SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(X) QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period under ending March 29, 1997
Commission File Number 0-11447
DATAKEY, INC.
(Exact name of small business issuer as specified in its charter)
MINNESOTA 41-1291472
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) Identification No.)
407 WEST TRAVELERS TRAIL, BURNSVILLE, MN 55337
Issuer's telephone number: (612) 890-6850
-----------------------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15 (d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes _X_ No ____
APPLICABLE ONLY TO CORPORATE ISSUERS
The number of shares outstanding of the issuer's common equity, as of May 9,
1997 is 2,887,235.
Transitional small business disclosure Format (check one):
Yes ____ No _X_
1
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM I. FINANCIAL STATEMENTS
DATAKEY, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
March 29, December 31,
1997 1996
------------ ------------
(UNAUDITED)
ASSETS
CURRENT ASSETS
<S> <C> <C>
Cash and cash equivalents $ 682,356 $ 140,030
Investment in held-to-maturity securities 4,050,873 5,993,228
Trade receivables, less allowance for
doubtful accounts of $49,701 and $45,000 761,716 634,538
Inventories 1,633,631 1,128,907
Prepaid and other 105,780 46,962
---------- ----------
Total current assets 7,234,356 7,943,665
---------- ----------
OTHER ASSETS
Deferred taxes 325,000 325,000
Prepaid licenses at cost 978,000 129,750
Patents at cost, less amortization
of $114,492 and $105,531 90,687 99,236
---------- ----------
1,393,687 553,986
---------- ----------
EQUIPMENT AND LEASEHOLD IMPROVEMENTS, at cost
Production tooling 1,172,449 1,179,021
Equipment 2,834,184 2,561,659
Furniture and fixtures 265,392 267,482
Leasehold improvements 234,452 234,452
4,506,477 4,242,614
Less accumulated depreciation (2,955,971) (2,840,909)
---------- ----------
1,550,506 1,401,705
---------- ----------
$ 10,178,549 $ 9,899,356
---------- ----------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 920,335 $ 559,280
Accrued severance obligation 290,500 332,000
Accrued license fees-current portion 439,000 0
Accrued expenses 559,947 315,549
---------- ----------
Total current liabilities 2,209,782 1,206,829
---------- ----------
Accrued license fees, less current portion 329,250 0
SHAREHOLDERS' EQUITY
Convertible preferred stock, voting, stated value
$2.50 per share; authorized 400,000 shares;
issued and outstanding 150,000 375,000 375,000
Common stock, par value $.05 per share;
authorized 10,000,000 shares; issued and
outstanding 2,887,235 and 2,882,069 144,362 144,103
Additional paid-in capital 4,089,283 4,070,815
---------- ----------
Retained earnings 3,030,872 4,102,609
---------- ----------
7,639,517 8,692,527
---------- ----------
$ 10,178,549 $ 9,899,356
---------- ----------
</TABLE>
See Notes to Consolidated Financial Statements
2
<PAGE>
DATAKEY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended
March 29, March 30,
1997 1996
----------- -----------
<S> <C> <C>
Revenue $ 1,409,801 $ 1,735,717
Cost of goods sold 934,872 1,037,335
----------- -----------
Gross Profit 474,929 698,382
Operating expenses:
Research, development
and engineering 1,016,352 274,576
Selling 394,375 282,256
General and administrative 211,556 208,975
----------- -----------
Total operating expenses 1,622,283 765,807
----------- -----------
Operating loss (1,147,354) (67,425)
Interest income 75,617 93,981
----------- -----------
Income(loss) before
income taxes (1,071,737) 26,556
Income tax expense 0 10,000
----------- -----------
Net income(loss) ($1,071,737) $ 16,556
----------- -----------
Net income(loss) per common and
common equivalent share (Primary
and fully diluted) ($ 0.37) $ 0.01
----------- -----------
Weighted average number of
common and common
equivalent shares
outstanding 2,884,769 3,063,328
----------- -----------
</TABLE>
See Notes to Consolidated Financial Statements
3
<PAGE>
DATAKEY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended
March 29, March 30,
1997 1996
----------- -----------
CASH FLOWS FROM
OPERATING ACTIVITIES
<S> <C> <C>
Net Income(loss) ($1,071,737) $ 16,556
Adjustments to reconcile net income(loss)
to net cash used in operating activities:
Depreciation 115,062 110,372
Amortization 8,961 34,567
Change in assets and liabilities
(Increase) decrease:
Trade receivables (127,178) (63,827)
Inventories (504,724) (20,965)
Prepaid expenses and other (58,818) (42,689)
Prepaid license fees (80,000) 0
Increase (decrease) in:
Accounts payable 361,055 (64,494)
Accrued expenses 244,398 (45,459)
Accrued severance (41,500) 0
Income taxes payable 0 9,586
----------- -----------
Net cash used in
operating activities (1,154,481) (66,353)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of tooling and equipment (263,863) (48,419)
Purchase of held-to-maturity
securities (72,807) (1,257,066)
Proceeds from maturity of
held-to-maturity securities 2,015,162 1,178,000
Patent and license costs (412) (6,071)
----------- -----------
Net cash provided by(used in)
investing activities 1,678,080 (133,556)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Net proceeds from issuance of
common stock 18,727 1,812
----------- -----------
Net cash provided by (used in) financing activities 18,727 1,812
----------- -----------
Increase(decrease) in cash
and cash equivalents 542,326 (198,097)
CASH AND CASH EQUIVALENTS
Beginning 140,030 713,230
Ending $ 682,356 $ 515,133
----------- -----------
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING
AND FINANCING ACTIVITIES
Obligation recorded in connection with prepaid
license fees $ 768,250 $ 0
----------- -----------
</TABLE>
See Notes to Consolidated Financial Statements
4
<PAGE>
DATAKEY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
GENERAL
In the opinion of management, the accompanying unaudited financial statements
contain all adjustments necessary to present fairly Datakey's financial position
as of March 29, 1997 and December 31, 1996 and results of its operations and
cash flows for the three-month periods ending March 29, 1997 and March 30, 1996.
The adjustments that have been made are of a normal recurring nature.
The accounting policies followed by the Company are set forth in Note 1 to the
Company's financial statements in the 1996 Datakey, Inc. Annual Report and in
Form 10-KSB for the year ended December 31, 1996.
INVESTMENT IN HELD-TO-MATURITY SECURITIES
The Company held marketable debt securities with an amortized cost of $4,050,873
as of March 29, 1997. As it is the intention of the Company to hold these
securities to maturity, they are accounted for as "Held-To-Maturity Securities"
as defined in FASB Statement No. 115. The market value of these U.S. Treasury
Bill securities is $4,048,385. The unrealized loss, therefore, is $2,488.
All of the securities have a maturity date of less than twelve months. The
Company has no marketable debt securities which are classified as
Available-For-Sale Securities or Trading Securities.
PREPAID LICENSE FEES
Prepaid license fees were $978,000 as of March 29, 1997. This includes $878,000
for licenses for client and server software to be bundled with the Company's
information security systems and licenses to use certain proprietary sofware and
encryption algorithms. The license agreements will be amortized to cost of goods
sold as the products incorporating the licensed software and algorithms are
sold. The Company has also recorded an accrual for payment of $768,250 for the
client and server software license fees which are due in quarterly installments
of $109,750 through October, 1998.
5
<PAGE>
ITEM 2. MANAGEMENTS'S DISCUSSION AND ANALYSIS OR PLAN OR OPERATION
DATAKEY, INC. AND SUBSIDIARY
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
RESULTS OF OPERATIONS
REVENUE - Net sales for the three-month period ended March 29, 1997
declined $325,916 or 19% from the comparable period in 1996. The decline in
sales in 1997 is due to a reduction in orders from some of our larger OEM
customers. Revenue in the second quarter is expected to increase slightly from
the first quarter but is still expected to be below the 1996 second quarter
revenue of $1,912,000. New end-user products being developed for the information
security marketplace are planned for sales introduction by mid-1997 and, based
upon current expectations, are expected to result in material revenue during the
second half of 1997. As with any new product line, revenue will depend on
customer acceptance, the extent of which is difficult to assess at this time. If
this revenue meets the company's present expectations, the total revenue in 1997
will exceed the 1996 level.
GROSS PROFIT MARGINS - Gross profit as a percentage of net sales decreased
to 34% in the three-month period ended March 29, 1997 compared to 40% in the
comparable 1996 period. The decline in gross profit percentage is primarily due
to a lower level of revenue compared to the prior year. Because approximately
half of the factory overhead is fixed or semi-fixed, such costs combined with a
reduction of revenue create a reduction in gross profit percentage. The Company
expects a gradual improvement in gross profit margins during 1997 through
selective price increases, effective material purchasing, improvements in
manufacturing efficiency and an increase in revenue. Again, an increase in
revenue depends upon customer acceptance of the Company's new products.
While Datakey believes that its strategy of providing token-based product
solutions at a price that is competitive with software-only products is
attainable, there are no assurances that competitive pressures will not force
the Company to accept reduced margins to compete in the future. Large companies
have recognized the need for information security and could enter this market as
competitors with much greater financial resources. A portion of its new end-user
products' cost is royalties and license fees which would need to be
re-negotiated to maintain acceptable margins.
6
<PAGE>
OPERATING EXPENSES - Operating expenses increased $856,476, or 112%, in the
three-month period ended March 29, 1997 as compared to the same period in 1996.
This increase results primarily from the cost of new employees and contract
services related to accelerated development and product promotion of advanced
information security products.
The Company will continue to fund new product development activities at a higher
level in 1997 than in 1996, and may also exceed the 1996 percentage of revenue
(35%) unless revenue from these new products in the second half of 1997 is
substantial.
Marketing and sales expenses are expected to increase by 30 to 40 percent in
1997 to support new product introductions and the expected increase in revenue,
but will be about the same percent of revenue (20%) as in 1996 provided the
revenue from new product sales materializes as expected. General and
administrative expenses in 1997 are expected to increase only slightly from the
1996 level and will remain at approximately the quarterly rate reflected in the
first quarter.
Additional development work is required for the introduction of the Company's
planned new information security products. No assurance can be given that the
Company's timetable for these development plans will be achieved or that
development efforts will be successful. Delays in the release of new products
will cause operational inefficiencies, increased development costs and reduced
revenues.
INTEREST INCOME - Interest income during the three-month period ended March
29, 1997 decreased $18,364, or 20%, from the comparable period in 1996. The
lower level of interest income resulted from a reduced level of investment in
held-to-maturity securities and interest bearing cash and cash equivalents.
Interest income is expected to decline in 1997 as the Company intends to use the
proceeds from maturing investments to fund continuing product development and
marketing activities to support the Company's planned introduction of advanced
information security products. Although the Company believes that the decision
to fund these new products is correct, there are no assurances that the
investments already made and additional investments planned for 1997 will result
in a financial return.
INCOME TAXES - As of December 31, 1996, the Company recorded an income tax
asset of $325,000 related to its net operating loss carryforwards. The Company
7
<PAGE>
has not recorded a tax benefit in the current quarter and does not plan to
record a tax benefit in future quarters until such time as the profitability
outlook in future periods justifies the resumption of income tax benefits.
FINANCIAL CONDITION - During the three-month period ended March 29, 1997,
the Company had a net increase in cash and cash equivalents of $542,326,
compared to a decrease of $198,097 in the comparable 1996 period. Investment in
held-to-maturity securities decreased $1,942,355 in the 1997 period compared to
an increase of $79,066 in the 1996 period. Cash, cash equivalents and investment
in held-to-maturity securities were $4,733,229 at March 29, 1997.
Datakey's balance sheet continues to reflect a strong financial position, with
$5,024,574 in working capital and a current assets to current liabilities ratio
of 3.3 to 1 as of March 29, 1997. The Company plans to continue new product
development and marketing activities during 1997 and expects to spend $4.5 to $5
million on these activities. Inventory levels increased $505,000 in the first
quarter primarily as a result of acquiring components to support expected sales
of newly developed products and purchasing inventory to meet annual requirements
to support an existing OEM customer.
The inventory levels are expected to continue to increase in 1997 to support
advanced information security products that are planned to be available for sale
in the second half of the year. 1997 investments in equipment and maintenance of
licenses and patents in 1997 are expected to be about 2 to 3 times the 1996
level of $515,000, primarily related to prepaid license fees for client and
server software to be bundled with the Company's information security products.
This spending will be funded by a reduction in the Company's marketable debt
securities. The Company's working capital and investments are sufficient to fund
its planned operations and continued development and promotional activities in
1997.
EXPECTED LOSS - The Company expects to report a loss in 1997. Although the
Company expects to have new end-user products available for sale in the second
half of 1997, the marketability of these products will not be known until at
least late 1997. The extent of the Company's loss will depend directly on
product availability and market acceptance.
8
<PAGE>
RISKS
As provided for under the Private Securities Litigation Reform Act of 1995, the
Company wishes to caution investors that certain important factors identified in
this document and in the "Outlook and Risks" section of Part I of the Company
1996 Form 10-KSB, in some cases have affected and in the future could affect the
Company's actual results of operations. Such factors may cause the Company's
actual results to differ materially from those anticipated in forward-looking
statements made in this document relating to (i) the introduction of new
products, (ii) increased revenues, (iii) improved gross margins, (iv)
expenditures for new product development and marketing and sales, (v) increased
inventory levels, (vi) and sufficiency of working capital.
9
<PAGE>
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
DATAKEY, INC. AND SUBSIDIARY
(A) Exhibits
Exhibit 27 Financial Data schedule (only filed with electronic copy)
(B) The Company was not required to and did not file a Form 8-K during the
quarter ended March 29, 1997.
10
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 and 15 (d) of the Securities and
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, therunto duly authorized.
Dated May 12, 1997 DATAKEY, INC.
BY: /s/ Carl P. Boecher
Carl P. Boecher
President & Chief Executive
Officer
(Principal Executive Officer)
BY: /s/ Alan G. Shuler
Alan G. Shuler
Vice President & Chief
Financial Officer
(Principal Financial and
Accounting Officer)
11
<PAGE>
DATAKEY, INC.
EXHIBIT INDEX TO FORM 10-QSB
FOR QUARTER ENDED MARCH 29, 1997
EXHIBIT NO. DESCRIPTION
27 Financial Data Schedule
12
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1
<CURRENCY> U.S. Dollars
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> MAR-29-1997
<EXCHANGE-RATE> 1
<CASH> 682,356
<SECURITIES> 4,050,873
<RECEIVABLES> 811,417
<ALLOWANCES> 49,701
<INVENTORY> 1,633,631
<CURRENT-ASSETS> 7,234,356
<PP&E> 4,506,477
<DEPRECIATION> 2,955,971
<TOTAL-ASSETS> 10,178,549
<CURRENT-LIABILITIES> 2,209,782
<BONDS> 0
0
375,000
<COMMON> 144,362
<OTHER-SE> 7,120,155
<TOTAL-LIABILITY-AND-EQUITY> 10,178,549
<SALES> 1,409,801
<TOTAL-REVENUES> 1,409,801
<CGS> 934,872
<TOTAL-COSTS> 934,872
<OTHER-EXPENSES> 1,622,283
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 0
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,071,737)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,071,737)
<EPS-PRIMARY> (.37)
<EPS-DILUTED> (.37)
</TABLE>
