common Stock shall be entitled to receive stock, securities or assets with respect to or in exchange for Common Stock, then, as a condition of such reorganization, reclassification, consolidation, merger or sale, and subject to subparagraph (a) above, lawful and adequate provision shall be made whereby the holders of Preferred Stock shall thereafter have the right to receive upon the basis and upon the terms and conditions specified herein and in lieu of the shares of the Common Stock of the corporation immediately theretofore receivable upon the conversion of Preferred Stock, such shares of stock, securities or assets as may be issued or payable with respect to or in exchange for a number of outstanding shares of such Common Stock equal to the number of shares of such stock immediately theretofore receivable upon the conversion of Preferred Stock had such reorganization, reclassification, consolidation, merger or sale not taken place, plus all dividends unpaid and accumulated or accrued thereon to the date of such reorganization, reclassification, consolidation, merger or sale, and in any such case appropriate provision shall be made with respect to the rights and interests of the holders of Preferred Stock to the end that the provisions hereof (including without limitation provisions for adjustments of the conversion price and of the number of shares receivable upon the conversion of Preferred Stock) shall thereafter be applicable, as nearly as may be in relation to any shares of stock, securities or assets thereafter receivable upon the conversion of Preferred Stock. The corporation shall not effect any such consolidation, merger or sale, unless prior to the consummation thereof the successor corporation (if other than the corporation) resulting from such consolidation or merger or the corporation purchasing such assets shall assume by written instrument executed and mailed to the holders of Preferred Stock, at the last addresses of such holders appearing on the books of the corporation, the obligation to deliver to such holder such shares of stock, securities or assets as, in accordance with the foregoing provisions, such holder may be entitled to receive. (8) Upon any adjustment of the conversion price, then and in each case the corporation shall give written notice thereof, by first-class mail, postage prepaid, addressed to the holders of Preferred Stock, at the addresses of such holders as shown on the books of the corporation, which notice shall state the conversion price resulting from such adjustment and the increase or decrease, if any, in the number of shares receivable at such price upon the conversion of Preferred Stock, setting forth in reasonable detail the method of calculation and the facts upon which such calculation is based. (9) In case at any time: (i) the corporation shall declare any cash dividend on its Common Stock at a rate in excess of the rate of the last cash dividend theretofore paid; (ii) the corporation shall pay any dividend payable in stock upon its Common Stock or make any distribution (other than regular cash dividends) to the holders of its Common Stock; (iii) the corporation shall offer for subscription pro rata to the holders of its Common Stock any additional shares of stock of any class or other rights; (iv) there shall be any capital reorganization, or reclassification of the capital stock of the corporation, or consolidation or merger of the corporation with, or sales of all or substantially all of its assets to, another corporation; or (v) there shall be a voluntary or involuntary dissolution, liquidation or winding up of the corporation; then, in any one or more of said cases, the corporation shall give written notice, by first-class mail, postage prepaid, addressed to the holders of Preferred Stock at the addresses of such holders as shown on the books of the corporation, of the date on which (a) the books of the corporation shall close or a record shall be taken for such dividend, distribution or subscription rights, or (b) such reorganization, reclassification, consolidation, merger, sale, dissolution, liquidation or winding up shall take place, as the case may be. Such notice shall also specify the date as of which the holders of Common Stock of record shall participate in such dividend, distribution or subscription rights, or shall be entitled to exchange their Common Stock for securities or other property deliverable upon such reorganization, reclassification, consolidation, merger, sale, dissolution, liquidation, or winding up, as the case may be. Such written notice shall be given at least 20 days prior to the action in question and not less than 20 days prior to the record date or the date on which the corporation's transfer books are closed in respect thereto. (10) If any event occurs as to which in the opinion of the Board of Directors of the corporation the other provisions of this paragraph (c) are not strictly applicable or if strictly applicable would not fairly protect the rights of the holders of Preferred Stock in accordance with the essential intent and principles of such provisions, then the Board of Directors shall make an adjustment in the application of such provisions, in accordance with such essential intent and principles, so as to protect such rights as aforesaid. (11) As used in this paragraph (c) the term "Common Stock" shall mean and include the corporation's presently authorized Common Stock and shall also include any capital stock of any class of the corporation hereafter authorized which shall not be limited to a fixed sum or percentage in respect of the rights of the holders thereof to participate in dividends or in the distribution of assets upon the voluntary or involuntary liquidation, dissolution or winding up of the corporation; provided that the shares receivable pursuant to conversion of shares of Preferred Stock shall include shares designated as Common Stock of the corporation as of the date of issuance of such shares of Preferred Stock, or, in case of any reclassification of the outstanding shares thereof, the stock, securities or assets provided for in subparagraph (7) above. (12) No fractional shares of Common Stock shall be issued upon conversion, but, instead of any fraction of a share which would otherwise be issuable, the corporation shall pay a cash adjustment in respect of such fraction in an amount equal to the same fraction of the market price per share of Common Stock, determined pursuant to subparagraph (3)(vii) above, as of the close of business on the day of conversion. Mandatory Conversion. Preferred Stock shall automatically be converted into shares of Common Stock of the corporation, without any act by the corporation or the holders of Preferred Stock, concurrently with the closing of the first public offering by the corporation of shares of Common Stock of the corporation registered under the Securities Act of 1933, as amended, in which (1) the offering is underwritten on a firm commitment basis by an underwriter, or a group of underwriters represented by an underwriter or underwriters, and (2) the aggregate public offering price of the securities sold for cash by the corporation in the offering, net of expenses payable by the corporation in connection with such offering, is at least $5,000,000, and (3) the public offering price per share of Common Stock is at least $5 (as adjusted from time to time to reflect stock splits, dividends, recapitalizations, combinations or the like). As used herein, the term "closing" shall mean the delivery by the corporation to the underwriters of certificates representing the shares of Common Stock of the corporation offered to the public against delivery to the corporation by such underwriters of payment therefor. The term "firm commitment basis" with respect to the underwriting of such public offering shall mean a commitment pursuant to a written underwriting agreement under which the nature of the underwriters' commitment is such that all securities will be purchased by such underwriters if any securities are purchased by such underwriters. Each holder of a share of Preferred Stock so converted shall be entitled to receive the full number of shares of Common Stock into which such share of Preferred Stock held by such holder could be converted if such holder had exercised its conversion right at the time of closing of such public offering. Upon such conversion, each holder of a share of Preferred Stock shall immediately surrender such share in exchange for appropriate stock certificates representing a share or shares of Common Stock of the corporation. ARTICLES OF AMENDMENT OF ARTICLES OF INCORPORATION OF DATAKEY, INC. Pursuant to the provisions of Minnesota Statutes, Section 302A.135, the following Amendment of Section 3.01 of the Articles of Incorporation of Datakey, Inc. was adopted at a meeting of the shareholders of the corporation duly convened and held on the 6th day of May, 1986, by a vote of 84% of the voting power of all shares entitled to vote: "3.01 The aggregate number of shares of stock which this corporation shall have authority to issue is 12,500,000 shares, consisting of 10,000,000 shares of Common Stock, par value $.05, 400,000 shares of Preferred Stock and 2,100,000 undesignated shares." I swear that the foregoing is true and accurate and that I have the authority to sign this document on behalf of the corporation. /s/ John H. Underwood ------------------------------ John H. Underwood, President STATE OF MINNESOTA ) ) SS. COUNTY OF Dakota ) The foregoing instrument was acknowledged before me this 25th day of June, 1986, by John H. Underwood, President of Datakey, Inc., a Minnesota corporation, on behalf of the corporation. /s/ Bette F. Feahr Notary Public - Minnesota Dakota County My commission expires 8-20-91 (Notarial Seal) ARTICLES OF AMENDMENT OF ARTICLES OF INCORPORATION OF DATAKEY, INC. Pursuant to the provisions of Minnesota Statutes, Section 302A.135, the following Amendment of the Articles of Incorporation of Datakey, Inc., adding Article VI, was adopted at a meeting of the shareholders of the corporation duly convened and held on the May 12, 1987, by a majority vote of the voting power of all shares entitled to vote: "ARTICLE VI - LIMITATION OF DIRECTOR LIABILITY 6.1) To the fullest extent permitted by the Minnesota Business Corporation Act as the same exists or may hereafter be amended, a director of this corporation shall not be personally liable to the corporation or its shareholders for monetary damages for breach of fiduciary duty as a director." I swear that the foregoing is true and accurate and that I have the authority to sign this document on behalf of the corporation. /s/ John H. Underwood ------------------------------------ John H. Underwood, President STATE OF MINNESOTA ) ) SS. COUNTY OF DAKOTA ) The foregoing instrument was acknowledged before me this 27 day of May, 1987, by John H. Underwood, President of Datakey, Inc., a Minnesota corporation, on behalf of the corporation. /s/ Bette F. Feahr Notary Public - Minnesota Dakota County My commission expires 8-20-91 (Notarial Seal) Notice of Change of Registered Office by DATAKEY, INC. Pursuant to Minnesota Statutes, Section 302A.123, the undersigned hereby certifies that the Board of Directors of the above named Minnesota Corporation has resolved to change the corporation's registered office or agent: FROM: Datakey, Inc. 12281 Nicollet Avenue South Burnsville, MN 55337 TO: Datakey, Inc. 407 West Travelers Trail Burnsville, MN 55337-2554 The new address may not be a post office box. It must be a street address, pursuant to Minnesota Statutes, Section 302A.011, Subd. 3. The effective date of the change will be the 1st day of July, 1987 or the day of filing of this certificate with the Secretary of State, whichever is later. I swear that the foregoing is true and accurate and that I have the authority to sign this document on behalf of the corporation. /s/ George H. M. Rountree George H. M. Rountree Vice President Finance July 11, 1988 State of Minnesota ) ) ss. County of Dakota ) The foregoing instrument was acknowledged before me on this 11th day of July, 1988. /s/ Bette F. Feahr Notary Public - Minnesota Dakota County My commission expires 8-20-91 State of Minnesota Department of State Filed: August 10, 1988 STATEMENT OF DESIGNATION OF SHARES OF DATAKEY, INC. The undersigned hereby certifies that the resolutions set forth on Exhibit A attached hereto were duly adopted by the Board of Directors of Datakey, Inc. on May 11, 1998. I swear that the foregoing is true and accurate and that I have the authority to sign this document on behalf of the corporation. May 14, 1998 DATAKEY, INC. /s/ Alan G. Shuler Alan G. Shuler Vice President and Chief Financial Officer EXHIBIT A DESIGNATION OF SERIES A CONVERTIBLE CUMULATIVE PREFERRED STOCK WHEREAS, pursuant to the Articles of Incorporation of this corporation, the Board of Directors has authority to establish, from the 2,100,000 undesignated shares of capital stock, one or more classes or series of shares, to designate each such class or series, and to fix the relative rights and preferences of each such class or series; and WHEREAS, the Board of Directors deem it advisable to designate shares of Series A Convertible Cumulative Preferred Stock; NOW, THEREFORE, RESOLVED, that of the 2,100,000 undesignated shares currently authorized, 150,000 shares are hereby designated as shares of Series A Convertible Cumulative Preferred Stock, which shares shall have the terms as set forth on Exhibit A hereto. EXHIBIT A RIGHTS, PREFERENCES AND RESTRICTIONS OF PREFERRED STOCK The rights, preferences, restrictions and other matters relating to the Series A Convertible Cumulative Preferred Stock (the "Series A Preferred Stock") are as follows: 1. Dividend Provisions. Upon issuance, dividends shall accrue on each share of outstanding Series A Preferred Stock at an annual rate equal to $1.264 per share per annum (8% of the Original Issue Price, as defined herein). Such dividends shall be cumulative and shall be payable upon any conversion of the Series A Preferred Stock pursuant to Section 3 hereof. Such dividends shall only be paid out of legally available funds of the Company. Such dividends shall be payable by the Company, in its sole discretion, all in cash or all by the issuance of a number of shares of the Company's unrestricted, freely tradable common stock equal to the dividends owing on the Series A Preferred Stock; provided, however, that prior to the payment of any such dividend by the issuance of shares of the Company's common stock, the Company shall deliver to the Investors an opinion of its counsel stating that all such shares have been validly registered, and that they are duly authorized, validly issued and nonassessable. For the purposes hereof, the number of shares of the Company's common stock issuable in lieu of any cash dividend payment shall equal the total dividend payment then due divided by the per share price of such stock. The per share price of the Company's common stock shall be determined based on the average closing bid price of such stock quoted on The Nasdaq Stock Market for the ten consecutive trading days prior to the payment of such dividends. Dividends on shares of the Series A Preferred Stock shall accrue beginning on the date of issuance of the shares of Series A Preferred Stock, shall compound on an annual basis and shall be payable upon conversion of the Series A Preferred Stock (a "Payment Date"). All accrued and unpaid dividends on the Series A Preferred Stock must be paid before any dividends may be declared or paid on any other junior series of preferred or common stock issued by the Company. 2. Liquidation Preference. (a) In the event of any liquidation, dissolution or winding up of the Company, either voluntary or involuntary, the holders of the previously issued Convertible Preferred Stock (the "Convertible Preferred Stock") and the Series A Preferred Stock shall be entitled to receive, prior and in preference to any distribution of any of the assets of the Company to the holders of common stock by reason of their ownership thereof, an amount per share equal to $2.50 for the Convertible Preferred Stock, and for the Series A Preferred Stock the sum of (i) $15.80, as adjusted pursuant to Section 4(c) hereof (the "Original Issue Price"), and (ii) an amount equal to cumulative unpaid dividends on such shares (respectively, a "Liquidation Amount"). If upon the occurrence of such an event, the assets and funds thus distributed among the holders of the Convertible Preferred Stock and the Series A Preferred Stock shall be insufficient to permit the payment to such holders of the full aforesaid preferential amounts, then, the entire assets and funds of the Company legally available for distribution shall be distributed ratably among the holders of the Convertible Preferred Stock and the Series A Preferred Stock in proportion to the amount of such stock owned by each such holder multiplied by the appropriate Liquidation Amount. (b) Upon the completion of the distribution required by subparagraph (a) of this Section 2, if assets remain in the Company, the remaining assets of the Company shall be distributed ratably among the holders of the Company's common stock and the Series A Preferred Stock in proportion to the number of shares of common stock held by each (assuming full conversion of all shares of Series A Preferred Stock). (c) (i) For purposes of this Section 2, a liquidation, dissolution or winding up of the Company shall be deemed to be occasioned by, or to include, (A) the acquisition of the Company by another entity by means of any transaction or series of related transactions (including any reorganization, merger or consolidation but excluding any merger effected exclusively for the purpose of changing the domicile of the Company); or (B) a sale of all or substantially all of the assets of the Company, unless the Company's shareholders as constituted immediately prior to such acquisition or sale will, immediately after such acquisition or sale (by virtue of securities issued as consideration for the Company's acquisition or sale or otherwise) hold at least 50% of the voting power of the surviving or acquiring entity. (ii) In any of such events, if the consideration received by the Company is other than cash, its value will be deemed its fair market value. (iii) In the event the requirements of this Section 2 are not complied with, the Company shall forthwith either: (A) cause such closing to be postponed until such time as the requirements of this Section 2 have been complied with, or (B) cancel such transaction, in which event the rights, preferences and privileges of the holders of the Convertible Preferred Stock and the Series A Preferred Stock shall revert to and be the same as such rights, preferences and privileges existing immediately prior to the date of the first notice referred to in subsection 2(c)(iv) hereof. (iv) The Company shall give each holder of record of Convertible Preferred Stock and the Series A Preferred Stock written notice of such impending transaction not later than 20 days prior to the shareholders' meeting called to approve such transaction, or 20 days prior to the closing of such transaction, whichever is earlier, and shall also notify such holders in writing of the final approval of such transaction; provided, however, that the holder of any shares of then outstanding Convertible Preferred Stock or Series A Preferred Stock shall have the right during such 20-day period to convert such shares pursuant to Section 3 hereof. The first of such notices shall describe the material terms and conditions of the impending transaction and the provisions of this Section 2, and the Company shall thereafter give such holders prompt notice of any material changes. The transaction shall in no event take place sooner than 20 days after the Company has given the first notice provided for herein or sooner than ten days after the Company has given notice of any material changes provided for herein; provided, however, that such periods may be shortened upon the written consent of the holders of the Convertible Preferred Stock and the Series A Preferred Stock that are entitled to such notice rights or similar notice rights and that represent at least a majority of the voting power of all then outstanding shares of each of the classes of preferred stock, voting separately as a class. 3. Conversion. (a) Conversion Right. At the option of the holder thereof, each share of Series A Preferred Stock shall be convertible at any time during the period commencing on the day on which the Series A Preferred Stock is issued and expiring on May 15, 2000 (the date which is the second anniversary of the date of issuance of the Series A Preferred Stock); provided, however, that such expiration date shall be extended for a number of days equal to the number of days beyond the 90th day following the date of issuance of the Series A Preferred Stock that the Registration Statement (as such term is defined in the Registration Rights Agreement, of even date herewith, entered into by and between the Company and the Investors set forth on Schedule A thereto) is not effective (such date, including any extension thereof pursuant to the foregoing proviso, being herein referred to as the "Second Anniversary"). The Series A Preferred Stock shall be convertible at the office of the Company or any transfer agent for such stock into such number of fully paid and nonassessable shares of the Company's common stock as is determined by dividing the Original Issue Price, subject to adjustment as provided in Section 4, by the Conversion Price applicable to such shares, determined as hereafter provided, in effect on the date the certificates representing such shares are surrendered for conversion (the "Conversion Date"). The Conversion Price shall be equal to the average closing bid price of one share of the Company's common stock as quoted by the Nasdaq SmallCap Market, the Nasdaq National Market or the principal exchange upon which shares of the Company's common stock may be listed, or, if the Company's common stock shall not then be quoted on the Nasdaq SmallCap Market or the Nasdaq National Market or listed on a national securities exchange, but shall otherwise be traded in the over-the-counter market, on such over-the-counter market for the ten-day period ending on the day prior to the Conversion Date (the "Trading Period") multiplied by .8 (the "Conversion Price"); provided, however, that in no event shall the Conversion Price exceed $5.00 per share or be less than $2.75 (the "Maximum Price" and "Minimum Price," respectively) per share; and provided, further, that appropriate adjustments shall be made in determining the average closing bid price if a recapitalization or other event affecting the Company's common stock shall occur during the Trading Period. (b) Dividend Payment. Should the Company, pursuant to Section 1 hereof, not elect to pay all outstanding, cumulative, accrued and unpaid dividends on the Series A Preferred Stock in shares of its common stock, the Company shall pay, in immediately available funds, to the holder of any shares of Series A Preferred Stock being converted, within two days, all such dividends on the date that it receives notice of such holder's intent to convert such shares pursuant to (d) below. Separately, should the Company elect to pay all outstanding, cumulative, accrued and unpaid dividends on the Series A Preferred Stock in shares of its common stock, it shall, within two business days of receiving a holder's notice of intent to convert, deliver certificates representing such shares to the holder of the Series A Preferred Stock. (c) Automatic Conversion. Any shares of Series A Preferred Stock remaining outstanding on the Second Anniversary shall be automatically converted pursuant to the conversion terms of Section 3(a) above. The Conversion Date with respect to such automatic conversion shall be the Second Anniversary. In any event, the Company shall, within two business days after automatic conversion of the Series A Preferred Stock, issue and deliver a certificate or certificates for the number of shares of the Company's common stock to which each former holder of Series A Preferred Stock is entitled. Notwithstanding the foregoing, no automatic conversion of the Series A Preferred Stock shall occur pursuant to this Section unless (i) all shares of the Company's common stock underlying the shares of Series A Preferred Stock may be sold pursuant to an effective registration statement under the Securities Act of 1933, as amended, (ii) the Company's common stock is listed and trading on The Nasdaq Stock Market, and (iii) the Company has reserved and available for issuance a number of shares of its common stock sufficient to cover conversion of all outstanding shares of Series A Preferred Stock. (d) Mechanics of Conversion. Before any holder of Series A Preferred Stock shall be entitled to convert the same into shares of the Company's common stock, he, she or it shall surrender the certificate or certificates therefor, duly endorsed, at the office of the Company or of any transfer agent for the Series A Preferred Stock, and shall give written notice, via facsimile, to the Company, at its principal corporate office, of the election to convert the same and shall state therein the name or names in which the certificate or certificates for shares of the Company's common stock are to be issued. The Company shall, immediately thereafter (and in any event no more than two business days thereafter), issue and deliver to such holder of Series A Preferred Stock at the address shown on the Company's records or at such other address as such party may designate by written notice to the Company, or to the nominee or nominees of such holder, a certificate or certificates for the number of shares of the Company's common stock to which such holder shall be entitled pursuant to Section 3(a) and a certificate representing shares of Series A Preferred Stock not so converted by the holder. Such conversion shall be deemed to have been made immediately prior to the close of business on the Conversion Date, and the person or persons entitled to receive the shares of the Company's common stock issuable upon such conversion shall be treated for all purposes as the record holder or holders of such shares of the Company's common stock as of such date. (e) Mechanics of Automatic Conversion. On the Conversion Date with respect to the automatic conversion pursuant to subsection 3(c) above, the certificates representing shares of Series A Preferred Stock shall immediately represent that number of shares of the Company's common stock into which such shares are convertible. Holders of Series A Preferred Stock shall deliver their certificates, duly endorsed in blank, to the principal office of the Company, together with a notice setting out the name or names (with addresses) and denominations in which the certificates representing such shares of common stock issuable upon conversion are to be issued and including instructions for delivery thereof. The person entitled to receive the shares of the Company's common stock issuable upon such conversion shall be treated for all purposes as the record holder of such shares of common stock at and on the Conversion Date, and the rights of such person as a holder of shares of Series A Preferred Stock shall cease and terminate at and on the Conversion Date, in any case without regard to any failure by such holder to deliver the certificates or the notice required by this subsection 3(e). On the Conversion Date with respect to automatic conversion, the Company shall pay all outstanding, cumulative, accrued and unpaid dividends, either by the issuance of shares of its common stock or in cash, pursuant to the provisions set forth in (a) above; provided, however, that should the Company elect to pay such dividends by the issuance of additional shares of its common stock, the person entitled to receive such shares of the Company's common stock issuable upon such conversion shall be treated for all purposes as the record holder of such additional shares on the Conversion Date (f) No Impairment. The Company will not, by amendment of its Articles of Incorporation or through any reorganization, recapitalization, transfer of assets, consolidation, merger, dissolution, issue or sale of securities or any other voluntary action, avoid or seek to avoid the observance or performance of any of the terms to be observed or performed hereunder by the Company, but will at all times in good faith assist in the carrying out of all the provisions of this Section 3 and in the taking of all such action as may be necessary or appropriate in order to protect the conversion rights of the holders of the Series A Preferred Stock against impairment. (g) No Fractional Shares. No fractional shares shall be issued upon the conversion of any share or shares of the Series A Preferred Stock, and the number of shares of the Company's common stock to be issued shall be rounded to the nearest whole share. Whether or not fractional shares are issuable upon such conversion shall be determined on the basis of the total number of shares of Series A Preferred Stock the holder is at the time converting into shares of the Company's common stock and the number of shares of such common stock issuable upon such aggregate conversion. (h) Notices of Record Date. In the event of any taking by the Company of a record of the holders of any class of securities for the purpose of determining the holders thereof who are entitled to receive any dividend or other distribution, any right to subscribe for, purchase or otherwise acquire any shares of stock of any class or any other securities or property, or to receive any other right, the Company shall mail to each holder of Series A Preferred Stock, at least 20 days prior to the date specified therein, a notice specifying the date on which any such record is to be taken for the purpose of such dividend, distribution or right, and the amount and character of such dividend, distribution or right. (i) Reservation of Stock Issuable Upon Conversion. The Company shall at all times reserve and keep available out of its authorized but unissued shares of common stock, solely for the purpose of effecting the conversion of the shares of the Series A Preferred Stock, such number of its shares of its common stock as shall from time to time be sufficient to effect the conversion of all outstanding shares of the Series A Preferred Stock; and if at any time the number of authorized but unissued shares of the Company's common stock shall not be sufficient to effect the conversion of all then outstanding shares of the Series A Preferred Stock, in addition to such other remedies as shall be available to the holder of such Series A Preferred Stock, the Company will take such corporate action as may, in the opinion of its counsel, be necessary to increase its authorized but unissued shares of common stock to such number of shares as shall be sufficient for such purposes, including engaging in best efforts to obtain the requisite shareholder approval of any necessary amendment to the Company's Articles of Incorporation. (j) Notices. Any notice required by the provisions of this Section 3 to be given to the holders of shares of Series A Preferred Stock shall be deemed given if deposited in the United States mail, postage prepaid, and addressed to each holder of record at his, her or its address appearing on the books of the Company. 4. Anti-Dilution Provisions. The Original Issue Price shall be subject to adjustment from time to time upon the happening of any of the following events: (a) In the event the Company shall issue or sell any shares of its common stock (except as provided in paragraph (e) hereof) for a consideration per share less than the greater of (A) $5.00, or (B) 80% of the Market Price (as defined below) on the date of such issue or sale, then the Original Issue Price shall be increased to such greater price (calculated to the nearest cent) as shall be determined by multiplying the Original Issue Price by a fraction, the numerator of which shall be the number of shares of the Company's common stock outstanding immediately after the issuance or sale of such additional shares, and the denominator of which shall be the sum of (i) the number of shares of the Company's common stock outstanding immediately prior to the issuance or sale of such additional shares, and (ii) the number of shares of the Company's common stock which the aggregate consideration received for the issuance or sale of such additional shares would purchase at the greater of $5.00, or if such shares of the Company's common stock shall have been issued for a consideration per share less than 80% of the Market Price on the date of issuance or sale, the current Market Price. For purposes of this paragraph, all shares of the Company's common stock issuable upon exercise of outstanding options and warrants shall be deemed to be outstanding. (b) For the purposes of paragraph 4(a) above, the following subparagraphs (i) to (vii), inclusive, shall be applicable: (i) If at any time the Company shall issue or sell any rights to subscribe for, or any rights or options to purchase, shares of its common stock or any stock or other securities convertible into or exchangeable for such common stock (such convertible or exchangeable stock or securities being hereinafter called "Convertible Securities"), whether or not such rights or options or the right to convert or exchange any such Convertible Securities shall be immediately exercisable, and the price per share for which shares of the Company's common stock shall be issuable upon the exercise of such rights or options or upon conversion or exchange of such Convertible Securities (determined by dividing (1) the total amount, if any, received or receivable by the Company as consideration for the granting of such rights or options, plus the minimum aggregate amount of additional consideration payable to the Company upon the exercise of such rights or options, plus, in the case of any such rights or options which shall relate to Convertible Securities, the minimum aggregate amount of additional consideration, if any, payable upon the issue or sale of such Convertible Securities and upon the conversion or exchange thereof, by (2) the total number of shares of the Company's common stock issuable upon the exercise of such rights or options or upon the conversion or exchange of all such Convertible Securities issuable upon the exercise of such rights or options) shall be less than the greater of (x) the $5.00, or (y) 80% of the Market Price at the time of such issue or sale, then the total number of shares of the Company's common stock issuable upon the exercise of such rights or options or upon conversion or exchange of the total amount of such Convertible Securities issuable upon the exercise of such rights or options shall (as of the date of granting of such rights or options) be deemed to be outstanding and to have been issued for such price per share, and except as provided in paragraph 4(d), no further adjustments of the Original Issue Price shall be made upon the actual issue of such shares of common stock or of such Convertible Securities, upon the exercise of such rights or options or upon the actual issue of such common stock upon conversion or exchange of such Convertible Securities. (ii) If at any time the Company shall issue or sell any Convertible Securities, whether or not the rights to exchange or convert thereunder shall be immediately exercisable, and the price per share for which shares of the Company's common stock shall be issuable upon such conversion or exchange (determined by dividing (1) the total amount received or receivable by the Company as consideration for the issue or sale of such Convertible Securities, plus the minimum aggregate amount of additional consideration, if any, payable to the Company upon the conversion or exchange thereof, by (2) the total number of shares of the Company's common stock issuable upon the conversion or exchange of all such Convertible Securities) shall be less than the greater of (x) $5.00, or (y) 80% of the Market Price at the time of such issue or sale, then the total number of shares of the Company's common stock issuable upon conversion or exchange of all such Convertible Securities shall (as of the date of the issue or sale of such Convertible Securities) be deemed to be outstanding and to have been issued for such price per share, and, except as provided in paragraph 4(d), no further adjustments of the Original Issue Price shall be made upon the actual issue of such shares of common stock upon conversion or exchange of such Convertible Securities. In addition, if any issue or sale of such Convertible Securities shall be made upon exercise of any rights to subscribe for or to purchase or any option to purchase any such Convertible Securities for which adjustments of the Original Issue Price shall have been or shall be made pursuant to other provisions of this paragraph 4(b)(ii), no further adjustment of the Original Issue Price shall be made by reason of such issue or sale. (iii) If at any time the Company shall declare and pay a dividend or make any other distribution upon the shares of its common stock payable in such stock or Convertible Securities, any such stock or Convertible Securities, as the case may be, issuable in payment of such dividend or distribution shall be deemed to have been issued or sold without consideration. (iv) If at any time any shares of the Company's common stock or Convertible Securities or any rights or options to purchase shares of any such stock or Convertible Securities shall be issued or sold for cash, the consideration received therefor shall be deemed to be the amount received by the Company therefor, without deduction therefrom of any expenses incurred or any underwriting commissions or concessions or discounts paid or allowed by the Company in connection therewith. In case any shares of the Company's common stock or Convertible Securities or any rights or options to purchase any such common stock or Convertible Securities shall be issued or sold for a consideration other than cash, the amount of the consideration other than cash received by the Company shall be deemed to be the fair value of such consideration as determined by the Company's Board of Directors, without deduction therefrom of any expenses incurred or any underwriting commissions or concessions or discounts paid or allowed by the Company in connection therewith. In case any shares of the Company's common stock or Convertible Securities or any rights or options to purchase any such common stock or Convertible Securities shall be issued in connection with any merger of another corporation into the Company, the amount of consideration therefor shall be deemed to be the fair value of the net assets of such merged corporation as determined by the Company's Board of Directors after deducting therefrom all cash and other consideration (if any) paid by the Company in connection with such merger. (v) If at any time the Company shall take a record of the holders of its common stock for the purpose of entitling them (1) to receive a dividend or other distribution payable in shares of the Company's common stock or in Convertible Securities, or (2) to subscribe for or purchase shares of the Company's common stock or Convertible Securities, then such record date shall be deemed to be the date of the issue or sale of the shares of the Company's common stock deemed to have been issued or sold upon the declaration of such dividend or the making of such other distribution or the date of the granting of such right of subscription or purchase, as the case may be. (vi) The number of shares of the Company's common stock outstanding at any given time shall not include shares owned or held by or for the account of the Company, provided that such shares are neither issued, sold or otherwise distributed by the Company. (vii) For purposes hereof, the "Market Price" shall mean the average closing bid price of the Company's common stock on the Nasdaq SmallCap Market, the Nasdaq National Market or the principal exchange upon which shares of the Company's common stock may be listed, or, if the Company's common stock shall not then be quoted on the Nasdaq SmallCap Market or the Nasdaq National Market or listed on a national securities exchange, but shall otherwise be traded in the over-the-counter market, on such over-the-counter market, in each case for the ten day period immediately preceding any determination of such "Market Price" (subject to appropriate adjustments which shall be made in determining the average closing bid price if a recapitalization or other event affecting the Company's common stock shall occur during such 10-day period). If at any time shares of the Company's common stock shall not be quoted on the Nasdaq SmallCap Market or the Nasdaq National Market, listed on a national securities exchange, or otherwise traded in the over-the-counter market, the "Market Price" of a share of the Company's common stock shall be deemed to be the higher of (x) the book value thereof (as determined by any firm of independent public accountants of nationally recognized standing selected by the Company's Board of Directors) as of the last day of any month ending within 60 days preceding the date of determination, or (y) the fair value thereof (as determined in good faith by the Company's Board of Directors) as of a date which shall be within 15 days of the date of determination. (c) In case at any time the Company shall subdivide its outstanding shares of common stock into a greater number of shares, the Original Issue Price in effect immediately prior to such subdivision, the Maximum Price and the Minimum Price shall be proportionately reduced, and the Company shall subdivide the Series A Preferred Stock in the same proportion. In case at any time the outstanding shares of the Company's common stock shall be combined into a smaller number of shares, the Original Issue Price in effect immediately prior to such combination, the Maximum Price and the Minimum Price shall be proportionately increased, and the Company shall combine the Series A Preferred Stock in the same proportion. Any adjustment under this paragraph 4(c) shall become effective at the close of business on the date the subdivision or combination shall become effective. The Company will take such corporate action as may, in the opinion of its counsel, be necessary to increase its authorized but unissued shares of Series A Preferred Stock to such number of shares as shall be sufficient for any such purposes, including engaging in best efforts to obtain the requisite shareholder approval of any necessary amendment to the Company's Articles of Incorporation. (d) If the purchase or exercise price provided for in any right or option referred to in paragraph 4(b)(i), or the rate at which any Convertible Securities referred to in paragraph 4(b)(i) or (ii) shall be convertible into or exchangeable for shares of the Company's common stock, shall change or a different purchase or exercise price or rate shall become effective at any time or from time to time (including any change resulting from termination of such right, option or convertible security), then, upon such change becoming effective, the Original Issue Price then in effect hereunder shall forthwith be increased or decreased to such Original Issue Price as would have been obtained had the adjustments made upon the granting or issuance of such rights or options or Convertible Securities been made upon the basis of (A) the issuance of the number of shares of the Company's common stock theretofore actually delivered upon the exercise of such options or rights or upon the conversion or exchange of such Convertible Securities, and (B) the granting or issuance at the time of such change of any such options, rights or Convertible Securities then still outstanding for the consideration, if any, received by the Company therefor and to be received on the basis of such changed price. (e) The Company shall not be required to make any adjustment to the Original Issue Price in the case of: (i) the granting, after the date hereof, by the Company of stock options under the Company's 1997 Stock Option Plan, so long as the shares of the Company's common stock underlying such options are covered by the 800,000 shares currently reserved for issuance under such plan as of the date hereof, assuming approval by the Company's shareholders of the 300,000 share increase at the Company's 1998 Annual Meeting of Shareholders; (ii) the issuance of shares of the Company's common stock, pursuant to the exercise of the options referred to in paragraph 4(e)(i) above or the exercise of any other options or warrants outstanding as of the date hereof; or (iii) the issuance of shares of the Series A Preferred Stock hereunder or of shares of the Company's common stock upon the conversion of any shares of the Series A Preferred Stock or upon the exercise of the Warrant or the Warrant issued to Miller, Johnson & Kuehn, Incorporated on the same date as the Preferred Stock Purchase Agreement to which this certificate of Designation is an Exhibit. 5. Voting Rights. The holder of each share of Series A Preferred Stock shall have the right to the number of votes on all matters submitted to the Company's shareholders that shall be equal to the number of shares of the Company's common stock into which such holder's shares of Series A Preferred Stock shall then be convertible (assuming a conversion as of the record date set for the vote). 6. Status of Converted Stock. In the event any shares of Series A Preferred Stock shall be converted pursuant to Section 3 hereof, the shares of Series A Preferred Stock so converted shall be canceled and shall not be issuable by the Company. The Articles of Incorporation of the Company shall be appropriately amended to effect the corresponding reduction in the Company's authorized capital stock. 7. Notice of Adjustment. The Company shall provide all holders of shares of Series A Preferred Stock five business days prior written notice of any adjustments in the Original Issue Price, the Maximum Price, the Minimum Price or any other adjustments made pursuant to the provisions hereof. Filed with State of Minnesota May 14, 1998 STATEMENT OF DESIGNATION OF ADDITIONAL SHARES OF DATAKEY, INC. The undersigned hereby certifies that the resolutions set forth below were duly adopted by the Board of Directors of Datakey, Inc., a Minnesota corporation, on January 25, 2000: WHEREAS, pursuant to the Articles of Incorporation of this corporation, the Board of Directors has authority to establish, from the 1,950,000 undesignated shares of capital stock, one or more classes or series of shares and to fix the relative rights and preferences of each such class of or series; and WHEREAS, the Board of Directors deems it advisable to designate additional common shares; NOW, THEREFORE, RESOLVED, that, of the 1,950,000 undesignated shares, currently authorized, 1,000,000 shares are designated as additional common shares. I swear that the foregoing is true and accurate and that I have the authority to sign this document on behalf of the corporation. Dated: February 10, 2000 /s/ Carl P. Boecher Carl P. Boecher, President and Chief Executive Officer of Datakey, Inc. FILED WITH STATE OF MINNESOTA FEB. 11, 2000 ARTICLES OF AMENDMENT OF ARTICLES OF INCORPORATION OF DATAKEY, INC. Pursuant to the provisions of Minnesota Statutes, Section 302A.135, the amendment to the Articles of Incorporation of Datakey, Inc., amending and restating Article 3.01 in its entirety, as set forth below, was duly adopted by the shareholders of the corporation on May 31, 2000: "3.01 The aggregate number of shares of stock which this corporation shall have authority to issue is 30,000,000 shares, consisting of 20,000,000 shares of common stock, par value $.05, 400,000 shares of convertible preferred stock, which shall have the rights and preferences as set forth on a Certificate of Rights and Preferences filed with the Minnesota Secretary of State on December 24, 1985, and 9,600,000 undesignated shares." The undersigned swears that the foregoing is true and accurate and that the undersigned has the authority to sign this document on behalf of the corporation. Dated: May 31, 2000 /s/ Carl P. Boecher Carl P. Boecher, President and Chief Executive Officer Filed with State of Minnesota June 19, 2000 STATEMENT OF DESIGNATION OF SERIES B PREFERRED STOCK OF DATAKEY, INC. (Pursuant to Chapter 302A of the Minnesota Business Corporation Act) Datakey, Inc., a corporation organized and existing under the Minnesota Business Corporation Act (hereinafter called the "Company"), hereby certifies that the following resolution was adopted by the Board of Directors of the Company at a meeting duly called and held on October 19, 2001: RESOLVED, that, pursuant to the authority granted to and vested in the Board of Directors of the Company (hereinafter called the "Board of Directors" or the "Board") in accordance with the provisions of Section 3.01 of the Articles of Incorporation, as amended to date (hereinafter called the "Articles of Incorporation"), the Board of Directors hereby creates a series of preferred stock, par value $.05 per share, of the Company and hereby states the designation and number of shares, and fixes the relative rights, preferences, and limitations thereof as follows: Series B Preferred Stock: Section 1. Designation and Amount. The shares of such preferred stock series shall be designated as "Series B Preferred Stock" (the "Series B Preferred Stock"), and the number of shares constituting the Series B Preferred Stock shall be One Hundred and Twenty-Thousand (120,000). Such number of shares may be increased or decreased by resolution of the Board of Directors; provided, that, no decrease shall reduce the number of shares of Series B Preferred Stock to a number less than the number of shares then outstanding plus the number of shares reserved for issuance upon the exercise of outstanding options, rights or warrants or upon the conversion of any outstanding securities issued by the Company convertible into Series B Preferred Stock. Section 2. Dividends and Distributions. (A) Subject to the rights of the holders of any shares of any series of preferred stock of the Company or preferred stock (or any similar stock) ranking prior and superior to the Series B Preferred Stock with respect to dividends, the holders of shares of Series B Preferred Stock, in preference to the holders of Common Stock, par value $.05 per share (the "Common Stock"), of the Company, and of any other junior stock, shall be entitled to receive, when, as and if declared by the Board of Directors out of funds legally available for the purpose, quarterly dividends payable in cash on the first day of March, June, September and December in each year (each such date being referred to herein as a "Quarterly Dividend Payment Date"), commencing on the first Quarterly Dividend Payment Date after the first issuance of a share or fraction of a share of Series B Preferred Stock, in an amount per share (rounded to the nearest cent) equal to the greater of (a) $1 or (b) subject to the provision for adjustment hereinafter set forth, 100 times (as adjusted, the "Dividend Multiple") the aggregate per share amount of all cash dividends, and 100 times the aggregate per share amount (payable in kind) of all non-cash dividends or other distributions, other than a dividend payable in shares of Common Stock or a subdivision of the outstanding shares of Common Stock (by reclassification or otherwise), declared on the Common Stock since the immediately preceding Quarterly Dividend Payment Date or, with respect to the first Quarterly Dividend Payment Date, since the first issuance of any share or fraction of a share of Series B Preferred Stock. In the event the Company shall at any time declare or pay any dividend on the Common Stock payable in shares of Common Stock, or effect a subdivision or combination or consolidation of the outstanding shares of Common Stock (by reclassification or otherwise) into a greater or lesser number of shares of Common Stock, then in each such case the Dividend Multiple shall be adjusted by multiplying such amount by a fraction, the numerator of which is the number of shares of Common Stock outstanding immediately after such event and the denominator of which is the number of shares of Common Stock that were outstanding immediately prior to such event. (B) The Company shall declare a dividend or distribution on the Series B Preferred Stock as provided in paragraph (A) of this Section immediately after it declares a dividend or distribution on the Common Stock (other than a dividend payable in shares of Common Stock); provided, that, in the event no dividend or distribution shall have been declared on the Common Stock during the period between any Quarterly Dividend Payment Date and the next subsequent Quarterly Dividend Payment Date, a dividend of $1 per share on the Series B Preferred Stock shall nevertheless be payable on such subsequent Quarterly Dividend Payment Date. (C) Dividends shall begin to accrue and be cumulative on outstanding shares of Series B Preferred Stock from the Quarterly Dividend Payment Date next preceding the date of issue of such shares, unless the date of issue of such shares is prior to the record date for the first Quarterly Dividend Payment Date, in which case dividends on such shares shall begin to accrue from the date of issue of such shares, or unless the date of issue is a Quarterly Dividend Payment Date or is a date after the record date for the determination of holders of shares of Series B Preferred Stock entitled to receive a quarterly dividend and before such Quarterly Dividend Payment Date, in either of which events such dividends shall begin to accrue and be cumulative from such Quarterly Dividend Payment Date. Accrued but unpaid dividends shall not bear interest. Dividends paid on the shares of Series B Preferred Stock in an amount less than the total amount of such dividends at the time accrued and payable on such shares shall be allocated pro rata on a share-by-share basis among all such shares at the time outstanding. The Board of Directors may fix a record date for the determination of holders of shares of Series B Preferred Stock entitled to receive payment of a dividend or distribution declared thereon, which record date shall be not more than sixty (60) days prior to the date fixed for the payment thereof. Section 3. Voting Rights. The holders of shares of Series B Preferred Stock shall have the following voting rights: (A) Subject to the provision for adjustment hereinafter set forth, each share of Series B Preferred Stock shall entitle the holder thereof to 100 votes (as adjusted, the "Vote Multiple") on all matters submitted to a vote of the stockholders of the Company. In the event the Company shall at any time declare or pay any dividend on the Common Stock payable in shares of Common Stock, or effect a subdivision or combination or consolidation of the outstanding shares of Common Stock (by reclassification or otherwise) into a greater or lesser number of shares of Common Stock, then in each such case the Vote Multiple shall be adjusted by multiplying such number by a fraction, the numerator of which is the number of shares of Common Stock outstanding immediately after such event and the denominator of which is the number of shares of Common Stock that were outstanding immediately prior to such event. (B) Except as otherwise provided in Section 10 hereof, in any other Statement of Designation creating a series of preferred stock or any similar stock, or by law, the holders of shares of Series B Preferred Stock and the holders of shares of Common Stock, the holders of Convertible Preferred Stock and any other capital stock of the Company having general voting rights shall vote together as one class on all matters submitted to a vote of stockholders of the Company. (C) Except as set forth herein, or as otherwise provided by law, holders of Series B Preferred Stock shall have no special voting rights and their consent shall not be required (except to the extent they are entitled to vote with holders of Common Stock as set forth herein) for taking any corporate action. Section 4. Certain Restrictions. (A) Whenever quarterly dividends or other dividends or distributions payable on the Series B Preferred Stock as provided in Section 2 are in arrears, thereafter and until all accrued and unpaid dividends and distributions, whether or not declared, on shares of Series B Preferred Stock outstanding shall have been paid in full, the Company shall not: (i) declare or pay dividends, or make any other distributions, on any shares of stock ranking junior (either as to dividends or upon liquidation, dissolution or winding up) to the Series B Preferred Stock; (ii) declare or pay dividends, or make any other distributions, on any shares of stock ranking on a parity (either as to dividends or upon liquidation, dissolution or winding up) with the Series B Preferred Stock, except dividends paid ratably on the Series B Preferred Stock and all such parity stock on which dividends are payable or in arrears in proportion to the total amounts to which the holders of all such shares are then entitled; (iii) redeem or purchase or otherwise acquire for consideration shares of any stock ranking junior (either as to dividends or upon liquidation, dissolution or winding up) to the Series B Preferred Stock, provided that the Company may at any time redeem, purchase or otherwise acquire shares of any such junior stock in exchange for shares of any stock of the Company ranking junior (as to dividends and upon dissolution, liquidation and winding up) to the Series B Preferred Stock; or (iv) redeem or purchase or otherwise acquire for consideration any shares of Series B Preferred Stock, or any shares of stock ranking on a parity (either as to dividends or upon liquidation, dissolution or winding up) with the Series B Preferred Stock, except in accordance with a purchase offer made in writing or by publication (as determined by the Board) to all holders of such shares upon such terms as the Board, after consideration of the respective annual dividend rates and other relative rights and preferences of the respective series or classes, shall determine in good faith will result in fair and equitable treatment among the respective series or classes. (B) The Company shall not permit any subsidiary of the Company to purchase or otherwise acquire for consideration any shares of stock of the Company unless the Company could, under paragraph (A) of this Section 4, purchase or otherwise acquire such shares at such time and in such manner. Section 5. Reacquired Shares. Any shares of Series B Preferred Stock purchased or otherwise acquired by the Company in any manner whatsoever shall be retired and cancelled promptly after the acquisition thereof. All such shares shall upon their cancellation become authorized but unissued undesignated shares and may be reissued as part of a new series of stock subject to the conditions and restrictions on issuance set forth herein, in the Articles of Incorporation, or in any other Statement of Designation creating a series of preferred stock or any similar stock or as otherwise required by law. Section 6. Liquidation, Dissolution or Winding Up. Upon any liquidation, dissolution or winding up of the Company, no distribution shall be made (A) to the holders of shares of stock ranking junior (either as to dividends or upon liquidation, dissolution or winding up) to the Series B Preferred Stock unless, prior thereto, the holders of shares of Series B Preferred Stock shall have received the greater of (i) $100 per share, plus an amount equal to accrued and unpaid dividends and distributions thereon, whether or not declared, to the date of such payment, or (ii) subject to the provision for adjustment hereinafter set forth, 100 times (as adjusted, the "Liquidation Preference Multiple") the aggregate amount to be distributed per share to holders of shares of Common Stock, or (B) to the holders of shares of stock ranking on a parity (either as to dividends or upon liquidation, dissolution or winding up) with the Series B Preferred Stock, except distributions made ratably on the Series B Preferred Stock and all such parity stock in proportion to the total amounts to which the holders of all such shares are entitled upon such liquidation, dissolution or winding up. In the event the Company shall at any time declare or pay any dividend on the Common Stock payable in shares of Common Stock, or effect a subdivision or combination or consolidation of the outstanding shares of Common Stock (by reclassification or otherwise) into a greater or lesser number of shares of Common Stock, then in each such case the Liquidation Preference Multiple shall be adjusted by multiplying such amount by a fraction the numerator of which is the number of shares of Common Stock outstanding immediately after such event and the denominator of which is the number of shares of Common Stock that were outstanding immediately prior to such event. Section 7. Consolidation, Merger, Etc. In case the Company shall enter into any consolidation, merger, statutory exchange combination or other transaction in which the shares of Common Stock are exchanged for or changed into other stock or securities, cash and/or any other property, then in any such case each share of Series B Preferred Stock shall at the same time be similarly exchanged or changed into an amount per share, subject to the provision for adjustment hereinafter set forth, equal to 100 times (as adjusted, the "Exchange Multiple") the aggregate amount of stock, securities, cash and/or any other property (payable in kind), as the case may be, into which or for which each share of Common Stock is changed or exchanged. In the event the Company shall at any time declare or pay any dividend on the Common Stock payable in shares of Common Stock, or effect a subdivision or combination or consolidation of the outstanding shares of Common Stock (by reclassification or otherwise) into a greater or lesser number of shares of Common Stock, then in each such case the Exchange Multiple shall be adjusted by multiplying such amount by a fraction, the numerator of which is the number of shares of Common Stock outstanding immediately after such event and the denominator of which is the number of shares of Common Stock that were outstanding immediately prior to such event. Section 8. No Redemption. The shares of Series B Preferred Stock shall not be redeemable. Section 9. Rank. The Series B Preferred Stock shall rank, with respect to the payment of dividends and the distribution of assets, junior to the Company's Convertible Preferred Shares outstanding and junior to any other class of the corporation's preferred stock hereafter issued. Section 10. Amendment. If any proposed amendment to the Articles of Incorporation or this Statement of Designation would alter or change the preferences, special rights or powers given to the Series B Preferred Stock so as to affect the Series B Preferred Stock adversely, except as otherwise provided in this Statement of Designation, then the holders of the Series B Preferred Stock shall be entitled to vote as a series upon such amendment, and the affirmative vote of two-thirds of the outstanding shares of Series B Preferred Stock shall be necessary to the adoption thereof, in addition to such other vote as may be required by the Minnesota Business Corporation Act. Section 11. Fractional Shares. Series B Preferred Stock may be issued in fractions of a share which shall entitle the holder, in proportion to such holder's fractional shares, to exercise voting rights, receive dividends, participate in distributions and to have the benefit of all other rights of holders of Series B Preferred Stock. I certify that I am authorized to execute this Statement of Designation, and I further certify that I understand that by signing this Statement of Designation I am subject to the penalties of perjury as set forth in Minnesota Statutes, Section 609.48, as if I had signed this Statement of Designation under oath. Dated: October 26, 2001 /s/ Alan G. Shuler --------------------------------------- Alan G. Shuler, Vice President and Chief Financial Officer EX-3.2 4 c75665exv3w2.txt EX-3.2 RESTATED BYLAWS EXHIBIT 3.2 AMENDED AND RESTATED BYLAWS OF DATAKEY, INC. ARTICLE 1. OFFICES 1.1) Offices. The address of the registered office of the corporation shall be designated in the Articles of Incorporation, as amended from time to time. The principal executive office of the corporation shall be located at such address as the Board of Directors may determine, and the corporation may have offices at such other places within or without the State of Minnesota as the Board of Directors shall from time to time determine or the business of the corporation requires. ARTICLE 2. MEETINGS OF SHAREHOLDERS 2.1) Regular Meetings. Regular meetings of the shareholders of the corporation entitled to vote shall be held on an annual or other less frequent basis as shall be determined by the Board of Directors or by the chief executive officer; provided, that if a regular meeting has not been held during the immediately preceding 15 months, a shareholder or shareholders holding three percent (3%) or more of the voting power of all shares entitled to vote may demand a regular meeting of shareholders by written notice of demand given to the chief executive officer or chief financial officer of the corporation. At each regular meeting, the shareholders, voting as provided in the Articles of Incorporation and these Bylaws, shall elect qualified successors for directors who serve for an indefinite term or for directors whose terms have expired or are due to expire within six months after the date of the meeting, and shall transact such other business as shall come before the meeting. No meeting shall be considered a regular meeting unless specifically designated as such in the notice of meeting or unless all the shareholders entitled to vote are present in person or by proxy and none of them objects to such designation. The Board of Directors shall have the ability to postpone previously scheduled annual meetings upon public notice given prior to the scheduled meeting date. 2.2) Advance Notice of Shareholder Nominees and Shareholder Business - Regular Meetings. Subject to the notice requirements set forth in this Section 2.2, any shareholder entitled to vote in the election of directors generally may: (a) make nominations for the election of directors; and (b) propose business to be brought before any regular meeting; if such nomination or business proposed is otherwise proper business before such meeting. Any such shareholder may nominate one or more persons for election as directors at a meeting or propose business to be brought before a meeting, or both, only if such shareholder has given timely notice to the secretary of the corporation in proper written form of the shareholder's intent -1- to make such nomination or nominations or to propose such business. To be timely, such shareholder's notice must be delivered to or mailed and received by the secretary of the corporation at the principal executive offices of the corporation not less than one hundred twenty (120) calendar days in advance of the date that is one year after the prior year's annual meeting of shareholders; provided, however, that in the event that no annual meeting was held in the previous year or the date of the annual meeting has been changed by more than thirty (30) days from the date of the prior year's annual meeting (in either case such an annual meeting date being referred to herein as an "Other Meeting Date"), notice by the shareholder to be timely must be so received by the later of: (i) the close of business on the date ninety (90) days prior to the Other Meeting Date or (ii) the close of business ten (10) days following the date on which the Other Meeting Date is first publicly announced. To be in proper form, a shareholder's notice to the secretary shall set forth: (i) the name and address of the shareholder who intends to make the nominations or propose the business and, as the case may be, of the person or persons to be nominated or of the business to be proposed; (ii) a representation that the shareholder is a holder of record of stock of the corporation entitled to vote at such meeting and, if applicable, intends to appear in person or by proxy at the meeting to nominate the person or persons specified in the notice; (iii) if applicable, a description of all arrangements or understandings between the shareholder and each nominee and any other person or persons (naming such person or persons) pursuant to which the nomination or nominations are to be made by the shareholder; (iv) beneficial stock ownership information of such nominee and such other information regarding each nominee or each matter of business to be proposed by such shareholder as would be required to be included in a proxy statement filed pursuant to the proxy rules of the Securities and Exchange Commission had the nominee been nominated, or intended to be nominated, or the matter been proposed, or intended to be proposed by the board of directors; and (v) if applicable, the consent of each nominee to serve as director of the corporation if so elected. The chairman of the meeting shall refuse to acknowledge the nomination of any person or the proposal of any business not made in compliance with the foregoing procedure. 2.3) Special Meetings. Special meetings of the shareholders entitled to vote may be called at any time by the Chairman of the Board, the chief executive officer, the chief financial officer, two or more directors, or a shareholder or shareholders holding ten percent (10%) (25% if the purpose is to effect a business combination, including a change of the board composition) or more of the voting power of all shares entitled to vote who shall demand such special meeting by giving written notice of demand (in accordance with Minn. Stat. 302A.433) to the chief executive officer or the chief financial officer specifying the purposes of the meeting. -2- 2.4) Meetings Held Upon Shareholder Demand. Within thirty (30) days after receipt by the chief executive officer or the chief financial officer of a demand from any shareholder or shareholders entitled to call a regular or special meeting of shareholders, the Board of Directors shall cause such meeting to be called and held on notice no later than ninety (90) days after receipt of such demand. If the Board of Directors fails to cause such a meeting to be called and held, the shareholder or shareholders making the demand may call the meeting by giving notice as provided in Section 2.6 hereof at the expense of the corporation. 2.5) Place of Meetings. Meetings of the shareholders shall be held at the principal executive office of the corporation or at such other place, within or without the State of Minnesota, as is designated by the Board of Directors, except that a regular or special meeting called by or at the demand of a shareholder shall be held in the county where the principal executive office of the corporation is located. 2.6) Notice of Meetings. Except as otherwise specified in Section 2.7 or required by law, a written notice setting out the place, date and hour of any regular or special meeting shall be given to each holder of shares entitled to vote not less than ten (10) days nor more than sixty (60) days prior to the date of the meeting; provided, that notice of a meeting at which there is to be considered a proposal (i) to dispose of all, or substantially all, of the property and assets of the corporation or (ii) to dissolve the corporation shall be given to all shareholders of record, whether or not entitled to vote; and provided further, that notice of a meeting at which there is to be considered a proposal to adopt a plan of merger or exchange shall be given to all shareholders of record, whether or not entitled to vote, at least fourteen (14) days prior thereto. Notice of any special meeting shall state the purpose or purposes of the proposed meeting, and the business transacted at all special meetings shall be confined to the purposes stated in the notice. 2.7) Waiver of Notice. A shareholder may waive notice of any meeting before, at or after the meeting, in writing, orally or by attendance. Attendance at a meeting by a shareholder is a waiver of notice of that meeting unless the shareholder objects at the beginning of the meeting to the transaction of business because the meeting is not lawfully called or convened, or objects before a vote on an item of business because the item may not be lawfully considered at such meeting and does not participate in the consideration of the item at such meeting. 2.8) Quorum and Adjourned Meeting. The holders of a majority of the voting power of the shares entitled to vote at a meeting, represented either in person or by proxy, shall constitute a quorum for the transaction of business at any regular or special meeting of shareholders. If a quorum is present when a duly called or held meeting is convened, the shareholders present may continue to transact business until adjournment, even though the withdrawal of a number of shareholders originally present leaves less than the proportion or number otherwise required for a quorum. In case a quorum is not present at any meeting, those present shall have the power to adjourn the meeting from time to time, without notice other than announcement at the meeting, until the requisite number of shares entitled to vote shall be represented. Whether or not a quorum is present, the Chairman of the Board shall have the ability to adjourn the meeting to a date not more than 45 days after such original meeting date. At such adjourned meeting at which the required amount of shares entitled to vote shall be represented, any business may be transacted which might have been transacted at the original meeting. -3- 2.9) Voting. At each meeting of the shareholders, every shareholder having the right to vote shall be entitled to vote in person or by proxy duly appointed by an instrument in writing subscribed by such shareholder. Each shareholder shall have one (1) vote for each share having voting power standing in each shareholder's name on the books of the corporation except as may be otherwise provided in the terms of the share. Upon the demand of any shareholder, the vote for directors or the vote upon any question before the meeting shall be by ballot. All elections shall be determined and all questions decided by a majority vote of the number of shares entitled to vote and represented at any meeting at which there is a quorum except in such cases as shall otherwise be required by statute or the Articles of Incorporation. 2.10) Order of Business. The chairman of the meeting shall have the right and authority to prescribe such rules, regulations and procedures and to do all such acts as, in the judgment of such chairman, are appropriate for conduct of the meeting. To the extent not prohibited by law, such rules, regulations or procedures may include, without limitation, establishment of: (1) an agenda or order of business for the meeting and the method by which business may be proposed, (2) rules and procedures for maintaining order at the meeting and the safety of those present, (3) limitations on attendance or participation in the meeting to shareholders or record of the corporation, their duly authorized proxies or such other persons as the chairman of the meeting shall determine, (4) restrictions on entry to the meeting after the time fixed for commencement thereof and (5) limitations on the time allotted to questions or comments by participants. Any proposed business contained in the notice of a regular meeting is deemed to be on the agenda and no further motions or other actions shall be required to bring such proposed business up for consideration. Unless and to the extent otherwise determined by the chairman of the meeting, it shall not be necessary to follow Robert's Rules of Order or any other rules or parliamentary procedure at the meeting of shareholders. Following completion of business of the meeting as determined by the chairman of the meeting, the chairman of the meeting shall have the exclusive authority to adjourn the meeting. ARTICLE 3. DIRECTORS 3.1) General Powers. The business and affairs of the corporation shall be managed by or under the direction of a Board of Directors. 3.2) Number, Term and Qualifications. At each annual meeting the Shareholders shall determine the number of directors which shall be not less than three (3) nor more than nine (9); provided, that between annual meetings the Board of Directors may increase the authorized number of directors within the limits stated above. However, notwithstanding the foregoing no increase or decrease in the number of directors may be effected except according to the further provisions contained in this Section 3.2. The directors shall be divided into three classes, designated Class I, Class II and Class III. Each class shall consist, as nearly as possible, of one-third of the total number of directors constituting the entire Board of Directors. At the first meeting of Shareholders held after April __, 2001, Class I directors shall be elected for a one-year term, the Class II directors for a two-year term, and the Class III directors -4- for a three-year term. At each succeeding annual meeting of the shareholders at which directors are elected, successors to the Class of directors whose term expires at that annual meeting shall be elected for a three-year term. A director shall hold office until the annual meeting for the year in which such director's term expires and until such director's successor shall be elected and shall qualify, or until such director's resignation or removal from office. If the number of directors is changed, any increase or decrease shall be apportioned by the Board of Directors among the classes so as to maintain, as nearly as possible, an equal number of directors in each class. In the event an increase or decrease makes it impossible to maintain an equal number of directors in each class, increases shall be allocated to the class or classes with the longest remaining term, and decreases shall be allocated to the class with the shortest remaining term. Any director elected to fill a vacancy resulting from an increase in such class shall hold office for a term that shall coincide with the remaining term of that class. In no event will a decrease in the number of directors result in the elimination of an entire class of directors, cause any class to contain a number of directors two or more greater than any other class, or shorten the term of any incumbent director. Any director elected to fill a vacancy not resulting from an increase in the number of directors shall have the same remaining term as that of such director's predecessor. 3.3) Vacancies. Vacancies on the Board of Directors may be filled by the affirmative vote of a majority of the remaining members of the Board, though less than a quorum; provided, that newly created directorships resulting from an increase in the authorized number of directors shall be filled by the affirmative vote of a majority of the directors serving at the time of such increase. Persons so elected shall be directors until their successors are elected by the shareholders, who may make such election at the next regular or special meeting of the shareholders. 3.4) Quorum and Voting. A majority of the directors currently holding office shall constitute a quorum for the transaction of business. In the absence of a quorum, a majority of the directors present may adjourn a meeting from time to time until a quorum is present. If a quorum is present when a duly called or held meeting is convened, the directors present may continue to transact business until adjournment even though the withdrawal of a number of directors originally present leaves less than the proportion or number otherwise required for a quorum. Except as otherwise required by law or the Articles of Incorporation, the acts of a majority of the directors present at a meeting at which a quorum is present shall be the acts of the Board of Directors. 3.5) Board Meetings; Place and Notice. Meetings of the Board of Directors may be held from time to time at any place within or without the State of Minnesota that the Board of Directors may designate. In the absence of designation by the Board of Directors, Board meetings shall be held at the principal executive office of the corporation, except as may be otherwise unanimously agreed orally, or in writing, or by attendance. Any director may call a Board meeting by giving two (2) days notice to all directors of the date and time of the meeting. The notice need not state the purpose of the meeting, and may be given by mail, telephone, telegram, or in person. If a meeting schedule is adopted by the Board, or if the date and time of a Board meeting has been announced at a previous meeting, no notice is required. -5- 3.6) Waiver of Notice. A director may waive notice of any meeting before, at or after the meeting, in writing, orally or by attendance. Attendance at a meeting by a director is a waiver of notice of that meeting unless the director objects at the beginning of the meeting to the transaction of business because the meeting is not lawfully called or convened and does not participate thereafter in the meeting. 3.7) Compensation. Directors who are not salaried officers of the corporation shall receive such fixed sum and expenses per meeting attended or such fixed annual sum or both as shall be determined from time to time by resolution of the Board of Directors. Nothing herein contained shall be construed to preclude any director from serving this corporation in any other capacity and receiving proper compensation therefor. 3.8) Committees. The Board of Directors may, by resolution approved by affirmative vote of a majority of the Board, establish committees having the authority of the Board in the management of the business of the corporation only to the extent provided in the resolution. Committees may include a special litigation committee consisting of one or more independent directors or other independent persons to consider legal rights or remedies of the corporation and whether those rights and remedies should be pursued. Each such committee shall consist of one or more natural persons (who need not be directors) appointed by the affirmative vote of a majority of the directors present, and shall, other than special litigation committees, be subject at all times to the direction and control of the Board. A majority of the members of a committee present at a meeting shall constitute a quorum for the transaction of business. 3.9) Order of Business. The suggested order of business at any meeting of the Board of Directors shall, to the extent appropriate and unless modified by the presiding chairman, be: 1. Roll call 2. Proof of due notice of meeting or waiver of notice, or unanimous presence and declaration by presiding chairman 3. Determination of existence of quorum 4. Reading and disposal of any unapproved minutes 5. Reports of officers and committees 6. Election of officers 7. Unfinished business 8. New business 9. Adjournment. ARTICLE 4. OFFICERS 4.1) Number and Designation. The corporation shall have one or more natural persons exercising the functions of the offices of chief executive officer and chief financial officer. The Board of Directors may elect or appoint such other officers or agents as it deems necessary for the operation and management of the corporation including, but not limited to, a Chairman of the Board, a President, one or more Vice Presidents, a Secretary and a Treasurer, each of whom shall have the powers, rights, duties and responsibilities set forth in these Bylaws unless otherwise determined by the Board. Any of the offices or functions of those offices may be held by the same person. -6- 4.2) Election, Term of Office and Qualification. At the first meeting of the Board following each election of directors, the Board shall elect officers, who shall hold office until the next election of officers or until their successors are elected or appointed and qualify; provided, however, that any officer may be removed with or without cause by the affirmative vote of a majority of the Board of Directors present (without prejudice, however, to any contract rights of such officer). 4.3) Resignation. Any officer may resign at any time by giving written notice to the corporation. The resignation is effective when notice is given to the corporation, unless a later date is specified in the notice, and acceptance of the resignation shall not be necessary to make it effective. 4.4) Vacancies in Office. If there be a vacancy in any office of the corporation, by reason of death, resignation, removal or otherwise, such vacancy may, or in the case of a vacancy in the office of chief executive officer or chief financial officer shall, be filled for the unexpired term by the Board of Directors. 4.5) Chief Executive Officer. Unless provided otherwise by a resolution adopted by the Board of Directors, the chief executive officer (a) shall have general active management of the business of the corporation; (b) shall, when present and in the absence of the Chairman of the Board, preside at all meetings of the shareholders and Board of Directors; (c) shall see that all orders and resolutions of the Board are carried into effect; (d) shall sign and deliver in the name of the corporation any deeds, mortgages, bonds, contracts or other instruments pertaining to the business of the corporation, except in cases in which the authority to sign and deliver is required by law to be exercised by another person or is expressly delegated by the Articles, these Bylaws or the Board to some other officer or agent of the corporation; (e) may maintain records of and certify proceedings of the Board and shareholders; and (f) shall perform such other duties as may from time to time be assigned to the chief executive officer by the Board. 4.6) Chief Financial Officer. Unless provided otherwise by a resolution adopted by the Board of Directors, the chief financial officer (a) shall keep accurate financial records for the corporation; (b) shall deposit all monies, drafts and checks in the name of and to the credit of the corporation in such banks and depositories as the Board of Directors shall designate from time to time; (c) shall endorse for deposit all notes, checks and drafts received by the corporation as ordered by the Board, making proper vouchers therefor; (d) shall disburse corporate funds and issue checks and drafts in the name of the corporation, as ordered by the Board; (e) shall render to the chief executive officer and the Board of Directors, whenever requested, an account of all transactions undertaken as chief financial officer and of the financial condition of the corporation; and (f) shall perform such other duties as may be prescribed by the Board of Directors or the chief executive officer from time to time. 4.7) Chairman of the Board. The Chairman of the Board shall preside at all meetings of the shareholders and of the Board and shall exercise general supervision and direction over the more significant matters of policy affecting the affairs of the corporation, including particularly its financial and fiscal affairs. The Chairman shall not be considered an officer unless such chairman is also serving as a full-time employee. -7- 4.8) President. Unless otherwise determined by the Board, the President shall be the chief executive officer. If an officer other than the President is designated chief executive officer, the President shall perform such duties as may from time to time be assigned to the President by the Board. If the office of Chairman of the Board is not filled, the President shall also perform the duties set forth in Section 4.7. 4.9) Vice President. Each Vice President shall have such powers and shall perform such duties as may be specified in these Bylaws or prescribed by the Board of Directors. In the event of absence or disability of the President, the Board of Directors may designate a Vice President or Vice Presidents to succeed to the power and duties of the President. 4.10) Secretary. The Secretary shall, unless otherwise determined by the Board, be secretary of and attend all meetings of the shareholders and Board of Directors, and may record the proceedings of such meetings in the minute book of the corporation and, whenever necessary, certify such proceedings. The Secretary shall give proper notice of meetings of shareholders and shall perform such other duties as may be prescribed by the Board of Directors or the chief executive officer from time to time. 4.11) Treasurer. Unless otherwise determined by the Board, the Treasurer shall be the chief financial officer of the corporation. If an officer other than the Treasurer is designated chief financial officer, the Treasurer shall perform such duties as may be prescribed by the Board of Directors or the chief executive officer from time to time. 4.12) Delegation. Unless prohibited by a resolution approved by the affirmative vote of a majority of the directors present, an officer elected or appointed by the Board may delegate in writing some or all of the duties and powers of such officer to other persons. ARTICLE 5. INDEMNIFICATION 5.1) Indemnification. The corporation shall indemnify such persons, for such expenses and liabilities, in such manner, under such circumstances, and to such extent, as permitted by Minnesota Statutes, Section 302A.521, as now enacted or hereafter amended. ARTICLE 6. SHARES AND THEIR TRANSFER 6.1) Certificate of Stock. Every owner of stock of the corporation shall be entitled to a certificate, in such form as the Board of Directors may prescribe, certifying the number of shares of stock of the corporation owned by such shareholder. The certificates for such stock shall be numbered (separately for each class) in the order in which they are issued and shall, unless otherwise determined by the Board, be signed by the chief executive officer, the chief financial officer, or any other officer of the corporation. A signature upon a certificate may be a facsimile. Certificates on which a facsimile signature of a former officer, transfer agent or registrar appears may be issued with the same effect as if such person were such officer, transfer agent or registrar on the date of issue. -8- 6.2) Stock Record. As used in these Bylaws, the term "shareholder" shall mean the person, firm or corporation in whose name outstanding shares of capital stock of the corporation are currently registered on the stock record books of the corporation. The corporation shall keep, at its principal executive office or at another place or places within the United States determined by the Board, a share register not more than one year old containing the names and addresses of the shareholders and the number and classes of shares held by each shareholder. The corporation shall also keep at its principal executive office or at another place or places within the United States determined by the Board, a record of the dates on which certificates representing shares were issued. Every certificate surrendered to the corporation for exchange or transfer shall be cancelled and no new certificate or certificates shall be issued in exchange for any existing certificate until such existing certificate shall have been so cancelled (except as provided for in Section 6.4 of this Article 6). 6.3) Transfer of Shares. Transfer of shares on the books of the corporation may be authorized only by the shareholder named in the certificate (or the shareholder's legal representative or duly authorized attorney-in-fact) and upon surrender for cancellation of the certificate or certificates for such shares. The shareholder in whose name shares of stock stand on the books of the corporation shall be deemed the owner thereof for all purposes as regards the corporation; provided, that when any transfer of shares shall be made as collateral security and not absolutely, such fact, if known to the corporation or to the transfer agent, shall be so expressed in the entry of transfer; and provided, further, that the Board of Directors may establish a procedure whereby a shareholder may certify that all or a portion of the shares registered in the name of the shareholder are held for the account of one or more beneficial owners. 6.4) Lost Certificate. Any shareholder claiming a certificate of stock to be lost or destroyed shall make an affidavit or affirmation of that fact in such form as the Board of Directors may require, and shall, if the directors so require, give the corporation a bond of indemnity in form and with one or more sureties satisfactory to the Board of at least double the value, as determined by the Board, of the stock represented by such certificate in order to indemnify the corporation against any claim that may be made against it on account of the alleged loss or destruction of such certificate, whereupon a new certificate may be issued in the same tenor and for the same number of shares as the one alleged to have been destroyed or lost. ARTICLE 7. GENERAL PROVISIONS 7.1) Record Dates. In order to determine the shareholders entitled to notice of and to vote at a meeting, or entitled to receive payment of a dividend or other distribution, the Board of Directors may fix a record date which shall not be more than sixty (60) days preceding the date of such meeting or distribution. In the absence of action by the Board, the record date for determining shareholders entitled to notice of and to vote at a meeting shall be at the close of business on the day preceding the day on which notice is given, and the record date for determining shareholders entitled to receive a distribution shall be at the close of business on the day on which the Board of Directors authorizes such distribution. -9- 7.2) Distributions; Acquisitions of Shares. Subject to the provisions of law, the Board of Directors may authorize the acquisition of the corporation's shares and may authorize distributions whenever and in such amounts as, in its opinion, the condition of the affairs of the corporation shall render it advisable. 7.3) Fiscal Year. The fiscal year of the corporation shall be established by the Board of Directors. 7.4) Seal. The corporation shall have such corporate seal or no corporate seal as the Board of Directors shall from time to time determine. 7.5) Securities of Other Corporations. (a) Voting Securities Held by the Corporation. Unless otherwise ordered by the Board of Directors, the chief executive officer shall have full power and authority on behalf of the corporation (i) to attend and to vote at any meeting of security holders of other companies in which the corporation may hold securities; (ii) to execute any proxy for such meeting on behalf of the corporation; and (iii) to execute a written action in lieu of a meeting of such other company on behalf of this corporation. At such meeting, by such proxy or by such writing in lieu of meeting, the chief executive officer shall possess and may exercise any and all rights and powers incident to the ownership of such securities that the corporation might have possessed and exercised if it had been present. The Board of Directors may from time to time confer like powers upon any other person or persons. (b) Purchase and Sale of Securities. Unless otherwise ordered by the Board of Directors, the chief executive officer shall have full power and authority on behalf of the corporation to purchase, sell, transfer or encumber securities of any other company owned by the corporation which represent not more than 10% of the outstanding securities of such issue, and may execute and deliver such documents as may be necessary to effectuate such purchase, sale, transfer or encumbrance. The Board of Directors may from time to time confer like powers upon any other person or persons. ARTICLE 8. MEETINGS 8.1) Telephone Meetings and Participation. A conference among directors by any means of communication through which the directors may simultaneously hear each other during the conference constitutes a Board meeting, if the same notice is given of the conference as would be required for a meeting, and if the number of directors participating in the conference would be sufficient to constitute a quorum at a meeting. Participation in a meeting by that means constitutes presence in person at the meeting. A director may participate in a Board meeting not heretofore described in this paragraph, by any means of communication through which the director, other directors so participating, and all directors physically present at the meeting may simultaneously hear each other during the meeting. Participation in a meeting by that means constitutes presence in person at the meeting. The provisions of this section shall apply to committees and members of committees to the same extent as they apply to the Board and directors. -10- 8.2) Authorization Without Meeting. Any action of the shareholders, the Board of Directors, or any committee of the corporation which may be taken at a meeting thereof, may be taken without a meeting if authorized by a writing signed by all of the holders of shares who would be entitled to vote on such action, by all of the directors (unless less than unanimous action is permitted by the Articles of Incorporation), or by all of the members of such committee, as the case may be. ARTICLE 9. AMENDMENTS OF BYLAWS 9.1) Amendments. Unless the Articles of Incorporation provide otherwise, these Bylaws may be altered, amended, added to or repealed by the affirmative vote of a majority of the members of the Board of Directors. Such authority in the Board of Directors is subject to the power of the shareholders to change or repeal such Bylaws, and the Board of Directors shall not make or alter any Bylaws fixing a quorum for meetings of shareholders, prescribing procedures for removing directors or filling vacancies on the Board, or fixing the number of directors or their classifications, qualifications or terms of office, but the Board may adopt or amend a Bylaw to increase the number of directors. The undersigned, Thomas R. King, Secretary of Datakey, Inc., hereby certifies that the foregoing Amended and Restated Bylaws were duly adopted as the Bylaws of the corporation by its shareholders on May 31, 2001. /s/ Thomas R. King Thomas R. King, Secretary -11- EX-10.18 5 c75665exv10w18.txt EX-10.18 2003 EXECUTIVE INCENTIVE PLAN EXHIBIT 10.18 DATAKEY, INC. 2003 EXECUTIVE INCENTIVE PLAN The Datakey, Inc. 2003 Executive Incentive Plan ("2003 Incentive Plan") is designed to pay for performance to revenue growth and profitability objectives set forth at the beginning of the year as defined in the Board approved 2003 Financial Plan. This plan provides for quarterly payments of cash and Datakey stock options issued at the closing price of the last day of the quarter and vesting in six months. The 2003 Incentive Plan applies to the following executives, and others if approved by the Board of Directors: o President & CEO o Vice President/General Manager ISS o Vice President & CFO o Vice President of Corporate Marketing In the event of a change in control, bonus amounts will be computed and paid throughout the year as if the approved business plan revenue and profitability goals have been met. CASH INCENTIVE Each executive is assigned a target annual incentive cash payment as determined by the Board of Directors. Payment of the cash incentive is based on achievement of revenue growth 2003 quarter over same quarter in 2002 and achievement of the planned profit/loss in conjunction with the following table, with the amounts as set forth by the Board of Directors:

Q1 Q2 Q3 Q4 2002 ISS REVENUE $2,493,000 $1,869,000 $1,388,000 $1,600,000 PLANNED 2003 ISS REVENUE PLANNED ISS REVENUE GROWTH % PLANNED REVENUE GROWTH ACTUAL ISS REVENUE ACTUAL ISS REVENUE GROWTH % = ACTUAL REVENUE GROWTH/ PLANNED REVENUE GROWTH (F) MEETS PROFIT PLAN? (0=NO, .5=YES) (PP) ISS PROFITABLE? (0=NO, .5=YES) (PR) % EARNED

Payment amount determination begins with the calculation of actual 2003 ISS revenue growth (Quarterly increase year-to-year) and its percentage (F) of revenue growth as specified in the 2003 Incentive Plan. (F) is further modified by consideration for meeting profit/loss planned for the quarter (PP) and quarter profitability (PR), all of which are taken after bonus payments have been applied, and according to the following formula: o F = Actual revenue growth/planned revenue growth o % EARNED = F x (1+PP+PR)/2 where PP is .5 if profit/loss in the plan is met and PR are .5 if the quarter is profitable. o QUARTER PAYMENT = % earned x target annual incentive payment/4 1 STOCK OPTION INCENTIVE Each executive is assigned a target stock option incentive payment as determined by the Board of Directors. Calculations for F, % EARNED, AND QUARTER PAYMENT are the same as for the cash incentive above. 2 EX-10.19 6 c75665exv10w19.txt EX-10.19 EMPLOYMENT AGREEMENT EXHIBIT 10.19 EMPLOYMENT AGREEMENT This Employment Agreement (the "Agreement") made and entered into effective as of March 1, 2003, by and between DATAKEY, INC., a Minnesota corporation (the "Company" or "Datakey"), and CARL P. BOECHER ("Executive"). RECITALS Executive joined the Company in January 1995 as Vice President of Sales and Marketing. He was appointed President and Chief Executive Officer on December 1, 1996 and has served in this capacity since that time. On January 1, 1999, the Company and Executive signed an employment agreement. Effective as of March 1, 2003, Executive resigned his position and agreed to serve as the Vice Chairman of the Board of Directors of Datakey pursuant to the terms and conditions of this Agreement. AGREEMENT 1. Employment a. Datakey agrees to employ Executive as Vice Chairman of the Board of Directors. 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 who will have responsibilities in the area of corporate development. His specific duties and responsibilities will be set by the Chairman of the Board of Directors within 30 days of the signing of this Agreement and he will report to the Chairman of the Board. c. Executive will continue as a member of Datakey's Board of Directors for at least as long as the Agreement remains in effect and shareholders have re-elected him. Executive will submit his resignation as a member of the Board of Directors immediately upon termination of the Agreement for any reason, and the Board of Directors may accept or reject his resignation. If Executive's resignation is not accepted, he will continue as a director until the next annual meeting of shareholders following the termination of the Agreement. In the unlikely event that Executive is not re-elected to the Board of Directors at the next annual meeting of shareholders, all of the other terms and conditions of the Agreement will remain in full force and effect and Executive's new title will be Vice President of Corporate Development. During his tenure as a director, Executive will receive no board fees or stock options related to his service as a director. 2. Term of Employment Subject to the terms and conditions hereof, Executive shall be employed for a term ("Employment Term") commencing effective as of March 1, 2003, and terminating on March 1, 2004. This Agreement will be extended only upon written agreement of the parties prior to March 1, 2004. 3. Compensation a. As compensation for his services to Datakey, Executive shall be paid a monthly salary of $8,333.33 payable in accordance with Datakey's periodic payment periods. b. In addition to his compensation described in 3a above, Executive will be paid $17,500 per month for a period of twelve months in lieu of any future severance payments which may have become due to him under his employment agreement dated January 1, 1999. c. All payments made to Executive under this Section 3 shall be made to him with one payroll check. 4. Bonus Executive will be eligible for a one-time bonus to be paid in a lump sum on or before April 15, 2004. The bonus will be paid based on the Company's financial and business performance during the term of this Agreement, Executive's performance of his duties hereunder and his contributions to the Company's performance. The payment of a bonus and the amount of such bonus, if a bonus is paid, will be in the discretion of the Board of Directors. Executive will not participate in any management incentive compensation plan currently in place or any management compensation plan which may be approved in the future. 5. Other Benefits a. During the term of this Agreement, Executive will be eligible to continue participation in the 401-K plan and to receive certain other benefits described in the attached Exhibit A, subject to such changes as Datakey may adopt from time to time for officers of the Company and salaried employees generally. b. In addition to the benefits described in Exhibit A, so long as this Agreement remains in effect, he will have a Company paid e-mail service, Company cell phone, a Company-paid telephone line in his home office and Company internet connection for his home office will be continued, and he may retain a laptop computer, docking station and business software for his use during the term of this Agreement. Executive will be entitled to use, from time to time, the 2 designated Board Member office in the Company facilities, new business cards reflecting his Vice Chairman title, cell phone contact number and home office phone line number. 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 his duties as an officer of the Company 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. (v) Termination by the Company or voluntary resignation by the Executive for any reason. b. For purposes of this Agreement, "cause" shall include the commission of any felony, misdemeanor, or 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 compensation, severance or other benefits except as specifically agreed to at time of termination or as set forth in this Section 7 below. The date of termination under this Section 7 shall be on the day the notice of termination for cause is given or the day the notice of resignation is given. Executive shall be entitled to the balance of any payments due to him under Section 3b above if he voluntarily resigns but not if he is terminated for cause. 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 be entitled to receive his agreed compensation under Sections 3a and 3b for the balance of the term of this Agreement. b. The payments provided for under this Section 8 shall, in the event of Executive's death, be payable to his wife if she survives or, if not, to his estate. 3 c. The Company will continue to provide medical and health coverage, under its plans as they currently exist or may hereafter be amended, at customary employee rates during the term of this Agreement. Thereafter, Executive and his covered dependents will be entitled to elect to continue coverage under COBRA to the extent it is available. For the first twelve months after termination, the COBRA medical and health coverage will be extended to Executive at customary employee rates. 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. 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. 10. 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; 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 4 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. 11. 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. 12. Noncompetition a. For a period of one year after termination of this Agreement for any reason, 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). 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 12 anywhere in the United States. Therefore, Executive agrees that the covenants contained in this Section 12 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 12, 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 12 by Datakey through an injunction or restraining order issued by the appropriate court. d. To the extent any provision of this Section 12 shall be invalid or unenforceable, it shall be considered deleted herefrom and the remainder of such provision and this Section 12 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 12 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 12 be given the construction which renders its provisions valid and enforceable to the maximum extent (not exceeding its expressed terms) possible under applicable laws. 5 13. Release of Claims a. In consideration of the new Employment Agreement entered into with Executive, and the compensation and benefits provided therein, by signing this Agreement, Executive releases and forever discharges Datakey from any and all manner of claims, demands, actions, liability, damages Executive may have against Datakey or any affiliates of Datakey, whether known or unknown in connection with law or equity, contract, or tort, arising out of or in connection with Executive's employment through March 1, 2003, and his Employment Agreement dated January 1, 1999, including specifically Executive's resignation as President and Chief Executive Officer of Datakey. b. This release includes, without limiting the generality of the foregoing, any claims you may have for wages, bonuses, commissions, penalties, deferred compensation, vacation pay, separation benefits, defamation, invasion of privacy, negligence, improper discharge (based on contract, common law, or statute, including any federal, state or local statute or ordinance prohibiting discrimination or retaliation in employment), alleged violation of the United States Constitution, the Minnesota Constitution, the Age Discrimination in Employment Act, 29 U.S.C. Section 621 et seq., the Minnesota Human Rights Act, Minn. Stat. Section 363.01 et seq., Title VII of the Civil Rights Act, 42 U.S.C. Section 2000e et seq., the Americans with Disabilities Act, 42 U.S.C. Section 12101 et seq., the Employment Retirement Income Security Act of 1976, 29 U.S.C. Section 1001 et seq., the Family and Medical Leave Act, 29 U.S.C. Section 2601 et seq., any claim arising under Minn. Stat. Chapters 177 and 181, any claim for retaliation arising under Minn. Stat. Chapter 176, and any claim for discrimination or retaliation based on sex, race, color, creed, religion, age, national origin, marital status, sexual orientation, disability, status with regard to public assistance, sexual harassment, or any other protected class status. 14 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. 6 IN WITNESS WHEREOF, the parties have hereto executed this Employment Agreement effective as of the day and year first above written. DATAKEY, INC. /s/ Gary R. Holland By: Gary Holland, Chairman of the Board /s/ Carl P. Boecher Carl P. Boecher, Executive 7 EXHIBIT A TO EMPLOYMENT AGREEMENT DATED EFFECTIVE AS OF MARCH 1, 2003 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 $300,000, based upon standard rates and underwriting decisions regarding medical history, paid 100% by the Company - -- Supplemental long-term disability insurance paying $5,000 per month based upon standard rates and underwriting decisions regarding medical history, paid 90% by the Company - -- Auto allowance of $600 per month - -- Vacation as required - -- Sick leave as needed, up to a maximum of 90 days at the discretion of the Chairman of the Board - -- Comprehensive annual physical examination at Park Nicollet Executive Health Center paid by the Company EX-23.1 7 c75665exv23w1.txt EX-23.1 CONSENT OF INDEPENDENT ACCOUNTANT EXHIBIT 23.1 CONSENT OF INDEPENDENT AUDITORS We hereby consent to the incorporation by reference of our report, dated January 31, 2003 with respect to the financial statements of Datakey, Inc. (the "Company") included in this Form 10-KSB into the Company's previously filed Registration Statements on Form S-8 No. 333-64470, No. 33-14144, No. 33-47068, No. 33-67280, No. 333-11405, No. 33-80894, No. 333-43937, No. 333-83999, 333-39556 and 333-91760 and on Form S-3 No. 333-58770, No. 333-56711, No. 333-84007, No. 333-91779, No. 333-90969, No. 333-94087 and No. 333-33332. /s/ McGladrey & Pullen, LLP Minneapolis, Minnesota March 26, 2003 EX-99.1 8 c75665exv99w1.txt EX-99.1 CERTIFICATION OF CHIEF EXECUTIVE OFFICER Exhibit 99.1 CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Datakey, Inc. (the "Company") on Form 10-KSB for the year ended December 31, 2002 as filed with the Securities and Exchange Commission (the "Report"), I, Timothy L. Russell, Chief Executive Officer of the Company, certify pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: March 26, 2003 Signature: /s/ Timothy L. Russell Timothy L. Russell Chief Executive Officer EX-99.2 9 c75665exv99w2.txt EX-99.1 CERTIFICATION OF CHIEF FINANCIAL OFFICER Exhibit 99.2 CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Datakey, Inc. (the "Company") on Form 10-KSB for the year ended December 31, 2002 as filed with the Securities and Exchange Commission (the "Report"), I, Alan G. Shuler, Chief Financial Officer of the Company, certify pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: March 26, 2003 Signature: /s/ Alan G. Shuler Alan G. 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EX-3.1

                                                                     EXHIBIT 3.1

                                 CERTIFICATE OF
                      RESTATED ARTICLES OF INCORPORATION OF
                                  DATAKEY, INC.


         We the undersigned William P. Flies and Thomas R. King, respectively
the president and secretary of Datakey, Inc., a corporation subject to the
provisions of the Minnesota Business Corporations Act, do hereby certify that,
pursuant to action taken by the directors of the Corporation at a regularly
scheduled meeting thereof and a majority vote of the outstanding shares of the
Corporation present in person or by proxy at an annual meeting thereof, the
Corporation effective as of May 24, 1982 elected to become governed by Minnesota
Statutes Ch. 302A and, in addition, approved and adopted the following Restated
Articles of Incorporation to supercede and take place of the existing Articles
of Incorporation.

                                    ARTICLE I

         The name of the Corporation is Datakey, Inc.


                                   ARTICLE II

         The registered office of this Corporation is located at 12281 Nicollet
Avenue South, Burnsville, Minnesota, 55337.

                                   ARTICLE III

         3.01 The aggregate number of shares of stock which this Corporation
shall have the authority to issue is 5,000,000. All common stock issued by the
Corporation shall have a par value of $.05 per share.

         3.02. The board of directors may from time to time establish by
resolution different classes or series of shares and may fix the rights and
preferences of said shares in any class or series.

         3.03. No shareholder of the Corporation shall have any preemptive
rights.

         3.04. No shareholder shall be entitled to any cumulative voting rights.

         3.05. The shareholders shall take action by the affirmative vote of the
holders of a majority of the voting power of all voting shares outstanding,
except where a larger proportion is required by law, these articles or a
shareholder control agreement.

                                   ARTICLE IV

         The name and address of the original incorporator of this Corporation
is: William P. Flies, 12808 Woodview Lane, Burnsville, Minnesota, 55337.




                                    ARTICLE V

         The names and addresses of the present board of directors are:

         William P. Flies                            Richard A. Walter
         12281 Nicollet Avenue                       10101 E. Bren Road
         Burnsville, MN  55337                       Minnetonka, MN  55343

         Thomas R. King                              Timothy P. Stepanek
         600 Midwest Plaza Bldg.                     1730 Midwest Plaza Bldg.
         Minneapolis, MN  55402                      Minneapolis, MN  55402


         IN WITNESS WHEREOF, we have hereunto set our hands this 24th day of
May, 1982.

                                                  /s/ William P. Flies
                                              ------------------------------
                                              William P. Flies, President

                                                   /s/ Thomas R. King
                                              ------------------------------
                                              Thomas R. King, Secretary

STATE OF MINNESOTA         )
                           ) ss.
COUNTY OF HENNEPIN         )

         William P. Flies and Thomas R. King, being duly sworn on oath, depose
and say that they are, respectively, the president and secretary of Datakey,
Inc., the corporation named in the foregoing certificate; that said certificate
contains a true statement of the action of the shareholders and board of
directors of said corporation; that said certificate is executed on behalf of
said corporation by its express authority; and that they further acknowledge the
same to be their free act and deed and the free act, and deed of said
corporation.

                                                      /s/ William Flies
                                              ----------------------------------

                                                      /s/ Thomas R. King
                                              ----------------------------------

Subscribed and sworn to before me this 24th day of May, 1982.

                                              /s/ Elizabeth A. Forehand
                                              Notary Public - Minnesota
                                              Hennepin County
                                              My commission expires 3-13-87




                            OFFICERS' CERTIFICATE OF
                                  DATAKEY, INC.

         We, the undersigned, John H. Underwood and Thomas R. King, the
respective President and Secretary of Datakey, Inc., a corporation subject to
the provisions of Minnesota Statutes, Chapter 302A, do hereby certify that the
Minutes of Action Without Meeting of the Board of Directors of the corporation
dated December 23, 1985, a copy of which is attached hereto and incorporated
herein by reference, in which the Board of Directors authorized the issuance of
Preferred Stock, were unanimously adopted and approved by such Board of
Directors.

         IN WITNESS WHEREOF, we have subscribed our names this 23rd day of
December, 1985.

                                               /s/ John H. Underwood
                                           ------------------------------------
                                           John H. Underwood
                                           President


                                                 /s/ Thomas R. King
                                           ------------------------------------
                                           Thomas R. King
                                           Secretary

STATE OF MINNESOTA         )
                           ) ss.
COUNTY OF HENNEPIN         )

         On this 23rd day of December, 1985, before a Notary Public within and
for said County, personally appeared John H. Underwood and Thomas R. King, to me
personally known, being by me duly sworn, and did say that they are the
President and Secretary, respectively, of the corporation named above and that
the said instrument was signed on behalf of the corporation and the persons who
signed said instrument acknowledged it to be the free act and deed of said
corporation.

                                           /s/ Diane M. Dossetto
                                           Notary Public - Minnesota
                                           Ramsey County
                                           My commission expires 7-10-90





                        MINUTES OF ACTION WITHOUT MEETING
                          OF THE BOARD OF DIRECTORS OF
                                  DATAKEY, INC.

         The undersigned, being all of the members of the Board of Directors of
Datakey, Inc., hereby adopt, by action without meeting, the following
resolutions to be effective as of December 23, 1985, to-wit:

         RESOLVED: That the Preferred Stock authorizing resolutions, which
         resolutions are attached hereto as Exhibit A and which resolutions
         establish a class of Convertible Preferred Stock be and they hereby are
         adopted.

         FURTHER RESOLVED: That the officers of the corporation be, and they
         hereby are, authorized and directed to take whatever action is
         necessary to effect the foregoing resolutions.


                                                /s/ John H. Underwood
                                                John H. Underwood


                                                /s/ William P. Flies
                                                William P. Flies


                                                /s/ Timothy A. Stepanek
                                                Timothy A. Stepanek


                                                /s/ Thomas R. King
                                                Thomas R. King






                                    EXHIBIT A


                                MINUTES OF ACTION
                             WITHOUT MEETING OF THE
                       BOARD OF DIRECTORS OF DATAKEY, INC.



         The undersigned, being all of the members of the Board of Directors of
Datakey, Inc., hereby adopt, by action without meeting, the following resolution
to be effective as of December 23, 1985, to-wit:

         WHEREAS, the Articles of Incorporation of Datakey, Inc., a Minnesota
corporation, authorize the corporation to issue an aggregate of 5,000,000 shares
of capital stock and empower the corporation's Board of Directors to establish
from time to time by resolution different classes or series of shares and to fix
the rights and preferences of said shares in any class or series; and

         WHEREAS, there currently are outstanding 2,979,750 shares of Common
Stock, the remaining 2,020,250 authorized shares of capital stock being
undesignated; and

         WHEREAS, the corporation's Board of Directors deems it to be in the
best interests of the corporation and its shareholders to establish a second
class of capital stock, Convertible Preferred Stock, having certain rights and
preferences;

         NOW, THEREFORE, BE IT RESOLVED, that the 5,000,000 shares of capital
stock authorized by the Articles of Incorporation of this corporation be, and
they hereby are, designated as belonging to the following classes having the
relative rights and preferences set forth below:

Section 1. Shares and Classes Authorized.

         Of the 5,000,000 shares which the corporation is authorized to issue,
4,000,000 shares shall be designated Common Stock, par value $.05, 400,000
shares shall be designated Convertible Preferred Stock and 600,000 shares shall
be undesignated capital stock.




Section 2. Right and Preferences of Convertible Preferred Stock.

         The rights and preferences of the 400,000 shares of Convertible
Preferred Stock shall be as set forth in Exhibit 1 which is attached hereto and
made a part hereof.


                                                  /s/ William P. Flies
                                                  William P. Flies


                                                  /s/ John H. Underwood
                                                  John H. Underwood


                                                  /s/ Timothy A. Stepanek
                                                  Timothy A. Stepanek


                                                  /s/ Thomas R. King
                                                  Thomas R. King






                                                                       EXHIBIT 1


                      CERTIFICATE OF RIGHTS AND PREFERENCES
                                       OF
                           CONVERTIBLE PREFERRED STOCK
                                       OF
                                  DATAKEY, INC.


(A). Classification of Undesignated Shares.

         Of the 1,000,000 undesignated shares which the corporation is
authorized to issue under its Articles of Incorporation, 400,000 of such shares
shall all be classified as shares of Convertible Preferred Stock of the
corporation (the "Preferred Stock"). Such shares of Preferred Stock, together
with the 4,000,000 authorized shares of Common Stock of the corporation (the
"Common Stock") and the balance of the undesignated shares of the corporation,
are sometimes hereinafter collectively referred to as the "capital stock".

(B). Voting Privileges.

                  (a) General. Each holder of Preferred Stock shall have that
number of votes on all matters submitted to the stockholders that is equal to
the number of shares of Common Stock into which such holder's shares of
Preferred Stock are then convertible, as hereinafter provided. Except as
otherwise provided in subparagraph (b) below, and except as otherwise required
by agreement or law, the shares of capital stock of the corporation shall vote
as a single class on all matters submitted to the stockholders.

                  (b) Without the affirmative vote of the holders (acting
together as a class) of at least a majority (with respect to (1) below) or at
least 90% (with respect to (2) below) of the shares of Preferred Stock at the
time outstanding, the corporation shall not:

         (1)      authorize or issue any shares of stock having a priority over
                  Preferred Stock or ranking on a parity therewith as to the
                  payment or distribution of assets upon the liquidation or
                  dissolution, voluntary or involuntary, of the corporation; or

         (2)      amend the Articles of Incorporation of the corporation so as
                  to alter any existing provision relating to Preferred Stock.

                  (c) No Cumulative Voting. No holder of shares of capital stock
shall have any cumulative voting rights.

(C). No Preemptive Rights.

         No holder of shares of any class of capital stock shall be entitled as
such, as a matter of right, to subscribe for, purchase or receive any part of
any new or additional issue of stock of any class whatsoever, or of securities
convertible into or exchangeable for any stock of any class




whatsoever, whether now or hereafter authorized and whether issued for cash or
other consideration or by way of dividend.

(D). Cash Dividends.

         Any dividend declared must be payable with respect to all outstanding
shares of capital stock of the corporation. In the event any dividend is
declared with respect to the capital stock, each holder of Preferred Stock shall
be paid such cash dividend on the basis of the number of shares of Common Stock
into which such holder's shares of Preferred Stock are then convertible, as
hereinafter provided.

(E). Other Terms of the Preferred Stock.

                  (a) Liquidation Preference. In the event of either an
involuntary or a voluntary liquidation or dissolution of the corporation, the
holders of shares of Preferred Stock shall be entitled to receive out of the
assets of the corporation an amount equal to $2.50 per share. In the event of
either an involuntary or voluntary liquidation or dissolution of the
corporation, payment shall be made to the holders of the Preferred Stock in the
amounts herein fixed before any payment shall be made or any assets distributed
to the holders of the Common Stock or any other class of shares of the
corporation ranking junior to the Preferred Stock with respect to payment of
dividends or upon dissolution or liquidation of the corporation. If upon any
such liquidation or dissolution of the corporation the assets available for
distribution 'shall be insufficient to pay the holders of all outstanding shares
of Preferred Stock the full amounts to which they respectively shall be
entitled, the holders of such shares shall share pro rata in any such
distribution.

                  The merger or consolidation of the corporation into or with
another corporation or the merger or consolidation of any other corporation into
or with the corporation (in which consolidation or merger the stockholders of
the corporation receive distribution of cash or securities or other property as
a result of such consolidation or merger), or the sale, transfer or other
disposition of all or substantially all of the assets of the corporation, shall
be deemed, for purposes of determining the amounts to be received by the holders
of the Preferred Stock in such merger, consolidation, sale, transfer or other
disposition, to be a liquidation or dissolution of the corporation for purposes
of this subparagraph (a) if the holders of a majority of the outstanding shares
of Preferred Stock so elect by giving written notice thereof to the corporation
at least two days before the effective date of such event. If no such notice is
given, the provisions of subparagraph (c)(7) hereof shall apply.

                  Nothing hereinabove set forth shall affect in any way the
right of each holder of shares of Preferred Stock to convert such shares at any
time and from time to time in accordance with subparagraph (c) below.

                  (b) Redemptions. Redemptions of shares of Preferred Stock by
the corporation without the consent of the holders thereof are not permitted.
Mandatory redemptions of shares of Preferred Stock by the corporation are not
required.

                  (c) Conversion Right; Mandatory Conversion. At the option of
the holders thereof, the shares of Preferred Stock shall be convertible, at the
office of the corporation (or at such other office or offices, if any, as the
Board of Directors may designate), into fully paid and




nonassessable shares (calculated as to each conversion to the nearest 1/100th of
a share) of Common Stock of the corporation, at the conversion price, determined
as hereinafter provided, in effect at the time of conversion, each share of the
Preferred Stock being taken at $2.50 for the purpose of such conversion. The
price at which shares of Common Stock shall be delivered upon conversion (herein
called the "conversion price") shall be initially $2.50 per share of Common
Stock (i.e., at an initial conversion rate of one share of Common Stock for each
share of Preferred Stock), provided, however, that such initial conversion price
shall be subject to adjustment from time to time in certain instances as
hereinafter provided. The following provisions shall govern such right of
conversion:

         (1)      In order to convert shares of Preferred Stock into shares of
                  Common Stock of the corporation, the holder thereof shall
                  surrender at any office hereinabove mentioned the certificate
                  or certificates therefor, duly endorsed to the corporation or
                  in blank, and give written notice to the corporation at such
                  office that such holder elects to convert such shares. Shares
                  of Preferred Stock shall be deemed to have been converted
                  immediately prior to the close of business on the day of the
                  surrender of such shares for conversion as herein provided,
                  and the person entitled to receive the shares of Common Stock
                  of the corporation issuable upon such conversion shall be
                  treated for all purposes as the record holder of such shares
                  of Common Stock at such time. As promptly as practicable on or
                  after the conversion date, the corporation shall issue and
                  deliver or cause to be issued and delivered at such office a
                  certificate or certificates for the number of shares of Common
                  Stock of the corporation issuable upon such conversion.

         (2)      The conversion price shall be subject to adjustment from time
                  to time as hereinafter provided. Upon each adjustment of the
                  conversion price each holder of shares of Preferred Stock
                  shall thereafter be entitled to receive the number of shares
                  of Common Stock of the corporation obtained by multiplying the
                  conversion price in effect immediately prior to such
                  adjustment by the number of shares issuable pursuant to
                  conversion immediately prior to such adjustment and dividing
                  the product thereof by the conversion price resulting from
                  such adjustment.

         (3)      Except for the issuance of Conversion Stock and Warrant Stock
                  (as those terms are defined in the Preferred Stock Purchase
                  Agreement dated December 16, 1985 among the corporation and
                  the Purchasers named therein) (a) if and whenever on or prior
                  to June 30, 1987 the corporation shall issue or sell any
                  shares of its Common Stock for a consideration per share less
                  than the conversion price in effect immediately prior to the
                  time of such issue or sale, then forthwith upon such issue or
                  sale the conversion price shall be reduced to such lesser
                  price, and (b) if and whenever after June 30, 1987 the
                  corporation shall issue or sell any shares of its Common Stock
                  for a consideration per share less than the conversion price
                  in effect immediately prior to the time of such issue or sale,
                  and/or the corporation shall issue or sell any shares of
                  Common Stock for a consideration per share less than the
                  market price on the date of such issue or sale, then forthwith
                  upon such issue or sale the conversion price shall be reduced
                  to




                  the price (calculated to the nearest cent) determined by
                  dividing (1) an amount equal to the sum of (aa) the number of
                  shares of Common Stock outstanding immediately prior to such
                  issue or sale multiplied by the then existing conversion
                  price, and (bb) the consideration, if any, received by the
                  corporation upon such issue or sale, by (2) an amount equal to
                  the sum of (aa) the number of shares of Common Stock
                  outstanding immediately prior to such issue or sale and (bb)
                  the number of shares of Common Stock thus issued or sold.

                           For the purposes of this subparagraph (3), the
                  following provisions (i) to (vii), inclusive, shall also be
                  applicable:

                  (i)      In case at any time the corporation shall grant
                           (whether directly or by assumption in a merger or
                           otherwise) any rights to subscribe for or to
                           purchase, or any options for the purchase of, (a)
                           Common Stock or (b) any obligations or any shares of
                           stock of the corporation which are convertible into,
                           or exchangeable for, Common Stock (any of such
                           obligations or shares of stock being hereinafter
                           called "Convertible Securities") whether or not such
                           rights or options or the right to convert or exchange
                           any such Convertible Securities are immediately
                           exercisable, and the price per share for which Common
                           Stock is issuable upon the exercise of such rights or
                           options or upon conversion or exchange of such
                           Convertible Securities (determined by dividing (x)
                           the total amount, if any, received or receivable by
                           the corporation as consideration for the granting of
                           such rights or options, plus the minimum aggregate
                           amount of additional consideration payable to the,
                           corporation upon the exercise of such rights or
                           options, plus, in the case of such Convertible
                           Securities, the minimum aggregate amount of
                           additional consideration, if any, payable upon the
                           issue of such Convertible Securities and upon the
                           conversion or exchange thereof, by (y) the total
                           maximum number of shares of Common Stock issuable
                           upon the exercise of such rights or options or upon
                           the conversion or exchange of all such Convertible
                           Securities issuable upon the exercise of such rights
                           or options) shall be less than the conversion price
                           in effect immediately prior to the time of the
                           granting of such rights or options, then the total
                           maximum number of shares of Common Stock issuable
                           upon the exercise of such rights or options or upon
                           conversion or exchange of the total maximum amount of
                           such Convertible Securities issuable upon the
                           exercise of such rights or options shall (as of the
                           date of granting of such rights or options) be deemed
                           to have been issued for such price per share. Except
                           as provided in subparagraph (6) below, no further
                           adjustments of the conversion price shall be made
                           upon the actual issue of such Common Stock




                           or of such Convertible Securities upon exercise of
                           such rights or options or upon the actual issue of
                           such Common Stock upon conversion or exchange of such
                           Convertible Securities.

                  (ii)     In case the corporation shall issue or sell (whether
                           directly or by assumption in a merger or otherwise)
                           any Convertible Securities, whether or not the rights
                           to exchange or convert thereunder are immediately
                           exercisable, and the price per share for which Common
                           Stock is issuable upon such conversion or exchange
                           (determined by dividing (x) the total amount received
                           or receivable by the corporation as consideration for
                           the issue or sale of such Convertible Securities,
                           plus the minimum aggregate amount of additional
                           consideration, if any, payable to the corporation
                           upon the conversion or exchange thereof, by (y) the
                           total maximum number of shares of Common Stock
                           issuable upon the conversion or exchange of all such
                           Convertible Securities) shall be less than the
                           conversion price in effect immediately prior to the
                           time of such issue or sale, then the total maximum
                           number of shares of Common Stock issuable upon
                           conversion or exchange of all such Convertible
                           Securities shall (as of the date of the issue or sale
                           of such Convertible Securities) be deemed to be
                           outstanding and to have been issued for such price
                           per share, provided that (a) except as provided in
                           subparagraph (6) below, no further adjustments of the
                           conversion price shall be made upon the actual issue
                           of such Common Stock upon conversion or exchange of
                           such Convertible Securities, and (b) if any such
                           issue or sale of such Convertible Securities is made
                           upon exercise of any rights to subscribe for or to
                           purchase or any option to purchase any such
                           Convertible Securities for which adjustments of the
                           conversion price have been or are to be made pursuant
                           to other provisions of this subparagraph (3), no
                           further adjustment of the conversion price shall be
                           made by reason of such issue or sale.

                  (iii)    In case the corporation shall, after June 30, 1987,
                           declare a dividend or make any other distribution
                           upon any capital stock of the corporation payable in
                           Common Stock or Convertible Securities, or in any
                           rights or options to purchase any Common Stock or
                           Convertible Securities, any Common Stock or
                           Convertible Securities, or any such rights or
                           options, as the case may be, issuable in payment of
                           such dividend or distribution shall be deemed to have
                           been issued or sold without consideration.




                  (iv)     In case any shares of Common Stock or Convertible
                           Securities or any rights or options to purchase any
                           such Common Stock or Convertible Securities shall be
                           issued or sold for cash, the consideration received
                           therefor shall be deemed to be the amount received by
                           the corporation therefor, without deducting therefrom
                           any expenses incurred or any underwriting commissions
                           or concessions paid or allowed by the corporation in
                           connection therewith. In case any shares of Common
                           Stock or Convertible Securities or any rights or
                           options to purchase any such Common Stock or
                           Convertible Securities shall be issued or sold for a
                           consideration other than cash, the amount of the
                           consideration other than cash received by the
                           corporation shall be deemed to be the fair value of
                           such consideration as determined by the Board of
                           Directors of the corporation, without deducting
                           therefrom any expenses incurred or any underwriting
                           commissions or concessions paid or allowed by the
                           corporation in connection therewith. In case any
                           shares of Common Stock or Convertible Securities or
                           any rights or options to purchase such Common Stock
                           or Convertible Securities shall be issued in
                           connection with any merger or consolidation in which
                           the corporation is the surviving corporation, the
                           amount of consideration therefor shall be deemed to
                           be the fair value as determined by the Board of
                           Directors of the corporation of such portion of the
                           assets and business of the non-surviving corporation
                           or corporations as such Board shall determine to be
                           attributable to such Common Stock, Convertible
                           Securities, rights or options, as the case may be. In
                           the event of any consolidation or merger of the
                           corporation in which the corporation is not the
                           surviving corporation or in the event of any sale of
                           all or substantially all of the assets of the
                           corporation for stock or other securities of any
                           other corporation, the corporation shall be deemed to
                           have issued a number of shares of its Common Stock
                           for stock or securities of the other corporation
                           computed on the basis of the actual exchange ratio on
                           which the transaction was predicated and for a
                           consideration equal to the fair market value on the
                           date of such transaction of such stock or securities
                           of the other corporation, and if any such calculation
                           results in adjustment of the conversion price, the
                           determination of the number of shares of Common Stock
                           issuable upon conversion immediately prior to such
                           merger, conversion or sale, for purposes of
                           subparagraph (7) below, shall be made after giving
                           effect to such adjustment of the conversion price.

                  (v)      In case the corporation shall take a record of the
                           holders of its Common Stock for the purpose of
                           entitling them (a) to




                           receive a dividend or other distribution payable in
                           Common Stock or in Convertible Securities, or in any
                           rights or options to purchase any Common Stock or
                           Convertible Securities, or (b) to subscribe for or
                           purchase Common Stock or Convertible Securities, then
                           the date of such record shall be deemed to be the
                           date of the issue or sale of the shares of Common
                           Stock deemed to have been issued or sold upon the
                           declaration of such dividend or the making of such
                           other distribution or the date of the granting of
                           such rights of subscription or purchase, as the case
                           may be.

                  (vi)     The number of shares of Common Stock outstanding at
                           any given time shall not include shares owned or held
                           by or for the account of the corporation, and the
                           disposition of any such shares shall be considered an
                           issue or sale of Common Stock for the purpose of this
                           subparagraph (3).

                  (vii)    "Market price" shall mean the average of the high and
                           low prices of the Common Stock sales on all exchanges
                           on which the Common Stock may at the time be listed,
                           or, if there shall have been no sales on any such
                           exchange on any such day, the average of the bid and
                           asked prices at the end of such day, or, if the
                           Common Stock shall not be so listed, the average of
                           the bid and asked prices at the end of the day in the
                           over-the-counter market, in each case averaged over a
                           period of 20 consecutive business days prior to the
                           date as of which "market price" is being determined.
                           If at any time the Common Stock is not listed on any
                           exchange or quoted in the over-the-counter market,
                           the "market price" shall be deemed to be the higher
                           of (i) the book value thereof as determined by any
                           firm of independent public accountants of recognized
                           standing selected by the Board of Directors of the
                           corporation as of the last day of any month ending
                           within 60 days preceding the date as of which the
                           determination is to be made, or (ii) the fair value
                           thereof determined in good faith by the Board of
                           Directors of the corporation as of a date which is
                           within 15 days of the date as of which the
                           determination is to be made.

         (4)      In case the corporation shall declare a dividend or make a
                  distribution upon the Common Stock payable otherwise than out
                  of earnings or earned surplus (including dividends or
                  distributions in Common Stock or Convertible Securities, or in
                  any rights or options to purchase any Common Stock or
                  Convertible Securities), then thereafter each holder of shares
                  of Preferred Stock upon the conversion thereof will be
                  entitled to receive the number of shares of Common Stock into
                  which such shares of Preferred Stock have been converted, and,
                  in addition and without payment therefor, the cash, stock or
                  other securities and other property which such holder would
                  have received by way of dividends (otherwise




                  than out of such earnings or surplus) if continuously since
                  such holder became the record holder of such shares of
                  Preferred Stock such holder (i) had been the record holder of
                  the number of shares of Common Stock then received, and (ii)
                  had retained all dividends or distributions in stock or
                  securities (including Common Stock or Convertible Securities,
                  or in any rights or options to purchase any Common Stock or
                  Convertible Securities) payable in respect of such Common
                  Stock or in respect of any stock or securities paid as
                  dividends or distributions and originating directly or
                  indirectly from such Common Stock. For the purposes of the
                  foregoing a dividend or distribution other than in cash shall
                  be considered payable out of earnings or earned surplus only
                  to the extent that such earnings or surplus are charged an
                  amount equal to the fair value of such dividend or
                  distribution as determined by the Board of Directors of the
                  corporation.

         (5)      In case the corporation shall at any time subdivide its
                  outstanding shares of Common Stock into a greater number of
                  shares, the conversion price in effect immediately prior to
                  such subdivision shall be proportionately reduced, and
                  conversely, in case the outstanding shares of Common Stock of
                  the corporation shall be combined into a smaller number of
                  shares, the conversion price in effect immediately prior to
                  such combination shall be proportionately increased.

         (6)      If (i) the purchase price provided for in any right or option
                  referred to in clause (i) of subparagraph (3), or (ii) the
                  additional consideration, if any, payable upon the conversion
                  or exchange of Convertible Securities referred to in clause
                  (i) or clause (ii) of subparagraph (3), or (iii) the rate at
                  which any Convertible Securities referred to in clause (i) or
                  clause (ii) of subparagraph (3) are convertible into or
                  exchangeable for Common Stock, shall change at any time (other
                  than under or by reason of provisions designed to protect
                  against dilution), the conversion price then in effect
                  hereunder shall forthwith be increased or decreased to such
                  conversion price as would have obtained had the adjustments
                  made upon the issuance of such rights, options or Convertible
                  Securities been made upon the basis of (a) the issuance of the
                  number of shares of Common Stock theretofore actually
                  delivered upon the exercise of such options or rights or upon
                  the conversion or exchange of such Convertible Securities, and
                  the total consideration received therefor, and (b) the
                  issuance at the time of such change of any such options,
                  rights, or Convertible Securities then still outstanding for
                  the consideration, if any, received by the corporation
                  therefor and to be received on the basis of such changed
                  price; and on the expiration of any such option or right or
                  the termination of any such right to convert or exchange such
                  Convertible Securities, the conversion price then in effect
                  hereunder shall forthwith be increased to such conversion
                  price as would have obtained had the adjustments made upon the
                  issuance of such rights or options or Convertible Securities
                  been made upon the basis of the issuance o the shares of
                  Common Stock theretofore actually delivered (and the total
                  consideration received therefor) upon the exercise of such
                  rights or options or upon the conversion or exchange of such




                  Convertible Securities. If the purchase price provided for in
                  any right or option referred to in clause (i) of subparagraph
                  (3), or the rate at which any Convertible Securities referred
                  to in clause (i) or clause (ii) of subparagraph (3) are
                  convertible into or exchangeable for Common Stock, shall
                  decrease at any time under or by reason of provisions with
                  respect thereto designed to protect against dilution, then in
                  case of the delivery of Common Stock upon the exercise of any
                  such right or option or upon conversion or exchange of any
                  such Convertible Security, the conversion price then in effect
                  hereunder shall forthwith be decreased to such conversion
                  price as would have obtained had the adjustments made upon the
                  issuance of such right, option or Convertible Security been
                  made upon the basis of the issuance of (and the total
                  consideration received for) the shares of Common Stock
                  delivered as aforesaid.

         (7)      If any capital reorganization or reclassification of the
                  capital stock of the corporation, or consolidation or merger
                  of the corporation with another corporation, or the sale of
                  all or substantially all of its assets to another corporation
                  shall be effected in such a way that holders of Common Stock
                  shall be entitled to receive stock, securities or assets with
                  respect to or in exchange for Common Stock, then, as a
                  condition of such reorganization, reclassification,
                  consolidation, merger or sale, and subject to subparagraph (a)
                  above, lawful and adequate provision shall be made whereby the
                  holders of Preferred Stock shall thereafter have the right to
                  receive upon the basis and upon the terms and conditions
                  specified herein and in lieu of the shares of the Common Stock
                  of the corporation immediately theretofore receivable upon the
                  conversion of Preferred Stock, such shares of stock,
                  securities or assets as may be issued or payable with respect
                  to or in exchange for a number of outstanding shares of such
                  Common Stock equal to the number of shares of such stock
                  immediately theretofore receivable upon the conversion of
                  Preferred Stock had such reorganization, reclassification,
                  consolidation, merger or sale not taken place, plus all
                  dividends unpaid and accumulated or accrued thereon to the
                  date of such reorganization, reclassification, consolidation,
                  merger or sale, and in any such case appropriate provision
                  shall be made with respect to the rights and interests of the
                  holders of Preferred Stock to the end that the provisions
                  hereof (including without limitation provisions for
                  adjustments of the conversion price and of the number of
                  shares receivable upon the conversion of Preferred Stock)
                  shall thereafter be applicable, as nearly as may be in
                  relation to any shares of stock, securities or assets
                  thereafter receivable upon the conversion of Preferred Stock.
                  The corporation shall not effect any such consolidation,
                  merger or sale, unless prior to the consummation thereof the
                  successor corporation (if other than the corporation)
                  resulting from such consolidation or merger or the corporation
                  purchasing such assets shall assume by written instrument
                  executed and mailed to the holders of Preferred Stock, at the
                  last addresses of such holders appearing on the books of the
                  corporation, the obligation to deliver to such holder such
                  shares of stock, securities or assets as, in accordance with
                  the foregoing provisions, such holder may be entitled to
                  receive.




         (8)      Upon any adjustment of the conversion price, then and in each
                  case the corporation shall give written notice thereof, by
                  first-class mail, postage prepaid, addressed to the holders of
                  Preferred Stock, at the addresses of such holders as shown on
                  the books of the corporation, which notice shall state the
                  conversion price resulting from such adjustment and the
                  increase or decrease, if any, in the number of shares
                  receivable at such price upon the conversion of Preferred
                  Stock, setting forth in reasonable detail the method of
                  calculation and the facts upon which such calculation is
                  based.

         (9)      In case at any time:

                  (i)      the corporation shall declare any cash dividend on
                           its Common Stock at a rate in excess of the rate of
                           the last cash dividend theretofore paid;

                  (ii)     the corporation shall pay any dividend payable in
                           stock upon its Common Stock or make any distribution
                           (other than regular cash dividends) to the holders of
                           its Common Stock;

                  (iii)    the corporation shall offer for subscription pro rata
                           to the holders of its Common Stock any additional
                           shares of stock of any class or other rights;

                  (iv)     there shall be any capital reorganization, or
                           reclassification of the capital stock of the
                           corporation, or consolidation or merger of the
                           corporation with, or sales of all or substantially
                           all of its assets to, another corporation; or

                  (v)      there shall be a voluntary or involuntary
                           dissolution, liquidation or winding up of the
                           corporation;

                  then, in any one or more of said cases, the corporation shall
                  give written notice, by first-class mail, postage prepaid,
                  addressed to the holders of Preferred Stock at the addresses
                  of such holders as shown on the books of the corporation, of
                  the date on which (a) the books of the corporation shall close
                  or a record shall be taken for such dividend, distribution or
                  subscription rights, or (b) such reorganization,
                  reclassification, consolidation, merger, sale, dissolution,
                  liquidation or winding up shall take place, as the case may
                  be. Such notice shall also specify the date as of which the
                  holders of Common Stock of record shall participate in such
                  dividend, distribution or subscription rights, or shall be
                  entitled to exchange their Common Stock for securities or
                  other property deliverable upon such reorganization,
                  reclassification, consolidation, merger, sale, dissolution,
                  liquidation, or winding up, as the case may be. Such written
                  notice shall be given at least 20 days prior to the action in
                  question and not less than 20 days prior to the record date or
                  the date on which the corporation's transfer books are closed
                  in respect thereto.




         (10)     If any event occurs as to which in the opinion of the Board of
                  Directors of the corporation the other provisions of this
                  paragraph (c) are not strictly applicable or if strictly
                  applicable would not fairly protect the rights of the holders
                  of Preferred Stock in accordance with the essential intent and
                  principles of such provisions, then the Board of Directors
                  shall make an adjustment in the application of such
                  provisions, in accordance with such essential intent and
                  principles, so as to protect such rights as aforesaid.

         (11)     As used in this paragraph (c) the term "Common Stock" shall
                  mean and include the corporation's presently authorized Common
                  Stock and shall also include any capital stock of any class of
                  the corporation hereafter authorized which shall not be
                  limited to a fixed sum or percentage in respect of the rights
                  of the holders thereof to participate in dividends or in the
                  distribution of assets upon the voluntary or involuntary
                  liquidation, dissolution or winding up of the corporation;
                  provided that the shares receivable pursuant to conversion of
                  shares of Preferred Stock shall include shares designated as
                  Common Stock of the corporation as of the date of issuance of
                  such shares of Preferred Stock, or, in case of any
                  reclassification of the outstanding shares thereof, the stock,
                  securities or assets provided for in subparagraph (7) above.

         (12)     No fractional shares of Common Stock shall be issued upon
                  conversion, but, instead of any fraction of a share which
                  would otherwise be issuable, the corporation shall pay a cash
                  adjustment in respect of such fraction in an amount equal to
                  the same fraction of the market price per share of Common
                  Stock, determined pursuant to subparagraph (3)(vii) above, as
                  of the close of business on the day of conversion.

Mandatory Conversion. Preferred Stock shall automatically be converted into
shares of Common Stock of the corporation, without any act by the corporation or
the holders of Preferred Stock, concurrently with the closing of the first
public offering by the corporation of shares of Common Stock of the corporation
registered under the Securities Act of 1933, as amended, in which (1) the
offering is underwritten on a firm commitment basis by an underwriter, or a
group of underwriters represented by an underwriter or underwriters, and (2) the
aggregate public offering price of the securities sold for cash by the
corporation in the offering, net of expenses payable by the corporation in
connection with such offering, is at least $5,000,000, and (3) the public
offering price per share of Common Stock is at least $5 (as adjusted from time
to time to reflect stock splits, dividends, recapitalizations, combinations or
the like). As used herein, the term "closing" shall mean the delivery by the
corporation to the underwriters of certificates representing the shares of
Common Stock of the corporation offered to the public against delivery to the
corporation by such underwriters of payment therefor. The term "firm commitment
basis" with respect to the underwriting of such public offering shall mean a
commitment pursuant to a written underwriting agreement under which the nature
of the underwriters' commitment is such that all securities will be purchased by
such underwriters if any securities are purchased by such underwriters. Each
holder of a share of Preferred Stock so converted shall be entitled to receive
the full number of shares of Common Stock into which such share of Preferred
Stock held by such holder could be converted if such holder had exercised its
conversion right at the time of closing of such public offering. Upon such
conversion, each holder of a share of Preferred Stock shall immediately
surrender such share in exchange for appropriate stock certificates representing
a share or shares of Common Stock of the corporation.





               ARTICLES OF AMENDMENT OF ARTICLES OF INCORPORATION
                                       OF
                                  DATAKEY, INC.

         Pursuant to the provisions of Minnesota Statutes, Section 302A.135, the
following Amendment of Section 3.01 of the Articles of Incorporation of Datakey,
Inc. was adopted at a meeting of the shareholders of the corporation duly
convened and held on the 6th day of May, 1986, by a vote of 84% of the voting
power of all shares entitled to vote:

                  "3.01 The aggregate number of shares of stock which this
         corporation shall have authority to issue is 12,500,000 shares,
         consisting of 10,000,000 shares of Common Stock, par value $.05,
         400,000 shares of Preferred Stock and 2,100,000 undesignated shares."

                  I swear that the foregoing is true and accurate and that I
         have the authority to sign this document on behalf of the corporation.

                                                       /s/ John H. Underwood
                                                  ------------------------------
                                                  John H. Underwood, President

STATE OF MINNESOTA         )
                           )  SS.
COUNTY OF Dakota           )


         The foregoing instrument was acknowledged before me this 25th day of
June, 1986, by John H. Underwood, President of Datakey, Inc., a Minnesota
corporation, on behalf of the corporation.

                                                /s/ Bette F. Feahr
                                                Notary Public - Minnesota
                                                Dakota County
                                                My commission expires 8-20-91

(Notarial Seal)




               ARTICLES OF AMENDMENT OF ARTICLES OF INCORPORATION
                                       OF
                                  DATAKEY, INC.



         Pursuant to the provisions of Minnesota Statutes, Section 302A.135, the
following Amendment of the Articles of Incorporation of Datakey, Inc., adding
Article VI, was adopted at a meeting of the shareholders of the corporation duly
convened and held on the May 12, 1987, by a majority vote of the voting power of
all shares entitled to vote:

         "ARTICLE VI - LIMITATION OF DIRECTOR LIABILITY

                  6.1) To the fullest extent permitted by the Minnesota Business
         Corporation Act as the same exists or may hereafter be amended, a
         director of this corporation shall not be personally liable to the
         corporation or its shareholders for monetary damages for breach of
         fiduciary duty as a director."

         I swear that the foregoing is true and accurate and that I have the
authority to sign this document on behalf of the corporation.


                                                   /s/ John H. Underwood
                                            ------------------------------------
                                            John H. Underwood, President



STATE OF MINNESOTA  )
                    ) SS.
COUNTY OF DAKOTA    )

         The foregoing instrument was acknowledged before me this 27 day of May,
1987, by John H. Underwood, President of Datakey, Inc., a Minnesota corporation,
on behalf of the corporation.

                                              /s/ Bette F. Feahr
                                              Notary Public - Minnesota
                                              Dakota County
                                              My commission expires 8-20-91

(Notarial Seal)





                      Notice of Change of Registered Office
                                       by
                                  DATAKEY, INC.

Pursuant to Minnesota Statutes, Section 302A.123, the undersigned hereby
certifies that the Board of Directors of the above named Minnesota Corporation
has resolved to change the corporation's registered office or agent:

FROM:    Datakey, Inc.
         12281 Nicollet Avenue South
         Burnsville, MN  55337

TO:      Datakey, Inc.
         407 West Travelers Trail
         Burnsville, MN  55337-2554

The new address may not be a post office box. It must be a street address,
pursuant to Minnesota Statutes, Section 302A.011, Subd. 3.

The effective date of the change will be the 1st day of July, 1987 or the day of
filing of this certificate with the Secretary of State, whichever is later.

I swear that the foregoing is true and accurate and that I have the authority to
sign this document on behalf of the corporation.


                                            /s/ George H. M. Rountree
                                            George H. M. Rountree
                                            Vice President Finance

July 11, 1988

State of Minnesota )
                   ) ss.
County of Dakota   )

         The foregoing instrument was acknowledged before me on this 11th day of
July, 1988.

                                           /s/ Bette F. Feahr
                                           Notary Public - Minnesota
                                           Dakota County
                                           My commission expires 8-20-91

State of Minnesota
Department of State

                                 Filed: August 10, 1988




                       STATEMENT OF DESIGNATION OF SHARES
                                       OF
                                  DATAKEY, INC.



         The undersigned hereby certifies that the resolutions set forth on
Exhibit A attached hereto were duly adopted by the Board of Directors of
Datakey, Inc. on May 11, 1998.

         I swear that the foregoing is true and accurate and that I have the
authority to sign this document on behalf of the corporation.


May 14, 1998
                                     DATAKEY, INC.


                                     /s/ Alan G. Shuler
                                     Alan G. Shuler
                                     Vice President and Chief Financial Officer






                                                                       EXHIBIT A


         DESIGNATION OF SERIES A CONVERTIBLE CUMULATIVE PREFERRED STOCK


         WHEREAS, pursuant to the Articles of Incorporation of this corporation,
the Board of Directors has authority to establish, from the 2,100,000
undesignated shares of capital stock, one or more classes or series of shares,
to designate each such class or series, and to fix the relative rights and
preferences of each such class or series; and

         WHEREAS, the Board of Directors deem it advisable to designate shares
of Series A Convertible Cumulative Preferred Stock;

         NOW, THEREFORE, RESOLVED, that of the 2,100,000 undesignated shares
currently authorized, 150,000 shares are hereby designated as shares of Series A
Convertible Cumulative Preferred Stock, which shares shall have the terms as set
forth on Exhibit A hereto.







                                    EXHIBIT A


             RIGHTS, PREFERENCES AND RESTRICTIONS OF PREFERRED STOCK


         The rights, preferences, restrictions and other matters relating to the
Series A Convertible Cumulative Preferred Stock (the "Series A Preferred Stock")
are as follows:

         1. Dividend Provisions. Upon issuance, dividends shall accrue on each
share of outstanding Series A Preferred Stock at an annual rate equal to $1.264
per share per annum (8% of the Original Issue Price, as defined herein). Such
dividends shall be cumulative and shall be payable upon any conversion of the
Series A Preferred Stock pursuant to Section 3 hereof. Such dividends shall only
be paid out of legally available funds of the Company. Such dividends shall be
payable by the Company, in its sole discretion, all in cash or all by the
issuance of a number of shares of the Company's unrestricted, freely tradable
common stock equal to the dividends owing on the Series A Preferred Stock;
provided, however, that prior to the payment of any such dividend by the
issuance of shares of the Company's common stock, the Company shall deliver to
the Investors an opinion of its counsel stating that all such shares have been
validly registered, and that they are duly authorized, validly issued and
nonassessable. For the purposes hereof, the number of shares of the Company's
common stock issuable in lieu of any cash dividend payment shall equal the total
dividend payment then due divided by the per share price of such stock. The per
share price of the Company's common stock shall be determined based on the
average closing bid price of such stock quoted on The Nasdaq Stock Market for
the ten consecutive trading days prior to the payment of such dividends.
Dividends on shares of the Series A Preferred Stock shall accrue beginning on
the date of issuance of the shares of Series A Preferred Stock, shall compound
on an annual basis and shall be payable upon conversion of the Series A
Preferred Stock (a "Payment Date"). All accrued and unpaid dividends on the
Series A Preferred Stock must be paid before any dividends may be declared or
paid on any other junior series of preferred or common stock issued by the
Company.

         2. Liquidation Preference.

                  (a) In the event of any liquidation, dissolution or winding up
of the Company, either voluntary or involuntary, the holders of the previously
issued Convertible Preferred Stock (the "Convertible Preferred Stock") and the
Series A Preferred Stock shall be entitled to receive, prior and in preference
to any distribution of any of the assets of the Company to the holders of common
stock by reason of their ownership thereof, an amount per share equal to $2.50
for the Convertible Preferred Stock, and for the Series A Preferred Stock the
sum of (i) $15.80, as adjusted pursuant to Section 4(c) hereof (the "Original
Issue Price"), and (ii) an amount equal to cumulative unpaid dividends on such
shares (respectively, a "Liquidation Amount"). If upon the occurrence of such an
event, the assets and funds thus distributed among the holders of the
Convertible Preferred Stock and the Series A Preferred Stock shall be
insufficient to permit the payment to such holders of the full aforesaid
preferential amounts, then, the entire assets and funds of the Company legally
available for distribution shall be distributed ratably among the holders of the
Convertible Preferred Stock and the Series A Preferred Stock in proportion to
the amount of such stock owned by each such holder multiplied by the appropriate
Liquidation Amount.





                  (b) Upon the completion of the distribution required by
subparagraph (a) of this Section 2, if assets remain in the Company, the
remaining assets of the Company shall be distributed ratably among the holders
of the Company's common stock and the Series A Preferred Stock in proportion to
the number of shares of common stock held by each (assuming full conversion of
all shares of Series A Preferred Stock).

                  (c) (i) For purposes of this Section 2, a liquidation,
dissolution or winding up of the Company shall be deemed to be occasioned by, or
to include, (A) the acquisition of the Company by another entity by means of any
transaction or series of related transactions (including any reorganization,
merger or consolidation but excluding any merger effected exclusively for the
purpose of changing the domicile of the Company); or (B) a sale of all or
substantially all of the assets of the Company, unless the Company's
shareholders as constituted immediately prior to such acquisition or sale will,
immediately after such acquisition or sale (by virtue of securities issued as
consideration for the Company's acquisition or sale or otherwise) hold at least
50% of the voting power of the surviving or acquiring entity.

                           (ii) In any of such events, if the consideration
received by the Company is other than cash, its value will be deemed its fair
market value.

                           (iii) In the event the requirements of this Section 2
are not complied with, the Company shall forthwith either:

                                    (A) cause such closing to be postponed until
such time as the requirements of this Section 2 have been complied with, or

                                    (B) cancel such transaction, in which event
the rights, preferences and privileges of the holders of the Convertible
Preferred Stock and the Series A Preferred Stock shall revert to and be the same
as such rights, preferences and privileges existing immediately prior to the
date of the first notice referred to in subsection 2(c)(iv) hereof.

                           (iv) The Company shall give each holder of record of
Convertible Preferred Stock and the Series A Preferred Stock written notice of
such impending transaction not later than 20 days prior to the shareholders'
meeting called to approve such transaction, or 20 days prior to the closing of
such transaction, whichever is earlier, and shall also notify such holders in
writing of the final approval of such transaction; provided, however, that the
holder of any shares of then outstanding Convertible Preferred Stock or Series A
Preferred Stock shall have the right during such 20-day period to convert such
shares pursuant to Section 3 hereof. The first of such notices shall describe
the material terms and conditions of the impending transaction and the
provisions of this Section 2, and the Company shall thereafter give such holders
prompt notice of any material changes. The transaction shall in no event take
place sooner than 20 days after the Company has given the first notice provided
for herein or sooner than ten days after the Company has given notice of any
material changes provided for herein; provided, however, that such periods may
be shortened upon the written consent of the holders of the Convertible
Preferred Stock and the Series A Preferred Stock that are entitled to such
notice rights or similar notice rights and that represent at least a majority of
the voting power of all then outstanding shares of each of the classes of
preferred stock, voting separately as a class.

         3. Conversion.




                  (a) Conversion Right. At the option of the holder thereof,
each share of Series A Preferred Stock shall be convertible at any time during
the period commencing on the day on which the Series A Preferred Stock is issued
and expiring on May 15, 2000 (the date which is the second anniversary of the
date of issuance of the Series A Preferred Stock); provided, however, that such
expiration date shall be extended for a number of days equal to the number of
days beyond the 90th day following the date of issuance of the Series A
Preferred Stock that the Registration Statement (as such term is defined in the
Registration Rights Agreement, of even date herewith, entered into by and
between the Company and the Investors set forth on Schedule A thereto) is not
effective (such date, including any extension thereof pursuant to the foregoing
proviso, being herein referred to as the "Second Anniversary"). The Series A
Preferred Stock shall be convertible at the office of the Company or any
transfer agent for such stock into such number of fully paid and nonassessable
shares of the Company's common stock as is determined by dividing the Original
Issue Price, subject to adjustment as provided in Section 4, by the Conversion
Price applicable to such shares, determined as hereafter provided, in effect on
the date the certificates representing such shares are surrendered for
conversion (the "Conversion Date"). The Conversion Price shall be equal to the
average closing bid price of one share of the Company's common stock as quoted
by the Nasdaq SmallCap Market, the Nasdaq National Market or the principal
exchange upon which shares of the Company's common stock may be listed, or, if
the Company's common stock shall not then be quoted on the Nasdaq SmallCap
Market or the Nasdaq National Market or listed on a national securities
exchange, but shall otherwise be traded in the over-the-counter market, on such
over-the-counter market for the ten-day period ending on the day prior to the
Conversion Date (the "Trading Period") multiplied by .8 (the "Conversion
Price"); provided, however, that in no event shall the Conversion Price exceed
$5.00 per share or be less than $2.75 (the "Maximum Price" and "Minimum Price,"
respectively) per share; and provided, further, that appropriate adjustments
shall be made in determining the average closing bid price if a recapitalization
or other event affecting the Company's common stock shall occur during the
Trading Period.

                  (b) Dividend Payment. Should the Company, pursuant to Section
1 hereof, not elect to pay all outstanding, cumulative, accrued and unpaid
dividends on the Series A Preferred Stock in shares of its common stock, the
Company shall pay, in immediately available funds, to the holder of any shares
of Series A Preferred Stock being converted, within two days, all such dividends
on the date that it receives notice of such holder's intent to convert such
shares pursuant to (d) below. Separately, should the Company elect to pay all
outstanding, cumulative, accrued and unpaid dividends on the Series A Preferred
Stock in shares of its common stock, it shall, within two business days of
receiving a holder's notice of intent to convert, deliver certificates
representing such shares to the holder of the Series A Preferred Stock.

                  (c) Automatic Conversion. Any shares of Series A Preferred
Stock remaining outstanding on the Second Anniversary shall be automatically
converted pursuant to the conversion terms of Section 3(a) above. The Conversion
Date with respect to such automatic conversion shall be the Second Anniversary.
In any event, the Company shall, within two business days after automatic
conversion of the Series A Preferred Stock, issue and deliver a certificate or
certificates for the number of shares of the Company's common stock to which
each former holder of Series A Preferred Stock is entitled. Notwithstanding the
foregoing, no automatic conversion of the Series A Preferred Stock shall occur
pursuant to this Section unless (i) all shares of the Company's common stock
underlying the shares of Series A Preferred Stock may be sold pursuant to an
effective registration statement under the Securities Act of 1933, as amended,
(ii) the Company's common stock is listed and trading on The Nasdaq Stock
Market,




and (iii) the Company has reserved and available for issuance a number of shares
of its common stock sufficient to cover conversion of all outstanding shares of
Series A Preferred Stock.

                  (d) Mechanics of Conversion. Before any holder of Series A
Preferred Stock shall be entitled to convert the same into shares of the
Company's common stock, he, she or it shall surrender the certificate or
certificates therefor, duly endorsed, at the office of the Company or of any
transfer agent for the Series A Preferred Stock, and shall give written notice,
via facsimile, to the Company, at its principal corporate office, of the
election to convert the same and shall state therein the name or names in which
the certificate or certificates for shares of the Company's common stock are to
be issued. The Company shall, immediately thereafter (and in any event no more
than two business days thereafter), issue and deliver to such holder of Series A
Preferred Stock at the address shown on the Company's records or at such other
address as such party may designate by written notice to the Company, or to the
nominee or nominees of such holder, a certificate or certificates for the number
of shares of the Company's common stock to which such holder shall be entitled
pursuant to Section 3(a) and a certificate representing shares of Series A
Preferred Stock not so converted by the holder. Such conversion shall be deemed
to have been made immediately prior to the close of business on the Conversion
Date, and the person or persons entitled to receive the shares of the Company's
common stock issuable upon such conversion shall be treated for all purposes as
the record holder or holders of such shares of the Company's common stock as of
such date.

                  (e) Mechanics of Automatic Conversion. On the Conversion Date
with respect to the automatic conversion pursuant to subsection 3(c) above, the
certificates representing shares of Series A Preferred Stock shall immediately
represent that number of shares of the Company's common stock into which such
shares are convertible. Holders of Series A Preferred Stock shall deliver their
certificates, duly endorsed in blank, to the principal office of the Company,
together with a notice setting out the name or names (with addresses) and
denominations in which the certificates representing such shares of common stock
issuable upon conversion are to be issued and including instructions for
delivery thereof. The person entitled to receive the shares of the Company's
common stock issuable upon such conversion shall be treated for all purposes as
the record holder of such shares of common stock at and on the Conversion Date,
and the rights of such person as a holder of shares of Series A Preferred Stock
shall cease and terminate at and on the Conversion Date, in any case without
regard to any failure by such holder to deliver the certificates or the notice
required by this subsection 3(e). On the Conversion Date with respect to
automatic conversion, the Company shall pay all outstanding, cumulative, accrued
and unpaid dividends, either by the issuance of shares of its common stock or in
cash, pursuant to the provisions set forth in (a) above; provided, however, that
should the Company elect to pay such dividends by the issuance of additional
shares of its common stock, the person entitled to receive such shares of the
Company's common stock issuable upon such conversion shall be treated for all
purposes as the record holder of such additional shares on the Conversion Date

                  (f) No Impairment. The Company will not, by amendment of its
Articles of Incorporation or through any reorganization, recapitalization,
transfer of assets, consolidation, merger, dissolution, issue or sale of
securities or any other voluntary action, avoid or seek to avoid the observance
or performance of any of the terms to be observed or performed hereunder by the
Company, but will at all times in good faith assist in the carrying out of all
the provisions of this Section 3 and in the taking of all such action as may be
necessary or appropriate in order



to protect the conversion rights of the holders of the Series A Preferred Stock
against impairment.

                  (g) No Fractional Shares. No fractional shares shall be issued
upon the conversion of any share or shares of the Series A Preferred Stock, and
the number of shares of the Company's common stock to be issued shall be rounded
to the nearest whole share. Whether or not fractional shares are issuable upon
such conversion shall be determined on the basis of the total number of shares
of Series A Preferred Stock the holder is at the time converting into shares of
the Company's common stock and the number of shares of such common stock
issuable upon such aggregate conversion.

                  (h) Notices of Record Date. In the event of any taking by the
Company of a record of the holders of any class of securities for the purpose of
determining the holders thereof who are entitled to receive any dividend or
other distribution, any right to subscribe for, purchase or otherwise acquire
any shares of stock of any class or any other securities or property, or to
receive any other right, the Company shall mail to each holder of Series A
Preferred Stock, at least 20 days prior to the date specified therein, a notice
specifying the date on which any such record is to be taken for the purpose of
such dividend, distribution or right, and the amount and character of such
dividend, distribution or right.

                  (i) Reservation of Stock Issuable Upon Conversion. The Company
shall at all times reserve and keep available out of its authorized but unissued
shares of common stock, solely for the purpose of effecting the conversion of
the shares of the Series A Preferred Stock, such number of its shares of its
common stock as shall from time to time be sufficient to effect the conversion
of all outstanding shares of the Series A Preferred Stock; and if at any time
the number of authorized but unissued shares of the Company's common stock shall
not be sufficient to effect the conversion of all then outstanding shares of the
Series A Preferred Stock, in addition to such other remedies as shall be
available to the holder of such Series A Preferred Stock, the Company will take
such corporate action as may, in the opinion of its counsel, be necessary to
increase its authorized but unissued shares of common stock to such number of
shares as shall be sufficient for such purposes, including engaging in best
efforts to obtain the requisite shareholder approval of any necessary amendment
to the Company's Articles of Incorporation.

                  (j) Notices. Any notice required by the provisions of this
Section 3 to be given to the holders of shares of Series A Preferred Stock shall
be deemed given if deposited in the United States mail, postage prepaid, and
addressed to each holder of record at his, her or its address appearing on the
books of the Company.

         4. Anti-Dilution Provisions.

                  The Original Issue Price shall be subject to adjustment from
time to time upon the happening of any of the following events: (a) In the event
the Company shall issue or sell any shares of its common stock (except as
provided in paragraph (e) hereof) for a consideration per share less than the
greater of (A) $5.00, or (B) 80% of the Market Price (as defined below) on the
date of such issue or sale, then the Original Issue Price shall be increased to
such greater price (calculated to the nearest cent) as shall be determined by
multiplying the Original Issue Price by a fraction, the numerator of which shall
be the number of shares of the Company's common stock outstanding immediately
after the issuance or sale of such additional shares, and the

denominator of which shall be the sum of (i) the number of shares of the
Company's common stock outstanding immediately prior to the issuance or sale of
such additional shares, and (ii) the number of shares of the Company's common
stock which the aggregate consideration received for the issuance or sale of
such additional shares would purchase at the greater of $5.00, or if such shares
of the Company's common stock shall have been issued for a consideration per
share less than 80% of the Market Price on the date of issuance or sale, the
current Market Price. For purposes of this paragraph, all shares of the
Company's common stock issuable upon exercise of outstanding options and
warrants shall be deemed to be outstanding.

                  (b) For the purposes of paragraph 4(a) above, the following
subparagraphs (i) to (vii), inclusive, shall be applicable:

                           (i) If at any time the Company shall issue or sell
any rights to subscribe for, or any rights or options to purchase, shares of its
common stock or any stock or other securities convertible into or exchangeable
for such common stock (such convertible or exchangeable stock or securities
being hereinafter called "Convertible Securities"), whether or not such rights
or options or the right to convert or exchange any such Convertible Securities
shall be immediately exercisable, and the price per share for which shares of
the Company's common stock shall be issuable upon the exercise of such rights or
options or upon conversion or exchange of such Convertible Securities
(determined by dividing (1) the total amount, if any, received or receivable by
the Company as consideration for the granting of such rights or options, plus
the minimum aggregate amount of additional consideration payable to the Company
upon the exercise of such rights or options, plus, in the case of any such
rights or options which shall relate to Convertible Securities, the minimum
aggregate amount of additional consideration, if any, payable upon the issue or
sale of such Convertible Securities and upon the conversion or exchange thereof,
by (2) the total number of shares of the Company's common stock issuable upon
the exercise of such rights or options or upon the conversion or exchange of all
such Convertible Securities issuable upon the exercise of such rights or
options) shall be less than the greater of (x) the $5.00, or (y) 80% of the
Market Price at the time of such issue or sale, then the total number of shares
of the Company's common stock issuable upon the exercise of such rights or
options or upon conversion or exchange of the total amount of such Convertible
Securities issuable upon the exercise of such rights or options shall (as of the
date of granting of such rights or options) be deemed to be outstanding and to
have been issued for such price per share, and except as provided in paragraph
4(d), no further adjustments of the Original Issue Price shall be made upon the
actual issue of such shares of common stock or of such Convertible Securities,
upon the exercise of such rights or options or upon the actual issue of such
common stock upon conversion or exchange of such Convertible Securities.

                           (ii) If at any time the Company shall issue or sell
any Convertible Securities, whether or not the rights to exchange or convert
thereunder shall be immediately exercisable, and the price per share for which
shares of the Company's common stock shall be issuable upon such conversion or
exchange (determined by dividing (1) the total amount received or receivable by
the Company as consideration for the issue or sale of such Convertible
Securities, plus the minimum aggregate amount of additional consideration, if
any, payable to the Company upon the conversion or exchange thereof, by (2) the
total number of shares of the Company's common stock issuable upon the
conversion or exchange of all such Convertible Securities) shall be less than
the greater of (x) $5.00, or (y) 80% of the Market Price at the time of such
issue or sale, then the total number of shares of the Company's common stock
issuable upon conversion or exchange of all such Convertible Securities shall
(as of the date of the issue





or sale of such Convertible Securities) be deemed to be outstanding and to have
been issued for such price per share, and, except as provided in paragraph 4(d),
no further adjustments of the Original Issue Price shall be made upon the actual
issue of such shares of common stock upon conversion or exchange of such
Convertible Securities. In addition, if any issue or sale of such Convertible
Securities shall be made upon exercise of any rights to subscribe for or to
purchase or any option to purchase any such Convertible Securities for which
adjustments of the Original Issue Price shall have been or shall be made
pursuant to other provisions of this paragraph 4(b)(ii), no further adjustment
of the Original Issue Price shall be made by reason of such issue or sale.

                           (iii) If at any time the Company shall declare and
pay a dividend or make any other distribution upon the shares of its common
stock payable in such stock or Convertible Securities, any such stock or
Convertible Securities, as the case may be, issuable in payment of such dividend
or distribution shall be deemed to have been issued or sold without
consideration.

                           (iv) If at any time any shares of the Company's
common stock or Convertible Securities or any rights or options to purchase
shares of any such stock or Convertible Securities shall be issued or sold for
cash, the consideration received therefor shall be deemed to be the amount
received by the Company therefor, without deduction therefrom of any expenses
incurred or any underwriting commissions or concessions or discounts paid or
allowed by the Company in connection therewith. In case any shares of the
Company's common stock or Convertible Securities or any rights or options to
purchase any such common stock or Convertible Securities shall be issued or sold
for a consideration other than cash, the amount of the consideration other than
cash received by the Company shall be deemed to be the fair value of such
consideration as determined by the Company's Board of Directors, without
deduction therefrom of any expenses incurred or any underwriting commissions or
concessions or discounts paid or allowed by the Company in connection therewith.
In case any shares of the Company's common stock or Convertible Securities or
any rights or options to purchase any such common stock or Convertible
Securities shall be issued in connection with any merger of another corporation
into the Company, the amount of consideration therefor shall be deemed to be the
fair value of the net assets of such merged corporation as determined by the
Company's Board of Directors after deducting therefrom all cash and other
consideration (if any) paid by the Company in connection with such merger.

                           (v) If at any time the Company shall take a record of
the holders of its common stock for the purpose of entitling them (1) to receive
a dividend or other distribution payable in shares of the Company's common stock
or in Convertible Securities, or (2) to subscribe for or purchase shares of the
Company's common stock or Convertible Securities, then such record date shall be
deemed to be the date of the issue or sale of the shares of the Company's common
stock deemed to have been issued or sold upon the declaration of such dividend
or the making of such other distribution or the date of the granting of such
right of subscription or purchase, as the case may be.

                           (vi) The number of shares of the Company's common
stock outstanding at any given time shall not include shares owned or held by or
for the account of the Company, provided that such shares are neither issued,
sold or otherwise distributed by the Company.




                           (vii) For purposes hereof, the "Market Price" shall
mean the average closing bid price of the Company's common stock on the Nasdaq
SmallCap Market, the Nasdaq National Market or the principal exchange upon which
shares of the Company's common stock may be listed, or, if the Company's common
stock shall not then be quoted on the Nasdaq SmallCap Market or the Nasdaq
National Market or listed on a national securities exchange, but shall otherwise
be traded in the over-the-counter market, on such over-the-counter market, in
each case for the ten day period immediately preceding any determination of such
"Market Price" (subject to appropriate adjustments which shall be made in
determining the average closing bid price if a recapitalization or other event
affecting the Company's common stock shall occur during such 10-day period). If
at any time shares of the Company's common stock shall not be quoted on the
Nasdaq SmallCap Market or the Nasdaq National Market, listed on a national
securities exchange, or otherwise traded in the over-the-counter market, the
"Market Price" of a share of the Company's common stock shall be deemed to be
the higher of (x) the book value thereof (as determined by any firm of
independent public accountants of nationally recognized standing selected by the
Company's Board of Directors) as of the last day of any month ending within 60
days preceding the date of determination, or (y) the fair value thereof (as
determined in good faith by the Company's Board of Directors) as of a date which
shall be within 15 days of the date of determination.

                           (c) In case at any time the Company shall subdivide
its outstanding shares of common stock into a greater number of shares, the
Original Issue Price in effect immediately prior to such subdivision, the
Maximum Price and the Minimum Price shall be proportionately reduced, and the
Company shall subdivide the Series A Preferred Stock in the same proportion. In
case at any time the outstanding shares of the Company's common stock shall be
combined into a smaller number of shares, the Original Issue Price in effect
immediately prior to such combination, the Maximum Price and the Minimum Price
shall be proportionately increased, and the Company shall combine the Series A
Preferred Stock in the same proportion. Any adjustment under this paragraph 4(c)
shall become effective at the close of business on the date the subdivision or
combination shall become effective. The Company will take such corporate action
as may, in the opinion of its counsel, be necessary to increase its authorized
but unissued shares of Series A Preferred Stock to such number of shares as
shall be sufficient for any such purposes, including engaging in best efforts to
obtain the requisite shareholder approval of any necessary amendment to the
Company's Articles of Incorporation.

                  (d) If the purchase or exercise price provided for in any
right or option referred to in paragraph 4(b)(i), or the rate at which any
Convertible Securities referred to in paragraph 4(b)(i) or (ii) shall be
convertible into or exchangeable for shares of the Company's common stock, shall
change or a different purchase or exercise price or rate shall become effective
at any time or from time to time (including any change resulting from
termination of such right, option or convertible security), then, upon such
change becoming effective, the Original Issue Price then in effect hereunder
shall forthwith be increased or decreased to such Original Issue Price as would
have been obtained had the adjustments made upon the granting or issuance of
such rights or options or Convertible Securities been made upon the basis of (A)
the issuance of the number of shares of the Company's common stock theretofore
actually delivered upon the exercise of such options or rights or upon the
conversion or exchange of such Convertible Securities, and (B) the granting or
issuance at the time of such change of any such options, rights or Convertible
Securities then still outstanding for the consideration, if any, received by the
Company therefor and to be received on the basis of such changed price.




                  (e) The Company shall not be required to make any adjustment
to the Original Issue Price in the case of:

                           (i) the granting, after the date hereof, by the
Company of stock options under the Company's 1997 Stock Option Plan, so long as
the shares of the Company's common stock underlying such options are covered by
the 800,000 shares currently reserved for issuance under such plan as of the
date hereof, assuming approval by the Company's shareholders of the 300,000
share increase at the Company's 1998 Annual Meeting of Shareholders;

                           (ii) the issuance of shares of the Company's common
stock, pursuant to the exercise of the options referred to in paragraph 4(e)(i)
above or the exercise of any other options or warrants outstanding as of the
date hereof; or

                           (iii) the issuance of shares of the Series A
Preferred Stock hereunder or of shares of the Company's common stock upon the
conversion of any shares of the Series A Preferred Stock or upon the exercise of
the Warrant or the Warrant issued to Miller, Johnson & Kuehn, Incorporated on
the same date as the Preferred Stock Purchase Agreement to which this
certificate of Designation is an Exhibit.

         5. Voting Rights. The holder of each share of Series A Preferred Stock
shall have the right to the number of votes on all matters submitted to the
Company's shareholders that shall be equal to the number of shares of the
Company's common stock into which such holder's shares of Series A Preferred
Stock shall then be convertible (assuming a conversion as of the record date set
for the vote).

         6. Status of Converted Stock. In the event any shares of Series A
Preferred Stock shall be converted pursuant to Section 3 hereof, the shares of
Series A Preferred Stock so converted shall be canceled and shall not be
issuable by the Company. The Articles of Incorporation of the Company shall be
appropriately amended to effect the corresponding reduction in the Company's
authorized capital stock.

         7. Notice of Adjustment. The Company shall provide all holders of
shares of Series A Preferred Stock five business days prior written notice of
any adjustments in the Original Issue Price, the Maximum Price, the Minimum
Price or any other adjustments made pursuant to the provisions hereof.


                                                                      Filed with
                                                              State of Minnesota
                                                                    May 14, 1998





                            STATEMENT OF DESIGNATION
                              OF ADDITIONAL SHARES
                                       OF
                                  DATAKEY, INC.



         The undersigned hereby certifies that the resolutions set forth below
were duly adopted by the Board of Directors of Datakey, Inc., a Minnesota
corporation, on January 25, 2000:


                  WHEREAS, pursuant to the Articles of Incorporation of this
         corporation, the Board of Directors has authority to establish, from
         the 1,950,000 undesignated shares of capital stock, one or more classes
         or series of shares and to fix the relative rights and preferences of
         each such class of or series; and

                  WHEREAS, the Board of Directors deems it advisable to
         designate additional common shares;

                  NOW, THEREFORE, RESOLVED, that, of the 1,950,000 undesignated
         shares, currently authorized, 1,000,000 shares are designated as
         additional common shares.


         I swear that the foregoing is true and accurate and that I have the
authority to sign this document on behalf of the corporation.


Dated:  February 10, 2000

                                       /s/ Carl P. Boecher
                                       Carl P. Boecher, President and
                                       Chief Executive Officer of Datakey, Inc.


                                                                      FILED WITH
                                                              STATE OF MINNESOTA
                                                                   FEB. 11, 2000





                              ARTICLES OF AMENDMENT
                                       OF
                            ARTICLES OF INCORPORATION
                                       OF
                                  DATAKEY, INC.



         Pursuant to the provisions of Minnesota Statutes, Section 302A.135, the
amendment to the Articles of Incorporation of Datakey, Inc., amending and
restating Article 3.01 in its entirety, as set forth below, was duly adopted by
the shareholders of the corporation on May 31, 2000:

                  "3.01 The aggregate number of shares of stock which this
         corporation shall have authority to issue is 30,000,000 shares,
         consisting of 20,000,000 shares of common stock, par value $.05,
         400,000 shares of convertible preferred stock, which shall have the
         rights and preferences as set forth on a Certificate of Rights and
         Preferences filed with the Minnesota Secretary of State on December 24,
         1985, and 9,600,000 undesignated shares."


         The undersigned swears that the foregoing is true and accurate and that
the undersigned has the authority to sign this document on behalf of the
corporation.


Dated: May 31, 2000


                         /s/ Carl P. Boecher
                         Carl P. Boecher, President and Chief Executive Officer

                                                                      Filed with
                                                              State of Minnesota
                                                                   June 19, 2000





                            STATEMENT OF DESIGNATION

                                       OF

                            SERIES B PREFERRED STOCK

                                       OF

                                  DATAKEY, INC.

                        (Pursuant to Chapter 302A of the
                       Minnesota Business Corporation Act)



         Datakey, Inc., a corporation organized and existing under the Minnesota
Business Corporation Act (hereinafter called the "Company"), hereby certifies
that the following resolution was adopted by the Board of Directors of the
Company at a meeting duly called and held on October 19, 2001:

         RESOLVED, that, pursuant to the authority granted to and vested in the
Board of Directors of the Company (hereinafter called the "Board of Directors"
or the "Board") in accordance with the provisions of Section 3.01 of the
Articles of Incorporation, as amended to date (hereinafter called the "Articles
of Incorporation"), the Board of Directors hereby creates a series of preferred
stock, par value $.05 per share, of the Company and hereby states the
designation and number of shares, and fixes the relative rights, preferences,
and limitations thereof as follows:

         Series B Preferred Stock:

         Section 1. Designation and Amount. The shares of such preferred stock
series shall be designated as "Series B Preferred Stock" (the "Series B
Preferred Stock"), and the number of shares constituting the Series B Preferred
Stock shall be One Hundred and Twenty-Thousand (120,000). Such number of shares
may be increased or decreased by resolution of the Board of Directors; provided,
that, no decrease shall reduce the number of shares of Series B Preferred Stock
to a number less than the number of shares then outstanding plus the number of
shares reserved for issuance upon the exercise of outstanding options, rights or
warrants or upon the conversion of any outstanding securities issued by the
Company convertible into Series B Preferred Stock.

         Section 2.  Dividends and Distributions.

         (A) Subject to the rights of the holders of any shares of any series of
preferred stock of the Company or preferred stock (or any similar stock) ranking
prior and superior to the Series B Preferred Stock with respect to dividends,
the holders of shares of Series B Preferred Stock, in preference to the holders
of Common Stock, par value $.05 per share (the "Common Stock"), of the Company,
and of any other junior stock, shall be entitled to receive, when, as and if
declared




by the Board of Directors out of funds legally available for the purpose,
quarterly dividends payable in cash on the first day of March, June, September
and December in each year (each such date being referred to herein as a
"Quarterly Dividend Payment Date"), commencing on the first Quarterly Dividend
Payment Date after the first issuance of a share or fraction of a share of
Series B Preferred Stock, in an amount per share (rounded to the nearest cent)
equal to the greater of (a) $1 or (b) subject to the provision for adjustment
hereinafter set forth, 100 times (as adjusted, the "Dividend Multiple") the
aggregate per share amount of all cash dividends, and 100 times the aggregate
per share amount (payable in kind) of all non-cash dividends or other
distributions, other than a dividend payable in shares of Common Stock or a
subdivision of the outstanding shares of Common Stock (by reclassification or
otherwise), declared on the Common Stock since the immediately preceding
Quarterly Dividend Payment Date or, with respect to the first Quarterly Dividend
Payment Date, since the first issuance of any share or fraction of a share of
Series B Preferred Stock. In the event the Company shall at any time declare or
pay any dividend on the Common Stock payable in shares of Common Stock, or
effect a subdivision or combination or consolidation of the outstanding shares
of Common Stock (by reclassification or otherwise) into a greater or lesser
number of shares of Common Stock, then in each such case the Dividend Multiple
shall be adjusted by multiplying such amount by a fraction, the numerator of
which is the number of shares of Common Stock outstanding immediately after such
event and the denominator of which is the number of shares of Common Stock that
were outstanding immediately prior to such event.

         (B) The Company shall declare a dividend or distribution on the Series
B Preferred Stock as provided in paragraph (A) of this Section immediately after
it declares a dividend or distribution on the Common Stock (other than a
dividend payable in shares of Common Stock); provided, that, in the event no
dividend or distribution shall have been declared on the Common Stock during the
period between any Quarterly Dividend Payment Date and the next subsequent
Quarterly Dividend Payment Date, a dividend of $1 per share on the Series B
Preferred Stock shall nevertheless be payable on such subsequent Quarterly
Dividend Payment Date.

         (C) Dividends shall begin to accrue and be cumulative on outstanding
shares of Series B Preferred Stock from the Quarterly Dividend Payment Date next
preceding the date of issue of such shares, unless the date of issue of such
shares is prior to the record date for the first Quarterly Dividend Payment
Date, in which case dividends on such shares shall begin to accrue from the date
of issue of such shares, or unless the date of issue is a Quarterly Dividend
Payment Date or is a date after the record date for the determination of holders
of shares of Series B Preferred Stock entitled to receive a quarterly dividend
and before such Quarterly Dividend Payment Date, in either of which events such
dividends shall begin to accrue and be cumulative from such Quarterly Dividend
Payment Date. Accrued but unpaid dividends shall not bear interest. Dividends
paid on the shares of Series B Preferred Stock in an amount less than the total
amount of such dividends at the time accrued and payable on such shares shall be
allocated pro rata on a share-by-share basis among all such shares at the time
outstanding. The Board of Directors may fix a record date for the determination
of holders of shares of Series B Preferred Stock entitled to receive payment of
a dividend or distribution declared thereon, which record date shall be not more
than sixty (60) days prior to the date fixed for the payment thereof.

         Section 3. Voting Rights. The holders of shares of Series B Preferred
Stock shall have the following voting rights:



                  (A) Subject to the provision for adjustment hereinafter set
         forth, each share of Series B Preferred Stock shall entitle the holder
         thereof to 100 votes (as adjusted, the "Vote Multiple") on all matters
         submitted to a vote of the stockholders of the Company. In the event
         the Company shall at any time declare or pay any dividend on the Common
         Stock payable in shares of Common Stock, or effect a subdivision or
         combination or consolidation of the outstanding shares of Common Stock
         (by reclassification or otherwise) into a greater or lesser number of
         shares of Common Stock, then in each such case the Vote Multiple shall
         be adjusted by multiplying such number by a fraction, the numerator of
         which is the number of shares of Common Stock outstanding immediately
         after such event and the denominator of which is the number of shares
         of Common Stock that were outstanding immediately prior to such event.

                  (B) Except as otherwise provided in Section 10 hereof, in any
         other Statement of Designation creating a series of preferred stock or
         any similar stock, or by law, the holders of shares of Series B
         Preferred Stock and the holders of shares of Common Stock, the holders
         of Convertible Preferred Stock and any other capital stock of the
         Company having general voting rights shall vote together as one class
         on all matters submitted to a vote of stockholders of the Company.

                  (C) Except as set forth herein, or as otherwise provided by
         law, holders of Series B Preferred Stock shall have no special voting
         rights and their consent shall not be required (except to the extent
         they are entitled to vote with holders of Common Stock as set forth
         herein) for taking any corporate action.

         Section 4. Certain Restrictions.

                  (A) Whenever quarterly dividends or other dividends or
         distributions payable on the Series B Preferred Stock as provided in
         Section 2 are in arrears, thereafter and until all accrued and unpaid
         dividends and distributions, whether or not declared, on shares of
         Series B Preferred Stock outstanding shall have been paid in full, the
         Company shall not:

                           (i) declare or pay dividends, or make any other
                  distributions, on any shares of stock ranking junior (either
                  as to dividends or upon liquidation, dissolution or winding
                  up) to the Series B Preferred Stock;

                           (ii) declare or pay dividends, or make any other
                  distributions, on any shares of stock ranking on a parity
                  (either as to dividends or upon liquidation, dissolution or
                  winding up) with the Series B Preferred Stock, except
                  dividends paid ratably on the Series B Preferred Stock and all
                  such parity stock on which dividends are payable or in arrears
                  in proportion to the total amounts to which the holders of all
                  such shares are then entitled;

                           (iii) redeem or purchase or otherwise acquire for
                  consideration shares of any stock ranking junior (either as to
                  dividends or upon liquidation, dissolution or winding up) to
                  the Series B Preferred Stock, provided that the Company may at
                  any time redeem, purchase or otherwise acquire shares of any
                  such junior stock in exchange for shares of any stock of the
                  Company ranking junior (as to dividends




                  and upon dissolution, liquidation and winding up) to the
                  Series B Preferred Stock; or

                           (iv) redeem or purchase or otherwise acquire for
                  consideration any shares of Series B Preferred Stock, or any
                  shares of stock ranking on a parity (either as to dividends or
                  upon liquidation, dissolution or winding up) with the Series B
                  Preferred Stock, except in accordance with a purchase offer
                  made in writing or by publication (as determined by the Board)
                  to all holders of such shares upon such terms as the Board,
                  after consideration of the respective annual dividend rates
                  and other relative rights and preferences of the respective
                  series or classes, shall determine in good faith will result
                  in fair and equitable treatment among the respective series or
                  classes.

                  (B) The Company shall not permit any subsidiary of the Company
         to purchase or otherwise acquire for consideration any shares of stock
         of the Company unless the Company could, under paragraph (A) of this
         Section 4, purchase or otherwise acquire such shares at such time and
         in such manner.

         Section 5. Reacquired Shares. Any shares of Series B Preferred Stock
purchased or otherwise acquired by the Company in any manner whatsoever shall be
retired and cancelled promptly after the acquisition thereof. All such shares
shall upon their cancellation become authorized but unissued undesignated shares
and may be reissued as part of a new series of stock subject to the conditions
and restrictions on issuance set forth herein, in the Articles of Incorporation,
or in any other Statement of Designation creating a series of preferred stock or
any similar stock or as otherwise required by law.

         Section 6. Liquidation, Dissolution or Winding Up. Upon any
liquidation, dissolution or winding up of the Company, no distribution shall be
made (A) to the holders of shares of stock ranking junior (either as to
dividends or upon liquidation, dissolution or winding up) to the Series B
Preferred Stock unless, prior thereto, the holders of shares of Series B
Preferred Stock shall have received the greater of (i) $100 per share, plus an
amount equal to accrued and unpaid dividends and distributions thereon, whether
or not declared, to the date of such payment, or (ii) subject to the provision
for adjustment hereinafter set forth, 100 times (as adjusted, the "Liquidation
Preference Multiple") the aggregate amount to be distributed per share to
holders of shares of Common Stock, or (B) to the holders of shares of stock
ranking on a parity (either as to dividends or upon liquidation, dissolution or
winding up) with the Series B Preferred Stock, except distributions made ratably
on the Series B Preferred Stock and all such parity stock in proportion to the
total amounts to which the holders of all such shares are entitled upon such
liquidation, dissolution or winding up. In the event the Company shall at any
time declare or pay any dividend on the Common Stock payable in shares of Common
Stock, or effect a subdivision or combination or consolidation of the
outstanding shares of Common Stock (by reclassification or otherwise) into a
greater or lesser number of shares of Common Stock, then in each such case the
Liquidation Preference Multiple shall be adjusted by multiplying such amount by
a fraction the numerator of which is the number of shares of Common Stock
outstanding immediately after such event and the denominator of which is the
number of shares of Common Stock that were outstanding immediately prior to such
event.

         Section 7. Consolidation, Merger, Etc. In case the Company shall enter
into any consolidation, merger, statutory exchange combination or other
transaction in which the shares



of Common Stock are exchanged for or changed into other stock or securities,
cash and/or any other property, then in any such case each share of Series B
Preferred Stock shall at the same time be similarly exchanged or changed into an
amount per share, subject to the provision for adjustment hereinafter set forth,
equal to 100 times (as adjusted, the "Exchange Multiple") the aggregate amount
of stock, securities, cash and/or any other property (payable in kind), as the
case may be, into which or for which each share of Common Stock is changed or
exchanged. In the event the Company shall at any time declare or pay any
dividend on the Common Stock payable in shares of Common Stock, or effect a
subdivision or combination or consolidation of the outstanding shares of Common
Stock (by reclassification or otherwise) into a greater or lesser number of
shares of Common Stock, then in each such case the Exchange Multiple shall be
adjusted by multiplying such amount by a fraction, the numerator of which is the
number of shares of Common Stock outstanding immediately after such event and
the denominator of which is the number of shares of Common Stock that were
outstanding immediately prior to such event.

         Section 8. No Redemption. The shares of Series B Preferred Stock shall
not be redeemable.

         Section 9. Rank. The Series B Preferred Stock shall rank, with respect
to the payment of dividends and the distribution of assets, junior to the
Company's Convertible Preferred Shares outstanding and junior to any other class
of the corporation's preferred stock hereafter issued.

         Section 10. Amendment. If any proposed amendment to the Articles of
Incorporation or this Statement of Designation would alter or change the
preferences, special rights or powers given to the Series B Preferred Stock so
as to affect the Series B Preferred Stock adversely, except as otherwise
provided in this Statement of Designation, then the holders of the Series B
Preferred Stock shall be entitled to vote as a series upon such amendment, and
the affirmative vote of two-thirds of the outstanding shares of Series B
Preferred Stock shall be necessary to the adoption thereof, in addition to such
other vote as may be required by the Minnesota Business Corporation Act.

         Section 11. Fractional Shares. Series B Preferred Stock may be issued
in fractions of a share which shall entitle the holder, in proportion to such
holder's fractional shares, to exercise voting rights, receive dividends,
participate in distributions and to have the benefit of all other rights of
holders of Series B Preferred Stock.

         I certify that I am authorized to execute this Statement of
Designation, and I further certify that I understand that by signing this
Statement of Designation I am subject to the penalties of perjury as set forth
in Minnesota Statutes, Section 609.48, as if I had signed this Statement of
Designation under oath.


Dated:  October 26, 2001
                                                  /s/ Alan G. Shuler
                                         ---------------------------------------
                                         Alan G. Shuler, Vice President and
                                            Chief Financial Officer

EX-3.2

                                                                     EXHIBIT 3.2

                           AMENDED AND RESTATED BYLAWS
                                       OF
                                  DATAKEY, INC.


                                   ARTICLE 1.
                                     OFFICES

         1.1) Offices. The address of the registered office of the corporation
shall be designated in the Articles of Incorporation, as amended from time to
time. The principal executive office of the corporation shall be located at such
address as the Board of Directors may determine, and the corporation may have
offices at such other places within or without the State of Minnesota as the
Board of Directors shall from time to time determine or the business of the
corporation requires.

                                   ARTICLE 2.
                            MEETINGS OF SHAREHOLDERS

         2.1) Regular Meetings. Regular meetings of the shareholders of the
corporation entitled to vote shall be held on an annual or other less frequent
basis as shall be determined by the Board of Directors or by the chief executive
officer; provided, that if a regular meeting has not been held during the
immediately preceding 15 months, a shareholder or shareholders holding three
percent (3%) or more of the voting power of all shares entitled to vote may
demand a regular meeting of shareholders by written notice of demand given to
the chief executive officer or chief financial officer of the corporation. At
each regular meeting, the shareholders, voting as provided in the Articles of
Incorporation and these Bylaws, shall elect qualified successors for directors
who serve for an indefinite term or for directors whose terms have expired or
are due to expire within six months after the date of the meeting, and shall
transact such other business as shall come before the meeting. No meeting shall
be considered a regular meeting unless specifically designated as such in the
notice of meeting or unless all the shareholders entitled to vote are present in
person or by proxy and none of them objects to such designation. The Board of
Directors shall have the ability to postpone previously scheduled annual
meetings upon public notice given prior to the scheduled meeting date.

         2.2) Advance Notice of Shareholder Nominees and Shareholder Business -
Regular Meetings.

         Subject to the notice requirements set forth in this Section 2.2, any
shareholder entitled to vote in the election of directors generally may:

         (a) make nominations for the election of directors; and

         (b) propose business to be brought before any regular meeting;

if such nomination or business proposed is otherwise proper business before such
meeting. Any such shareholder may nominate one or more persons for election as
directors at a meeting or propose business to be brought before a meeting, or
both, only if such shareholder has given timely notice to the secretary of the
corporation in proper written form of the shareholder's intent


                                      -1-



to make such nomination or nominations or to propose such business. To be
timely, such shareholder's notice must be delivered to or mailed and received by
the secretary of the corporation at the principal executive offices of the
corporation not less than one hundred twenty (120) calendar days in advance of
the date that is one year after the prior year's annual meeting of shareholders;
provided, however, that in the event that no annual meeting was held in the
previous year or the date of the annual meeting has been changed by more than
thirty (30) days from the date of the prior year's annual meeting (in either
case such an annual meeting date being referred to herein as an "Other Meeting
Date"), notice by the shareholder to be timely must be so received by the later
of: (i) the close of business on the date ninety (90) days prior to the Other
Meeting Date or (ii) the close of business ten (10) days following the date on
which the Other Meeting Date is first publicly announced. To be in proper form,
a shareholder's notice to the secretary shall set forth:

         (i)      the name and address of the shareholder who intends to make
                  the nominations or propose the business and, as the case may
                  be, of the person or persons to be nominated or of the
                  business to be proposed;

         (ii)     a representation that the shareholder is a holder of record of
                  stock of the corporation entitled to vote at such meeting and,
                  if applicable, intends to appear in person or by proxy at the
                  meeting to nominate the person or persons specified in the
                  notice;

         (iii)    if applicable, a description of all arrangements or
                  understandings between the shareholder and each nominee and
                  any other person or persons (naming such person or persons)
                  pursuant to which the nomination or nominations are to be made
                  by the shareholder;

         (iv)     beneficial stock ownership information of such nominee and
                  such other information regarding each nominee or each matter
                  of business to be proposed by such shareholder as would be
                  required to be included in a proxy statement filed pursuant to
                  the proxy rules of the Securities and Exchange Commission had
                  the nominee been nominated, or intended to be nominated, or
                  the matter been proposed, or intended to be proposed by the
                  board of directors; and

         (v)      if applicable, the consent of each nominee to serve as
                  director of the corporation if so elected.

The chairman of the meeting shall refuse to acknowledge the nomination of any
person or the proposal of any business not made in compliance with the foregoing
procedure.

         2.3) Special Meetings. Special meetings of the shareholders entitled to
vote may be called at any time by the Chairman of the Board, the chief executive
officer, the chief financial officer, two or more directors, or a shareholder or
shareholders holding ten percent (10%) (25% if the purpose is to effect a
business combination, including a change of the board composition) or more of
the voting power of all shares entitled to vote who shall demand such special
meeting by giving written notice of demand (in accordance with Minn. Stat.
302A.433) to the chief executive officer or the chief financial officer
specifying the purposes of the meeting.


                                      -2-



         2.4) Meetings Held Upon Shareholder Demand. Within thirty (30) days
after receipt by the chief executive officer or the chief financial officer of a
demand from any shareholder or shareholders entitled to call a regular or
special meeting of shareholders, the Board of Directors shall cause such meeting
to be called and held on notice no later than ninety (90) days after receipt of
such demand. If the Board of Directors fails to cause such a meeting to be
called and held, the shareholder or shareholders making the demand may call the
meeting by giving notice as provided in Section 2.6 hereof at the expense of the
corporation.

         2.5) Place of Meetings. Meetings of the shareholders shall be held at
the principal executive office of the corporation or at such other place, within
or without the State of Minnesota, as is designated by the Board of Directors,
except that a regular or special meeting called by or at the demand of a
shareholder shall be held in the county where the principal executive office of
the corporation is located.

         2.6) Notice of Meetings. Except as otherwise specified in Section 2.7
or required by law, a written notice setting out the place, date and hour of any
regular or special meeting shall be given to each holder of shares entitled to
vote not less than ten (10) days nor more than sixty (60) days prior to the date
of the meeting; provided, that notice of a meeting at which there is to be
considered a proposal (i) to dispose of all, or substantially all, of the
property and assets of the corporation or (ii) to dissolve the corporation shall
be given to all shareholders of record, whether or not entitled to vote; and
provided further, that notice of a meeting at which there is to be considered a
proposal to adopt a plan of merger or exchange shall be given to all
shareholders of record, whether or not entitled to vote, at least fourteen (14)
days prior thereto. Notice of any special meeting shall state the purpose or
purposes of the proposed meeting, and the business transacted at all special
meetings shall be confined to the purposes stated in the notice.

         2.7) Waiver of Notice. A shareholder may waive notice of any meeting
before, at or after the meeting, in writing, orally or by attendance. Attendance
at a meeting by a shareholder is a waiver of notice of that meeting unless the
shareholder objects at the beginning of the meeting to the transaction of
business because the meeting is not lawfully called or convened, or objects
before a vote on an item of business because the item may not be lawfully
considered at such meeting and does not participate in the consideration of the
item at such meeting.

         2.8) Quorum and Adjourned Meeting. The holders of a majority of the
voting power of the shares entitled to vote at a meeting, represented either in
person or by proxy, shall constitute a quorum for the transaction of business at
any regular or special meeting of shareholders. If a quorum is present when a
duly called or held meeting is convened, the shareholders present may continue
to transact business until adjournment, even though the withdrawal of a number
of shareholders originally present leaves less than the proportion or number
otherwise required for a quorum. In case a quorum is not present at any meeting,
those present shall have the power to adjourn the meeting from time to time,
without notice other than announcement at the meeting, until the requisite
number of shares entitled to vote shall be represented. Whether or not a quorum
is present, the Chairman of the Board shall have the ability to adjourn the
meeting to a date not more than 45 days after such original meeting date. At
such adjourned meeting at which the required amount of shares entitled to vote
shall be represented, any business may be transacted which might have been
transacted at the original meeting.


                                      -3-



         2.9) Voting. At each meeting of the shareholders, every shareholder
having the right to vote shall be entitled to vote in person or by proxy duly
appointed by an instrument in writing subscribed by such shareholder. Each
shareholder shall have one (1) vote for each share having voting power standing
in each shareholder's name on the books of the corporation except as may be
otherwise provided in the terms of the share. Upon the demand of any
shareholder, the vote for directors or the vote upon any question before the
meeting shall be by ballot. All elections shall be determined and all questions
decided by a majority vote of the number of shares entitled to vote and
represented at any meeting at which there is a quorum except in such cases as
shall otherwise be required by statute or the Articles of Incorporation.

         2.10) Order of Business. The chairman of the meeting shall have the
right and authority to prescribe such rules, regulations and procedures and to
do all such acts as, in the judgment of such chairman, are appropriate for
conduct of the meeting. To the extent not prohibited by law, such rules,
regulations or procedures may include, without limitation, establishment of: (1)
an agenda or order of business for the meeting and the method by which business
may be proposed, (2) rules and procedures for maintaining order at the meeting
and the safety of those present, (3) limitations on attendance or participation
in the meeting to shareholders or record of the corporation, their duly
authorized proxies or such other persons as the chairman of the meeting shall
determine, (4) restrictions on entry to the meeting after the time fixed for
commencement thereof and (5) limitations on the time allotted to questions or
comments by participants. Any proposed business contained in the notice of a
regular meeting is deemed to be on the agenda and no further motions or other
actions shall be required to bring such proposed business up for consideration.
Unless and to the extent otherwise determined by the chairman of the meeting, it
shall not be necessary to follow Robert's Rules of Order or any other rules or
parliamentary procedure at the meeting of shareholders. Following completion of
business of the meeting as determined by the chairman of the meeting, the
chairman of the meeting shall have the exclusive authority to adjourn the
meeting.


                                   ARTICLE 3.
                                    DIRECTORS

         3.1) General Powers. The business and affairs of the corporation shall
be managed by or under the direction of a Board of Directors.

         3.2) Number, Term and Qualifications. At each annual meeting the
Shareholders shall determine the number of directors which shall be not less
than three (3) nor more than nine (9); provided, that between annual meetings
the Board of Directors may increase the authorized number of directors within
the limits stated above. However, notwithstanding the foregoing no increase or
decrease in the number of directors may be effected except according to the
further provisions contained in this Section 3.2.

         The directors shall be divided into three classes, designated Class I,
Class II and Class III. Each class shall consist, as nearly as possible, of
one-third of the total number of directors constituting the entire Board of
Directors.

         At the first meeting of Shareholders held after April __, 2001, Class I
directors shall be elected for a one-year term, the Class II directors for a
two-year term, and the Class III directors


                                      -4-



for a three-year term. At each succeeding annual meeting of the shareholders at
which directors are elected, successors to the Class of directors whose term
expires at that annual meeting shall be elected for a three-year term.

         A director shall hold office until the annual meeting for the year in
which such director's term expires and until such director's successor shall be
elected and shall qualify, or until such director's resignation or removal from
office. If the number of directors is changed, any increase or decrease shall be
apportioned by the Board of Directors among the classes so as to maintain, as
nearly as possible, an equal number of directors in each class. In the event an
increase or decrease makes it impossible to maintain an equal number of
directors in each class, increases shall be allocated to the class or classes
with the longest remaining term, and decreases shall be allocated to the class
with the shortest remaining term.

         Any director elected to fill a vacancy resulting from an increase in
such class shall hold office for a term that shall coincide with the remaining
term of that class. In no event will a decrease in the number of directors
result in the elimination of an entire class of directors, cause any class to
contain a number of directors two or more greater than any other class, or
shorten the term of any incumbent director. Any director elected to fill a
vacancy not resulting from an increase in the number of directors shall have the
same remaining term as that of such director's predecessor.

         3.3) Vacancies. Vacancies on the Board of Directors may be filled by
the affirmative vote of a majority of the remaining members of the Board, though
less than a quorum; provided, that newly created directorships resulting from an
increase in the authorized number of directors shall be filled by the
affirmative vote of a majority of the directors serving at the time of such
increase. Persons so elected shall be directors until their successors are
elected by the shareholders, who may make such election at the next regular or
special meeting of the shareholders.

         3.4) Quorum and Voting. A majority of the directors currently holding
office shall constitute a quorum for the transaction of business. In the absence
of a quorum, a majority of the directors present may adjourn a meeting from time
to time until a quorum is present. If a quorum is present when a duly called or
held meeting is convened, the directors present may continue to transact
business until adjournment even though the withdrawal of a number of directors
originally present leaves less than the proportion or number otherwise required
for a quorum. Except as otherwise required by law or the Articles of
Incorporation, the acts of a majority of the directors present at a meeting at
which a quorum is present shall be the acts of the Board of Directors.

         3.5) Board Meetings; Place and Notice. Meetings of the Board of
Directors may be held from time to time at any place within or without the State
of Minnesota that the Board of Directors may designate. In the absence of
designation by the Board of Directors, Board meetings shall be held at the
principal executive office of the corporation, except as may be otherwise
unanimously agreed orally, or in writing, or by attendance. Any director may
call a Board meeting by giving two (2) days notice to all directors of the date
and time of the meeting. The notice need not state the purpose of the meeting,
and may be given by mail, telephone, telegram, or in person. If a meeting
schedule is adopted by the Board, or if the date and time of a Board meeting has
been announced at a previous meeting, no notice is required.


                                      -5-



         3.6) Waiver of Notice. A director may waive notice of any meeting
before, at or after the meeting, in writing, orally or by attendance. Attendance
at a meeting by a director is a waiver of notice of that meeting unless the
director objects at the beginning of the meeting to the transaction of business
because the meeting is not lawfully called or convened and does not participate
thereafter in the meeting.

         3.7) Compensation. Directors who are not salaried officers of the
corporation shall receive such fixed sum and expenses per meeting attended or
such fixed annual sum or both as shall be determined from time to time by
resolution of the Board of Directors. Nothing herein contained shall be
construed to preclude any director from serving this corporation in any other
capacity and receiving proper compensation therefor.

         3.8) Committees. The Board of Directors may, by resolution approved by
affirmative vote of a majority of the Board, establish committees having the
authority of the Board in the management of the business of the corporation only
to the extent provided in the resolution. Committees may include a special
litigation committee consisting of one or more independent directors or other
independent persons to consider legal rights or remedies of the corporation and
whether those rights and remedies should be pursued. Each such committee shall
consist of one or more natural persons (who need not be directors) appointed by
the affirmative vote of a majority of the directors present, and shall, other
than special litigation committees, be subject at all times to the direction and
control of the Board. A majority of the members of a committee present at a
meeting shall constitute a quorum for the transaction of business.

         3.9) Order of Business. The suggested order of business at any meeting
of the Board of Directors shall, to the extent appropriate and unless modified
by the presiding chairman, be:

         1.       Roll call

         2.       Proof of due notice of meeting or waiver of notice, or
                  unanimous presence and declaration by presiding chairman

         3.       Determination of existence of quorum

         4.       Reading and disposal of any unapproved minutes

         5.       Reports of officers and committees

         6.       Election of officers

         7.       Unfinished business

         8.       New business

         9.       Adjournment.

                                   ARTICLE 4.
                                    OFFICERS

         4.1) Number and Designation. The corporation shall have one or more
natural persons exercising the functions of the offices of chief executive
officer and chief financial officer. The Board of Directors may elect or appoint
such other officers or agents as it deems necessary for the operation and
management of the corporation including, but not limited to, a Chairman of the
Board, a President, one or more Vice Presidents, a Secretary and a Treasurer,
each of whom shall have the powers, rights, duties and responsibilities set
forth in these Bylaws unless otherwise determined by the Board. Any of the
offices or functions of those offices may be held by the same person.


                                      -6-



         4.2) Election, Term of Office and Qualification. At the first meeting
of the Board following each election of directors, the Board shall elect
officers, who shall hold office until the next election of officers or until
their successors are elected or appointed and qualify; provided, however, that
any officer may be removed with or without cause by the affirmative vote of a
majority of the Board of Directors present (without prejudice, however, to any
contract rights of such officer).

         4.3) Resignation. Any officer may resign at any time by giving written
notice to the corporation. The resignation is effective when notice is given to
the corporation, unless a later date is specified in the notice, and acceptance
of the resignation shall not be necessary to make it effective.

         4.4) Vacancies in Office. If there be a vacancy in any office of the
corporation, by reason of death, resignation, removal or otherwise, such vacancy
may, or in the case of a vacancy in the office of chief executive officer or
chief financial officer shall, be filled for the unexpired term by the Board of
Directors.

         4.5) Chief Executive Officer. Unless provided otherwise by a resolution
adopted by the Board of Directors, the chief executive officer (a) shall have
general active management of the business of the corporation; (b) shall, when
present and in the absence of the Chairman of the Board, preside at all meetings
of the shareholders and Board of Directors; (c) shall see that all orders and
resolutions of the Board are carried into effect; (d) shall sign and deliver in
the name of the corporation any deeds, mortgages, bonds, contracts or other
instruments pertaining to the business of the corporation, except in cases in
which the authority to sign and deliver is required by law to be exercised by
another person or is expressly delegated by the Articles, these Bylaws or the
Board to some other officer or agent of the corporation; (e) may maintain
records of and certify proceedings of the Board and shareholders; and (f) shall
perform such other duties as may from time to time be assigned to the chief
executive officer by the Board.

         4.6) Chief Financial Officer. Unless provided otherwise by a resolution
adopted by the Board of Directors, the chief financial officer (a) shall keep
accurate financial records for the corporation; (b) shall deposit all monies,
drafts and checks in the name of and to the credit of the corporation in such
banks and depositories as the Board of Directors shall designate from time to
time; (c) shall endorse for deposit all notes, checks and drafts received by the
corporation as ordered by the Board, making proper vouchers therefor; (d) shall
disburse corporate funds and issue checks and drafts in the name of the
corporation, as ordered by the Board; (e) shall render to the chief executive
officer and the Board of Directors, whenever requested, an account of all
transactions undertaken as chief financial officer and of the financial
condition of the corporation; and (f) shall perform such other duties as may be
prescribed by the Board of Directors or the chief executive officer from time to
time.

         4.7) Chairman of the Board. The Chairman of the Board shall preside at
all meetings of the shareholders and of the Board and shall exercise general
supervision and direction over the more significant matters of policy affecting
the affairs of the corporation, including particularly its financial and fiscal
affairs. The Chairman shall not be considered an officer unless such chairman is
also serving as a full-time employee.


                                      -7-



         4.8) President. Unless otherwise determined by the Board, the President
shall be the chief executive officer. If an officer other than the President is
designated chief executive officer, the President shall perform such duties as
may from time to time be assigned to the President by the Board. If the office
of Chairman of the Board is not filled, the President shall also perform the
duties set forth in Section 4.7.

         4.9) Vice President. Each Vice President shall have such powers and
shall perform such duties as may be specified in these Bylaws or prescribed by
the Board of Directors. In the event of absence or disability of the President,
the Board of Directors may designate a Vice President or Vice Presidents to
succeed to the power and duties of the President.

         4.10) Secretary. The Secretary shall, unless otherwise determined by
the Board, be secretary of and attend all meetings of the shareholders and Board
of Directors, and may record the proceedings of such meetings in the minute book
of the corporation and, whenever necessary, certify such proceedings. The
Secretary shall give proper notice of meetings of shareholders and shall perform
such other duties as may be prescribed by the Board of Directors or the chief
executive officer from time to time.

         4.11) Treasurer. Unless otherwise determined by the Board, the
Treasurer shall be the chief financial officer of the corporation. If an officer
other than the Treasurer is designated chief financial officer, the Treasurer
shall perform such duties as may be prescribed by the Board of Directors or the
chief executive officer from time to time.

         4.12) Delegation. Unless prohibited by a resolution approved by the
affirmative vote of a majority of the directors present, an officer elected or
appointed by the Board may delegate in writing some or all of the duties and
powers of such officer to other persons.


                                   ARTICLE 5.
                                 INDEMNIFICATION

         5.1) Indemnification. The corporation shall indemnify such persons, for
such expenses and liabilities, in such manner, under such circumstances, and to
such extent, as permitted by Minnesota Statutes, Section 302A.521, as now
enacted or hereafter amended.


                                   ARTICLE 6.
                            SHARES AND THEIR TRANSFER

         6.1) Certificate of Stock. Every owner of stock of the corporation
shall be entitled to a certificate, in such form as the Board of Directors may
prescribe, certifying the number of shares of stock of the corporation owned by
such shareholder. The certificates for such stock shall be numbered (separately
for each class) in the order in which they are issued and shall, unless
otherwise determined by the Board, be signed by the chief executive officer, the
chief financial officer, or any other officer of the corporation. A signature
upon a certificate may be a facsimile. Certificates on which a facsimile
signature of a former officer, transfer agent or registrar appears may be issued
with the same effect as if such person were such officer, transfer agent or
registrar on the date of issue.


                                      -8-



         6.2) Stock Record. As used in these Bylaws, the term "shareholder"
shall mean the person, firm or corporation in whose name outstanding shares of
capital stock of the corporation are currently registered on the stock record
books of the corporation. The corporation shall keep, at its principal executive
office or at another place or places within the United States determined by the
Board, a share register not more than one year old containing the names and
addresses of the shareholders and the number and classes of shares held by each
shareholder. The corporation shall also keep at its principal executive office
or at another place or places within the United States determined by the Board,
a record of the dates on which certificates representing shares were issued.
Every certificate surrendered to the corporation for exchange or transfer shall
be cancelled and no new certificate or certificates shall be issued in exchange
for any existing certificate until such existing certificate shall have been so
cancelled (except as provided for in Section 6.4 of this Article 6).

         6.3) Transfer of Shares. Transfer of shares on the books of the
corporation may be authorized only by the shareholder named in the certificate
(or the shareholder's legal representative or duly authorized attorney-in-fact)
and upon surrender for cancellation of the certificate or certificates for such
shares. The shareholder in whose name shares of stock stand on the books of the
corporation shall be deemed the owner thereof for all purposes as regards the
corporation; provided, that when any transfer of shares shall be made as
collateral security and not absolutely, such fact, if known to the corporation
or to the transfer agent, shall be so expressed in the entry of transfer; and
provided, further, that the Board of Directors may establish a procedure whereby
a shareholder may certify that all or a portion of the shares registered in the
name of the shareholder are held for the account of one or more beneficial
owners.

         6.4) Lost Certificate. Any shareholder claiming a certificate of stock
to be lost or destroyed shall make an affidavit or affirmation of that fact in
such form as the Board of Directors may require, and shall, if the directors so
require, give the corporation a bond of indemnity in form and with one or more
sureties satisfactory to the Board of at least double the value, as determined
by the Board, of the stock represented by such certificate in order to indemnify
the corporation against any claim that may be made against it on account of the
alleged loss or destruction of such certificate, whereupon a new certificate may
be issued in the same tenor and for the same number of shares as the one alleged
to have been destroyed or lost.


                                   ARTICLE 7.
                               GENERAL PROVISIONS

         7.1) Record Dates. In order to determine the shareholders entitled to
notice of and to vote at a meeting, or entitled to receive payment of a dividend
or other distribution, the Board of Directors may fix a record date which shall
not be more than sixty (60) days preceding the date of such meeting or
distribution. In the absence of action by the Board, the record date for
determining shareholders entitled to notice of and to vote at a meeting shall be
at the close of business on the day preceding the day on which notice is given,
and the record date for determining shareholders entitled to receive a
distribution shall be at the close of business on the day on which the Board of
Directors authorizes such distribution.


                                      -9-



         7.2) Distributions; Acquisitions of Shares. Subject to the provisions
of law, the Board of Directors may authorize the acquisition of the
corporation's shares and may authorize distributions whenever and in such
amounts as, in its opinion, the condition of the affairs of the corporation
shall render it advisable.

         7.3) Fiscal Year. The fiscal year of the corporation shall be
established by the Board of Directors.

         7.4) Seal. The corporation shall have such corporate seal or no
corporate seal as the Board of Directors shall from time to time determine.

         7.5) Securities of Other Corporations.

                  (a) Voting Securities Held by the Corporation. Unless
         otherwise ordered by the Board of Directors, the chief executive
         officer shall have full power and authority on behalf of the
         corporation (i) to attend and to vote at any meeting of security
         holders of other companies in which the corporation may hold
         securities; (ii) to execute any proxy for such meeting on behalf of the
         corporation; and (iii) to execute a written action in lieu of a meeting
         of such other company on behalf of this corporation. At such meeting,
         by such proxy or by such writing in lieu of meeting, the chief
         executive officer shall possess and may exercise any and all rights and
         powers incident to the ownership of such securities that the
         corporation might have possessed and exercised if it had been present.
         The Board of Directors may from time to time confer like powers upon
         any other person or persons.

                  (b) Purchase and Sale of Securities. Unless otherwise ordered
         by the Board of Directors, the chief executive officer shall have full
         power and authority on behalf of the corporation to purchase, sell,
         transfer or encumber securities of any other company owned by the
         corporation which represent not more than 10% of the outstanding
         securities of such issue, and may execute and deliver such documents as
         may be necessary to effectuate such purchase, sale, transfer or
         encumbrance. The Board of Directors may from time to time confer like
         powers upon any other person or persons.


                                   ARTICLE 8.
                                    MEETINGS

         8.1) Telephone Meetings and Participation. A conference among directors
by any means of communication through which the directors may simultaneously
hear each other during the conference constitutes a Board meeting, if the same
notice is given of the conference as would be required for a meeting, and if the
number of directors participating in the conference would be sufficient to
constitute a quorum at a meeting. Participation in a meeting by that means
constitutes presence in person at the meeting. A director may participate in a
Board meeting not heretofore described in this paragraph, by any means of
communication through which the director, other directors so participating, and
all directors physically present at the meeting may simultaneously hear each
other during the meeting. Participation in a meeting by that means constitutes
presence in person at the meeting. The provisions of this section shall apply to
committees and members of committees to the same extent as they apply to the
Board and directors.


                                      -10-



         8.2) Authorization Without Meeting. Any action of the shareholders, the
Board of Directors, or any committee of the corporation which may be taken at a
meeting thereof, may be taken without a meeting if authorized by a writing
signed by all of the holders of shares who would be entitled to vote on such
action, by all of the directors (unless less than unanimous action is permitted
by the Articles of Incorporation), or by all of the members of such committee,
as the case may be.


                                   ARTICLE 9.
                              AMENDMENTS OF BYLAWS

         9.1) Amendments. Unless the Articles of Incorporation provide
otherwise, these Bylaws may be altered, amended, added to or repealed by the
affirmative vote of a majority of the members of the Board of Directors. Such
authority in the Board of Directors is subject to the power of the shareholders
to change or repeal such Bylaws, and the Board of Directors shall not make or
alter any Bylaws fixing a quorum for meetings of shareholders, prescribing
procedures for removing directors or filling vacancies on the Board, or fixing
the number of directors or their classifications, qualifications or terms of
office, but the Board may adopt or amend a Bylaw to increase the number of
directors.


         The undersigned, Thomas R. King, Secretary of Datakey, Inc., hereby
certifies that the foregoing Amended and Restated Bylaws were duly adopted as
the Bylaws of the corporation by its shareholders on May 31, 2001.



                                              /s/ Thomas R. King
                                              Thomas R. King, Secretary





                                      -11-

EX-10.18

                                                                   EXHIBIT 10.18

                                  DATAKEY, INC.
                          2003 EXECUTIVE INCENTIVE PLAN

The Datakey, Inc. 2003 Executive Incentive Plan ("2003 Incentive Plan") is
designed to pay for performance to revenue growth and profitability objectives
set forth at the beginning of the year as defined in the Board approved 2003
Financial Plan. This plan provides for quarterly payments of cash and Datakey
stock options issued at the closing price of the last day of the quarter and
vesting in six months. The 2003 Incentive Plan applies to the following
executives, and others if approved by the Board of Directors:

    o  President & CEO

    o  Vice President/General Manager ISS

    o  Vice President & CFO

    o  Vice President of Corporate Marketing

In the event of a change in control, bonus amounts will be computed and paid
throughout the year as if the approved business plan revenue and profitability
goals have been met.

CASH INCENTIVE

Each executive is assigned a target annual incentive cash payment as determined
by the Board of Directors.

Payment of the cash incentive is based on achievement of revenue growth 2003
quarter over same quarter in 2002 and achievement of the planned profit/loss in
conjunction with the following table, with the amounts as set forth by the Board
of Directors:



                                            Q1            Q2           Q3           Q4
                                                                    
2002 ISS REVENUE                         $2,493,000   $1,869,000   $1,388,000   $1,600,000
PLANNED 2003 ISS REVENUE
PLANNED ISS REVENUE GROWTH
% PLANNED REVENUE GROWTH
ACTUAL ISS REVENUE
ACTUAL ISS REVENUE GROWTH
% = ACTUAL REVENUE GROWTH/
  PLANNED REVENUE GROWTH (F)
MEETS PROFIT PLAN? (0=NO, .5=YES) (PP)
ISS PROFITABLE? (0=NO, .5=YES) (PR)
% EARNED


Payment amount determination begins with the calculation of actual 2003 ISS
revenue growth (Quarterly increase year-to-year) and its percentage (F) of
revenue growth as specified in the 2003 Incentive Plan. (F) is further modified
by consideration for meeting profit/loss planned for the quarter (PP) and
quarter profitability (PR), all of which are taken after bonus payments have
been applied, and according to the following formula:

    o  F = Actual revenue growth/planned revenue growth

    o  % EARNED = F x (1+PP+PR)/2 where PP is .5 if profit/loss in the plan is
       met and PR are .5 if the quarter is profitable.

    o  QUARTER PAYMENT = % earned x target annual incentive payment/4


                                       1


STOCK OPTION INCENTIVE

Each executive is assigned a target stock option incentive payment as determined
by the Board of Directors.

Calculations for F, % EARNED, AND QUARTER PAYMENT are the same as for the cash
incentive above.




                                       2

EX-10.19

                                                                   EXHIBIT 10.19


                              EMPLOYMENT AGREEMENT


         This Employment Agreement (the "Agreement") made and entered into
effective as of March 1, 2003, by and between DATAKEY, INC., a Minnesota
corporation (the "Company" or "Datakey"), and CARL P. BOECHER ("Executive").


                                    RECITALS

         Executive joined the Company in January 1995 as Vice President of Sales
and Marketing. He was appointed President and Chief Executive Officer on
December 1, 1996 and has served in this capacity since that time. On January 1,
1999, the Company and Executive signed an employment agreement. Effective as of
March 1, 2003, Executive resigned his position and agreed to serve as the Vice
Chairman of the Board of Directors of Datakey pursuant to the terms and
conditions of this Agreement.


                                    AGREEMENT

1.       Employment

         a. Datakey agrees to employ Executive as Vice Chairman of the Board of
Directors.

         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 who will have responsibilities in the area of corporate
development. His specific duties and responsibilities will be set by the
Chairman of the Board of Directors within 30 days of the signing of this
Agreement and he will report to the Chairman of the Board.

         c. Executive will continue as a member of Datakey's Board of Directors
for at least as long as the Agreement remains in effect and shareholders have
re-elected him. Executive will submit his resignation as a member of the Board
of Directors immediately upon termination of the Agreement for any reason, and
the Board of Directors may accept or reject his resignation. If Executive's
resignation is not accepted, he will continue as a director until the next
annual meeting of shareholders following the termination of the Agreement. In
the unlikely event that Executive is not re-elected to the Board of Directors at
the next annual meeting of shareholders, all of the other terms and conditions
of the Agreement will remain in full force and effect and Executive's new title
will be Vice President of Corporate Development. During his tenure as a
director, Executive will receive no board fees or stock options related to his
service as a director.





2. Term of Employment

         Subject to the terms and conditions hereof, Executive shall be employed
for a term ("Employment Term") commencing effective as of March 1, 2003, and
terminating on March 1, 2004. This Agreement will be extended only upon written
agreement of the parties prior to March 1, 2004.

3. Compensation

         a. As compensation for his services to Datakey, Executive shall be paid
a monthly salary of $8,333.33 payable in accordance with Datakey's periodic
payment periods.

         b. In addition to his compensation described in 3a above, Executive
will be paid $17,500 per month for a period of twelve months in lieu of any
future severance payments which may have become due to him under his employment
agreement dated January 1, 1999.

         c. All payments made to Executive under this Section 3 shall be made to
him with one payroll check.

4. Bonus

         Executive will be eligible for a one-time bonus to be paid in a lump
sum on or before April 15, 2004. The bonus will be paid based on the Company's
financial and business performance during the term of this Agreement,
Executive's performance of his duties hereunder and his contributions to the
Company's performance. The payment of a bonus and the amount of such bonus, if a
bonus is paid, will be in the discretion of the Board of Directors. Executive
will not participate in any management incentive compensation plan currently in
place or any management compensation plan which may be approved in the future.

5. Other Benefits

         a. During the term of this Agreement, Executive will be eligible to
continue participation in the 401-K plan and to receive certain other benefits
described in the attached Exhibit A, subject to such changes as Datakey may
adopt from time to time for officers of the Company and salaried employees
generally.

         b. In addition to the benefits described in Exhibit A, so long as this
Agreement remains in effect, he will have a Company paid e-mail service, Company
cell phone, a Company-paid telephone line in his home office and Company
internet connection for his home office will be continued, and he may retain a
laptop computer, docking station and business software for his use during the
term of this Agreement. Executive will be entitled to use, from time to time,
the


                                       2


designated Board Member office in the Company facilities, new business cards
reflecting his Vice Chairman title, cell phone contact number and home office
phone line number.

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 his duties as an officer of the
                  Company 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.

                  (v) Termination by the Company or voluntary resignation by the
                  Executive for any reason.

         b. For purposes of this Agreement, "cause" shall include the commission
of any felony, misdemeanor, or 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 compensation, severance or other benefits
except as specifically agreed to at time of termination or as set forth in this
Section 7 below. The date of termination under this Section 7 shall be on the
day the notice of termination for cause is given or the day the notice of
resignation is given. Executive shall be entitled to the balance of any payments
due to him under Section 3b above if he voluntarily resigns but not if he is
terminated for cause.

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 be entitled to receive his agreed compensation under Sections 3a
and 3b for the balance of the term of this Agreement.

         b. The payments provided for under this Section 8 shall, in the event
of Executive's death, be payable to his wife if she survives or, if not, to his
estate.


                                       3



         c. The Company will continue to provide medical and health coverage,
under its plans as they currently exist or may hereafter be amended, at
customary employee rates during the term of this Agreement. Thereafter,
Executive and his covered dependents will be entitled to elect to continue
coverage under COBRA to the extent it is available. For the first twelve months
after termination, the COBRA medical and health coverage will be extended to
Executive at customary employee rates. 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. 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.

10. 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;

         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


                                       4



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.

11. 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.

12. Noncompetition

         a. For a period of one year after termination of this Agreement for any
reason, 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).

         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 12 anywhere in the United States.
Therefore, Executive agrees that the covenants contained in this Section 12
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 12, 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 12 by Datakey through an
injunction or restraining order issued by the appropriate court.

         d. To the extent any provision of this Section 12 shall be invalid or
unenforceable, it shall be considered deleted herefrom and the remainder of such
provision and this Section 12 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 12 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 12 be given the construction which
renders its provisions valid and enforceable to the maximum extent (not
exceeding its expressed terms) possible under applicable laws.


                                       5



13. Release of Claims

         a. In consideration of the new Employment Agreement entered into with
Executive, and the compensation and benefits provided therein, by signing this
Agreement, Executive releases and forever discharges Datakey from any and all
manner of claims, demands, actions, liability, damages Executive may have
against Datakey or any affiliates of Datakey, whether known or unknown in
connection with law or equity, contract, or tort, arising out of or in
connection with Executive's employment through March 1, 2003, and his Employment
Agreement dated January 1, 1999, including specifically Executive's resignation
as President and Chief Executive Officer of Datakey.

         b. This release includes, without limiting the generality of the
foregoing, any claims you may have for wages, bonuses, commissions, penalties,
deferred compensation, vacation pay, separation benefits, defamation, invasion
of privacy, negligence, improper discharge (based on contract, common law, or
statute, including any federal, state or local statute or ordinance prohibiting
discrimination or retaliation in employment), alleged violation of the United
States Constitution, the Minnesota Constitution, the Age Discrimination in
Employment Act, 29 U.S.C. Section 621 et seq., the Minnesota Human Rights Act,
Minn. Stat. Section 363.01 et seq., Title VII of the Civil Rights Act, 42 U.S.C.
Section 2000e et seq., the Americans with Disabilities Act, 42 U.S.C. Section
12101 et seq., the Employment Retirement Income Security Act of 1976, 29 U.S.C.
Section 1001 et seq., the Family and Medical Leave Act, 29 U.S.C. Section 2601
et seq., any claim arising under Minn. Stat. Chapters 177 and 181, any claim for
retaliation arising under Minn. Stat. Chapter 176, and any claim for
discrimination or retaliation based on sex, race, color, creed, religion, age,
national origin, marital status, sexual orientation, disability, status with
regard to public assistance, sexual harassment, or any other protected class
status.

14 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.


                                       6



         IN WITNESS WHEREOF, the parties have hereto executed this Employment
Agreement effective as of the day and year first above written.

                                      DATAKEY, INC.


                                      /s/ Gary R. Holland
                                      By:  Gary Holland, Chairman of the Board




                                      /s/ Carl P. Boecher
                                      Carl P. Boecher, Executive



                                       7



                                    EXHIBIT A
                                       TO
            EMPLOYMENT AGREEMENT DATED EFFECTIVE AS OF MARCH 1, 2003


                               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 $300,000, based upon
         standard rates and underwriting decisions regarding medical history,
         paid 100% by the Company

- --       Supplemental long-term disability insurance paying $5,000 per month
         based upon standard rates and underwriting decisions regarding medical
         history, paid 90% by the Company

- --       Auto allowance of $600 per month

- --       Vacation as required

- --       Sick leave as needed, up to a maximum of 90 days at the discretion of
         the Chairman of the Board

- --       Comprehensive annual physical examination at Park Nicollet Executive
         Health Center paid by the Company

EX-23.1

                                                                    EXHIBIT 23.1


                         CONSENT OF INDEPENDENT AUDITORS


We hereby consent to the incorporation by reference of our report, dated January
31, 2003 with respect to the financial statements of Datakey, Inc. (the
"Company") included in this Form 10-KSB into the Company's previously filed
Registration Statements on Form S-8 No. 333-64470, No. 33-14144, No. 33-47068,
No. 33-67280, No. 333-11405, No. 33-80894, No. 333-43937, No. 333-83999,
333-39556 and 333-91760 and on Form S-3 No. 333-58770, No. 333-56711, No.
333-84007, No. 333-91779, No. 333-90969, No. 333-94087 and No. 333-33332.


                                          /s/ McGladrey & Pullen, LLP


Minneapolis, Minnesota
March 26, 2003

EX-99.1

                                                                    Exhibit 99.1


                    CERTIFICATION OF CHIEF EXECUTIVE OFFICER
           PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO
                  SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002


     In connection with the Annual Report of Datakey, Inc. (the "Company") on
Form 10-KSB for the year ended December 31, 2002 as filed with the Securities
and Exchange Commission (the "Report"), I, Timothy L. Russell, Chief Executive
Officer of the Company, certify pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 that:

     (1) The Report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934; and

     (2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.


     Date: March 26, 2003         Signature: /s/ Timothy L. Russell
                                             Timothy L. Russell
                                             Chief Executive Officer

EX-99.2

                                                                    Exhibit 99.2


                    CERTIFICATION OF CHIEF FINANCIAL OFFICER
              PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO
                     SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002


     In connection with the Annual Report of Datakey, Inc. (the "Company") on
Form 10-KSB for the year ended December 31, 2002 as filed with the Securities
and Exchange Commission (the "Report"), I, Alan G. Shuler, Chief Financial
Officer of the Company, certify pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 that:

     (1) The Report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934; and

     (2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.


     Date: March 26, 2003         Signature: /s/ Alan G. Shuler
                                             Alan G. Shuler
                                             Chief Financial Officer


2747866-6