SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(X) QUARTERY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended July 4, 1998
Commission File Number 0-11447
DATAKEY, INC.
(Exact name of small business issuer as specified in its charter)
MINNESOTA 41-1291472
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
407 WEST TRAVELERS TRAIL, BURNSVILLE, MN 55337
Issuer's telephone number: (612) 890-6850
(Former name, former address and former fiscal year,
if changed since last report)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15 (d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes X No ___
APPLICABLE ONLY TO CORPORATE ISSUERS
The number of shares outstanding of the issuer's common equity, as of
August 14, 1998, is 2,949,735.
Transitional Small Business Disclosure Format (check One):
Yes No X
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM I. FINANCIAL STATEMENTS
DATAKEY, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
July 4, December 31,
1998 1997
----------- ------------
(UNAUDITED)
ASSETS
CURRENT ASSETS
<S> <C> <C>
Cash and cash equivalents $ 1,748,701 $ 1,305,392
Trade receivables, less allowance for
doubtful accounts of $31,707 and $30,000 1,047,562 634,267
Inventories 1,159,640 1,082,737
Prepaid and other 74,836 53,360
----------- ------------
Total current assets 4,030,739 3,075,756
----------- ------------
OTHER ASSETS
Prepaid licenses at cost less amortization 1,000,925 996,611
of $92,676 and $89,890
Patents at cost, less amortization
of $112,103 and $91,911 112,871 107,691
----------- ------------
1,113,796 1,104,302
----------- ------------
EQUIPMENT AND LEASEHOLD IMPROVEMENTS, at cost
Production tooling 1,214,249 1,215,012
Equipment 3,004,135 2,956,269
Furniture and fixtures 304,852 298,771
Leasehold improvements 286,916 281,956
----------- ------------
4,810,152 4,752,008
Less accumulated depreciation (3,530,877) (3,278,760)
----------- ------------
1,279,275 1,473,248
----------- ------------
$ 6,423,810 $ 5,653,306
=========== ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 419,427 $ 184,103
Accrued severance obligation 77,400 185,672
Accrued license fees 439,000 439,000
Accrued dividends 15,799 0
Accrued expenses 227,885 316,157
----------- ------------
Total current liabilities 1,179,511 1,124,932
----------- ------------
SHAREHOLDERS' EQUITY
Convertible preferred stock, voting, stated value
$2.50 per share; authorized 400,000 shares;
issued and outstanding 150,000 shares 375,000 375,000
Convertible preferred stock series A, voting, 8% cumulative,
stated value $15.80 per share; authorized 150,000 shares;
issued and outstanding 100,000 shares 1,580,000 0
Common stock, par value $.05 per share;
authorized 10,000,000 shares; issued and
outstanding 2,943,901 and 2,887,235 147,195 144,361
Additional paid-in capital 4,535,587 4,089,283
Accumulated deficit (1,393,483) (80,270)
----------- ------------
5,244,299 4,528,374
----------- ------------
$ 6,423,810 $ 5,653,306
=========== ============
</TABLE>
See Notes to Consolidated Financial Statements
2
<PAGE>
DATAKEY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
July 4, June 28, July 4, June 28,
1998 1997 1998 1997
<S> <C> <C> <C> <C>
Revenue $ 1,742,630 $ 1,934,129 $ 3,226,185 $ 3,343,930
Cost of goods sold 1,049,410 1,195,375 1,939,500 2,130,247
----------- ----------- ----------- -----------
Gross Profit 693,220 738,754 1,286,685 1,213,683
Operating expenses:
Research, development
and engineering 412,839 1,047,175 811,962 2,063,527
Marketing and sales 502,519 393,625 978,676 788,000
General and administrative 210,529 217,810 422,845 429,366
----------- ----------- ----------- -----------
Total operating expenses 1,125,887 1,658,610 2,213,483 3,280,893
----------- ----------- ----------- -----------
Operating loss (432,667) (919,856) (926,798) (2,067,210)
Interest income 12,843 43,537 24,384 119,154
----------- ----------- ----------- -----------
Loss before
income taxes (419,824) (876,319) (902,414) (1,948,056)
----------- ----------- ----------- -----------
Income tax expense 0 0 0 0
Net loss ($ 419,824) ($ 876,319) ($ 902,414) ($1,948,056)
=========== =========== =========== ===========
Basic and diluted
loss per share ($ 0.28) ($ 0.30) ($ 0.45) ($ 0.67)
=========== =========== =========== ===========
Weighted average number of
common shares outstanding 2,921,085 2,887,235 2,903,885 2,886,023
=========== =========== =========== ===========
</TABLE>
See Notes to Consolidated Financial Statements
3
<PAGE>
DATAKEY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
July 4, June 28, July 4, June 28,
1998 1997 1998 1997
CASH FLOWS FROM
OPERATING ACTIVITIES
<S> <C> <C> <C> <C>
Net loss ($ 419,824) ($ 876,319) ($ 902,414) ($1,948,056)
Adjustments to reconcile net loss
to net cash used in operating activities:
Depreciation 128,766 122,575 252,117 237,637
Amortization 11,543 30,827 22,978 39,788
Change in assets and liabilities
(Increase) decrease:
Trade receivables (152,553) (453,579) (413,295) (580,757)
Inventories 10,016 (166,338) (76,903) (671,062)
Prepaid expenses and other (349) 6,399 (21,476) (52,419)
Prepaid license fees (10,000) (103,665) (7,100) (183,665)
Increase (decrease) in:
Accounts payable 109,195 4,887 235,324 365,942
Accrued expenses (85,914) (7,258) (88,270) 237,140
Accrued license fees 0 (109,750) 0 (109,750)
Accrued severance (41,500) (47,100) (108,272) (88,600)
----------- ----------- ----------- -----------
Net cash used in
operating activities (450,620) (1,599,321) (1,107,311) (2,753,802)
----------- ----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of tooling and equipment (36,986) (200,446) (58,144) (464,309)
Purchase of held-to-maturity
securities 0 (41,192) 0 (113,999)
Proceeds from maturity of
held-to-maturity securities 0 2,502,421 0 4,517,583
Patent costs (12,954) (19,457) (25,372) (19,869)
----------- ----------- ----------- -----------
Net cash provided by(used in)
investing activities (49,940) 2,241,326 (83,516) 3,919,406
----------- ----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Net proceeds from issuance of
preferred stock 1,426,222 0 1,426,222 0
Net proceeds from issuance of
common stock 207,914 0 207,914 18,727
----------- ----------- ----------- -----------
Net cash provided by financing activities 1,634,136 0 1,634,136 18,727
----------- ----------- ----------- -----------
Increase in cash and
cash equivalents 1,133,576 642,005 443,309 1,184,331
CASH AND CASH EQUIVALENTS
Beginning 615,125 682,356 1,305,392 140,030
----------- ----------- ----------- -----------
Ending 1,748,701 1,324,361 1,748,701 1,324,361
=========== =========== =========== ===========
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING
AND FINANCING ACTIVITIES
Accrued preferred stock dividends 15,799 0 15,799 0
Obligation recorded in connection with prepaid
license fees 0 768,250 0 768,250
----------- ----------- ----------- -----------
15,799 768,250 15,799 768,250
=========== =========== =========== ===========
</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 July 4, 1998, and December 31, 1997, and results of its operations and
cash flows for the three-month and six-month periods ended July 4, 1998, and
June 28, 1997. 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 1997 Datakey, Inc. Annual Report and in
Form 10-KSB for the year ended December 31, 1997.
PRIVATE PREFERRED STOCK FINANCING
The Company completed, in May 1998, a $1.58 million convertible preferred stock
financing which entitles the preferred shareholders, for a two-year period, to
convert their investment into common shares at 80% of the average closing price
(for a 10 day period prior to conversion) of the Company's common stock with a
maximum conversion price of $5.00 per share and a minimum conversion price of
$2.75 per share. This "beneficial conversion" feature has been interpreted by
the office of the SEC chief accountant to be an assumed preferred stock dividend
of fourteen cents per common share, which must be taken into account when
computing basic and diluted loss per share.
BASIC AND DILUTED LOSS PER SHARE
Basic and diluted loss per share, in accordance with Statement of Financial
Accounting Standards No. 128 are as follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
July 4, 1998 June 28, 1997 July 4, 1998 June 28, 1997
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Net Loss $ (419,824) $ (876,319) $ (902,414) $(1,948,056)
Less:
Accrued preferred stock dividend (15,799) 0 (15,799) 0
Assumed preferred stock dividend (395,000) 0 (395,000) 0
----------- ----------- ----------- -----------
Loss available to common stockholders $ (830,623) $ (876,319) $(1,313,213) $(1,948,056)
=========== =========== =========== ===========
Weighted average common shares 2,921,085 2,887,235 2,903,885 2,886,023
Basic and diluted loss per share $ (0.28) $ (0.30) $ (0.45) $ (0.67)
=========== =========== =========== ===========
</TABLE>
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
DATAKEY, INC. AND SUBSIDIARY
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
RESULTS OF OPERATIONS
REVENUE - Revenue for the three-month and six-month periods ended July
4, 1998, decreased by $191,499 and $117,745, or 10 and 4 percent, respectively,
compared to the comparable 1997 periods. The decrease in revenue is due to
unusually strong revenue in the second quarter of 1997. The newly introduced
information security products are currently in evaluation or pilot program
stages with several companies. If larger quantity orders are received in the
second half of 1998, as the Company currently anticipates, revenue from the new
products could exceed revenue from the existing products by the 1998 fourth
quarter, in which case total 1998 revenue would then exceed 1997 revenue. The
Company's ability to achieve acceptable revenue growth is primarily dependent on
the generation of significant sales of its information security products which
cannot at this time be assured.
GROSS PROFIT MARGIN - Gross profit as a percentage of revenue increased
to 40 percent in the three-month and six-month periods ended July 4, 1998,
compared to 38 and 36 percent respectively, in the comparable 1997 periods. The
1998 improvement in margin percentage is due to improved factory direct labor
utilization, a reduction in scrap and yield loss, and a favorable product mix.
The Company expects the gross profit margin as a percentage of revenue to remain
at about the current levels for the balance of 1998.
OPERATING EXPENSES - Operating expense decreased by $532,723, or 32
percent, in the three-month period and $1,067,410 or 33 percent in the six-month
period ended July 4, 1998, compared to the comparable 1997 periods. The decrease
is attributable to a substantial reduction in research, development, and
engineering (R&D) expense, offset in part by an increase in marketing and sales
expense. R&D expense declined substantially because the initial major new
product development phase was completed in late 1997, and the Company is now
able to concentrate on product enhancements and upgrades during 1998.
Consequently, the Company expects to invest about 45 percent less on R&D in 1998
than in 1997. Marketing and sales expense increased $108,894 or 28 percent in
the three-month period and $190,676 or 24 percent in the six-month period ended
July 4, 1998, compared to the comparable 1997 periods as the Company increased
its advertising and promotional activities for the newly introduced information
security products. Marketing and sales expenses are expected to continue at
about a 30 to 40 percent higher level than was incurred in 1997.
INTEREST INCOME - Interest income declined $30,694, or 71 percent, in
the three-month period ended July 4, 1998 and $94,770 or 80 percent in the
six-month period ended July 4, 1998, compared to the comparable 1997 periods as
proceeds from interest bearing accounts were utilized to fund new product
development and product promotion activities. Interest income is expected to
remain lower than the comparable 1997 periods for the balance of 1998.
<PAGE>
FINANCIAL CONDITION - During the three-month and six-month periods
ended July 4, 1998, the Company had a net increase of $1,133,576 and $443,309
respectively, in cash and cash equivalents as compared to an increase of
$642,005 and $1,184,331 respectively, in the comparable 1997 periods. The 1997
increases were primarily due to realization of proceeds from maturing marketable
debt securities during the periods. Net cash used in operating activities
decreased to $450,620 and $1,107,311 respectively, in the three-month and
six-month periods ended July 4, 1998, compared to $1,599,321 and $2,753,802
respectively, in the comparable 1997 periods. The reduced use of cash in the
1998 periods is directly attributable to a reduction in the operating loss to
$419,824 and $902,414 in the three-month and six-month periods respectively, in
1998, from $1,599,321 and $2,753,802 in 1997.
Datakey's balance sheet reflects $2,851,228 in working capital as of
July 4, 1998, and a current assets to current liabilities ratio of 3.42 to 1.
The Company expects to continue spending on R&D at a reduced amount compared to
1997, and on marketing and sales activities at an increased amount compared to
1997. Inventory and accounts receivable levels are expected to increase during
the balance of 1998 to support the expected ramp-up in revenue from the
Company's new information security products. The Company believes that it will
have adequate financial resources to fund its operations and R&D and marketing
activities during 1998 through utilization of its $1 million bank line of
credit, proceeds from the private preferred stock financing described above, and
positive cash flow from operations later in the year if the Company returns to
profitability as it currently expects. If market acceptance of the Company's
information security products is slow to develop or does not develop as
currently anticipated the Company may need funds in addition to its bank line
and recent private preferred stock financing. In such circumstances, there is no
assurance that the necessary funding would be available upon acceptable terms.
The Company has evaluated the impact, if any, from the changeover of
various computer systems during the year 2000. Based upon its current internal
analysis and results of questions posed to major software and service suppliers,
the Company feels that year 2000 will have no significant financial or
operational impact.
CAUTIONARY STATEMENTS
The Management's Discussion and Analysis contains certain forward-looking
statements relating primarily to the introduction and acceptance of the
Company's information security products, the anticipated generation of
significant revenue from such products in 1998 and the impact of year 2000
issues on its business. The statements are subject to certain risks and
uncertainties, which could cause results to differ from those projected. These
risks and uncertainties, in addition to those discussed above, include: (i) the
ability of the Company to successfully develop all of the new products under
development and to control costs as necessary; (ii) the capability of the new
products to function as currently anticipated; (iii) the potential introduction
of competitive products by companies with greater resources than that of the
Company; (iv) market acceptance of the new products, and (v) the accuracy and
reliability of the Company's and its suppliers' assessment and remediation of
year 2000 issues.
<PAGE>
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On May 15, 1998, the Company issued an aggregate of 100,000 shares of Series A
Convertible Cumulative Preferred Stock and five-year warrants to purchase an
aggregate of 188,095 shares of Common Stock for gross proceeds of $1,580,000.
The shares were sold with the assistance of Miller, Johnson & Kuehn,
Incorporated (MJK) to 12 accredited investors. MJK received commissions equal to
$110,600 as part of the offering, and ten-year warrants to purchase 37,890
shares of Common Stock, with an exercise price of $6.60 per share. Because the
offering was not a public offering and was offered only to accredited investors,
the Company relied upon Section 4 (6) and Rule 506 of Regulation D of the
Securities Act of 1933, as amended, for exemptions from the registration
requirements of such Act. The shares of Series A Convertible Cumulative
Preferred Stock have 8 percent dividend rights and are convertible into shares
of Common Stock at any time on or before May 15, 2000. The conversion price is
equal to 80 percent of the market price (equal to average closing bid price for
the 10-day period prior to the conversion date), with the minimum and maximum
conversion price of $2.75 and $5.00, respectively. Investor warrants were also
granted and are exercisable at $6.30 per share for five years. The Company has
filed a Registration Statement on Form S-3 covering the resale of the shares of
Company Common Stock: (i) underlying the Series A preferred shares; (ii)
issuable upon exercise of the agent and investor warrants; and (iii) issuable in
connection with the payment of any dividends paid in Company Common Stock on the
Series A preferred shares.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY SHAREHOLDERS
DATAKEY, INC. AND SUBSIDIARY
The Company held its Annual Meeting on Tuesday, June 2, 1998.
Proxies for the Annual Meeting were solicited pursuant to Regulation 14 under
the Securities Exchange Act of 1934. There was no solicitation in opposition to
management's nominees as listed in the Company's proxy statement, and all
nominees were elected.
By a vote of 2,810,986 shares in favor, with 3,425 shares opposed and 50 shares
abstaining, the shareholders set the number of directors to be elected at six
(6).
The following persons were elected to serve as directors of the Company, by the
votes indicated, until the next annual meeting of shareholders:
NUMBER OF NUMBER OF VOTES
NOMINEE VOTES FOR WITHHELD
--------- --------- ---------------
John H. Underwood 2,800,311 14,150
Terrence W. Glarner 2,805,261 9,200
Thomas R. King 2,805,261 9,200
Gary R. Holland 2,805,261 9,200
Eugene W. Courtney 2,804,761 9,700
Carl P. Boecher 2,804,761 9,700
<PAGE>
The shareholders approved, by a vote of 1,300,162 for, 629,458 against, 5,673
abstaining and 879,168 broker non-votes, an increase of shares, from 500,000 to
800,000 in the Company's 1997 Stock Option Plan.
The shareholders also ratified the appointment of McGladrey and Pullen, LLP, as
independent auditors for the Company for the fiscal year ending December 31,
1998, by a vote of 2,810,286 shares in favor, 850 shares opposing and 3,325
shares abstaining.
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibits
(a) Exhibit 27 Financial Data Schedule (only filed with electronic copy)
(b) Reports on Form 8-K:
The Company filed a Form 8-K on May 20, 1998, that fully
described the details of the private preferred stock
financing which was completed on May 15, 1998.
<PAGE>
SIGNATURES
In accordance with the requirements of the Exchange Act, the Registrant has duly
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
Dated August 14, 1998 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)
<PAGE>
Datakey, Inc.
EXHIBIT INDEX TO FORM 10-QSB
FOR QUARTER ENDED JULY 4, 1998
EXHIBIT NO. DESCRIPTION
27 Financial Data Schedule
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1
<CURRENCY> U.S. Dollars
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUL-04-1998
<EXCHANGE-RATE> 1
<CASH> 1,748,701
<SECURITIES> 0
<RECEIVABLES> 1,079,269
<ALLOWANCES> 31,707
<INVENTORY> 1,159,640
<CURRENT-ASSETS> 4,030,739
<PP&E> 4,810,152
<DEPRECIATION> 3,530,877
<TOTAL-ASSETS> 6,423,810
<CURRENT-LIABILITIES> 1,179,511
<BONDS> 0
0
1,955,000
<COMMON> 147,195
<OTHER-SE> 3,142,104
<TOTAL-LIABILITY-AND-EQUITY> 6,423,810
<SALES> 3,226,185
<TOTAL-REVENUES> 3,226,185
<CGS> 1,939,500
<TOTAL-COSTS> 1,939,500
<OTHER-EXPENSES> 2,213,483
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 0
<INCOME-TAX> 0
<INCOME-CONTINUING> (902,414)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (902,414)
<EPS-PRIMARY> (.45)
<EPS-DILUTED> (.45)
</TABLE>
