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 3, 1999
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 17, 1999, are 3,651,772.
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 3, December 31,
1999 1998
---------- ----------
(UNAUDITED)
ASSETS
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents $624,375 $853,827
Trade receivables, less allowance for
doubtful accounts of $30,000 672,542 859,636
Inventories 1,447,145 1,007,948
Prepaid and other 43,962 56,237
---------- ----------
Total current assets 2,788,024 2,777,648
---------- ----------
OTHER ASSETS
Prepaid licenses at cost less amortization 544,701 554,425
of $110,430 and $95,705
Patents at cost, less amortization
of $153,586 and $133,818 108,265 120,056
---------- ----------
652,966 674,481
---------- ----------
EQUIPMENT AND LEASEHOLD IMPROVEMENTS, at cost
Production tooling 1,257,389 1,251,857
Equipment 2,975,841 3,012,184
Furniture and fixtures 304,853 304,853
Leasehold improvements 263,021 286,916
---------- ----------
4,801,104 4,855,810
Less accumulated depreciation (3,831,305) (3,771,659)
---------- ----------
969,799 1,084,151
---------- ----------
$4,410,789 $4,536,280
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $664,711 $435,873
Accrued severance obligation 0 10,687
Accrued expenses 260,299 218,186
Accrued dividends 106,619 67,023
---------- ----------
Total current liabilities 1,031,629 731,769
---------- ----------
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 74,367 in 1999 and 100,000 shares in 1998 1,174,999 1,326,519
Common stock, par value $.05 per share;
authorized 10,000,000 shares; issued and outstanding
3,651,772 in 1999 and 3,045,704 in 1998 182,589 152,285
Additional paid-in capital 6,170,894 4,793,665
Accumulated deficit (4,524,322) (2,842,958)
---------- ----------
3,379,160 3,804,511
---------- ----------
$4,410,789 $4,536,280
========== ==========
</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 3, July 4, July 3, July 4,
1999 1998 1999 1998
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Revenue $ 1,154,008 $ 1,742,630 $ 2,513,990 $ 3,226,185
Cost of goods sold 708,203 1,049,410 1,502,192 1,939,500
----------- ----------- ----------- -----------
Gross Profit 445,805 693,220 1,011,798 1,286,685
Operating expenses:
Research, development
and engineering 563,775 412,839 1,040,957 811,962
Marketing and sales 546,543 502,519 1,135,952 978,676
General and administrative 238,329 210,529 468,810 422,845
----------- ----------- ----------- -----------
Total operating expenses 1,348,647 1,125,887 2,645,719 2,213,483
----------- ----------- ----------- -----------
Operating loss (902,842) (432,667) (1,633,921) (926,798)
Interest income (expense) (4,277) 12,843 342 24,384
----------- ----------- ----------- -----------
Loss before
income taxes (907,119) (419,824) (1,633,579) (902,414)
Income tax expense 0 0 0 0
----------- ----------- ----------- -----------
Net loss ($ 907,119) ($ 419,824) ($1,633,579) ($ 902,414)
=========== =========== =========== ===========
Net loss attributable to common stockholders:
Net loss (907,119) (419,824) (1,633,579) (902,414)
Preferred stock dividends (23,436) (410,799) (47,786) (410,799)
----------- ----------- ----------- -----------
Net loss attributable to
common stockholders ($ 930,555) ($ 830,623) ($1,681,365) ($1,313,213)
=========== =========== =========== ===========
Basic and diluted
loss per share ($ 0.29) ($ 0.28) ($ 0.53) ($ 0.45)
=========== =========== =========== ===========
Weighted average number of
common shares outstanding 3,188,299 2,921,085 3,138,137 2,903,885
=========== =========== =========== ===========
</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 3, July 4, July 3, July 4,
1999 1998 1999 1998
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
CASH FLOWS FROM
OPERATING ACTIVITIES
Net loss ($ 907,119) ($ 419,824) ($1,633,579) ($ 902,414)
Adjustments to reconcile net loss
to net cash used in operating activities:
Depreciation 114,169 128,766 221,382 252,117
Amortization 13,350 11,543 34,493 22,978
Change in assets and liabilities
(Increase) decrease:
Trade receivables (7,092) (152,553) 187,094 (413,295)
Inventories (333,168) 10,016 (439,197) (76,903)
Prepaid expenses and other 58,783 (349) 12,275 (21,476)
Prepaid license fees (5,000) (10,000) (5,000) (7,100)
Increase (decrease) in:
Accounts payable 243,200 109,195 228,838 235,324
Accrued expenses (62,430) (85,914) 42,113 (88,270)
Accrued severance (32,550) (41,500) (10,687) (108,272)
---------- ---------- ---------- ----------
Net cash used in
operating activities (917,857) (450,620) (1,362,268) (1,107,311)
---------- ---------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of tooling and equipment (71,501) (36,986) (107,030) (58,144)
Patent costs (557) (12,954) (7,977) (25,372)
---------- ---------- ---------- ----------
Net cash used in
investing activities (72,058) (49,940) (115,007) (83,516)
---------- ---------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES
Net proceeds from issuance of
preferred stock 0 1,426,222 0 1,426,222
Net proceeds from issuance of
common stock 1,218,823 207,914 1,247,823 207,914
---------- ---------- ---------- ----------
Net cash provided by financing activities 1,218,823 1,634,136 1,247,823 1,634,136
---------- ---------- ---------- ----------
Increase (decrease) in cash and
cash equivalents 228,908 1,133,576 (229,452) 443,309
CASH AND CASH EQUIVALENTS
Beginning 395,467 615,125 853,827 1,305,392
---------- ---------- ---------- ----------
Ending 624,375 1,748,701 624,375 1,748,701
---------- ---------- ---------- ----------
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING
AND FINANCING ACTIVITIES
Preferred stock dividend accrual 23,436 15,799 39,596 15,799
Preferred stock dividend converted to common stock 0 0 8,190 0
Conversion of preferred stock to common 0 0 151,520 0
---------- ---------- ---------- ----------
23,436 15,799 191,116 15,799
========== ========== ========== ==========
</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 3, 1999, and December 31, 1998, and results of its operations and
cash flows for the three-month and six-month periods ended July 3, 1999, and
July 4, 1998. 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 1998 Datakey, Inc. Annual Report and in
Form 10-KSB for the year ended December 31, 1998.
PRIVATE COMMON STOCK FINANCING
The Company completed, in June 1999, a $1.35 million private equity financing
with 35 accredited investors. Each investor paid $2.50 per common share, the
closing bid price of the stock, and received a five-year warrant to purchase,
for $2.50, one common share for each share purchased. A portion of the proceeds
were used to pay off the bank credit line and to provide working capital.
OPERATING SEGMENTS
The Company adopted SFAS No. 131, Disclosures About Segments of an Enterprise
and Related Information, for the year ended December 31, 1998. This statement
requires public enterprises to report selected information about operating
segments in annual and interim reports issued to shareholders. The adoption of
this statement had no impact on the Company's financial condition or results of
operations.
The Company's reportable segments are strategic business units that offer
different products and services. They are managed separately because each
business requires different technology and marketing strategies. The Company has
two reportable segments: Electronic Products (EP) and Integrated Systems
Solutions (ISS). The Electronic Products segment produces and markets
proprietary memory keys, cards, and other custom-shaped tokens that serve as a
convenient way to carry electronic information. The Integrated Systems Solutions
segment produces and markets products for the information security market, which
enable user identification and authentication, secure data exchange, and
information validation.
The accounting policies of the segments are the same as those described in the
summary of significant accounting policies. There are no intersegment
transactions. The Company evaluates performance based on operating earnings of
the respective segments.
<PAGE>
<TABLE>
<CAPTION>
--------------------------------------------- ----------------------------------------------
Three Months Ended July 3, 1999 Six Months Ended July 3, 1999
--------------------------------------------- ----------------------------------------------
EP ISS UNALLOCATED TOTAL EP ISS UNALLOCATED TOTAL
---------- -------- ----------- ---------- --------- -------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenue............... $1,051,462 $102,546 $ - $1,154,008 $2,268,171 $ 245,819 $ - $ 2,513,990
Interest income
(expense)............. - - (4,277) (4,277) - - 342 342
Depreciation and
amortization.......... 100,182 27,314 - 127,496 195,397 62,698 - 258,095
Segment profit (loss). (51,666) (855,453) (4,277) (907,119) 104,089 (1,737,668) 342 (1,633,579)
---------- -------- ----------- ---------- --------- -------- ----------- -----------
Three Months Ended July 4, 1998 Six Months Ended July 4, 1998
--------------------------------------------- ----------------------------------------------
EP ISS UNALLOCATED TOTAL EP ISS UNALLOCATED TOTAL
---------- -------- ----------- ---------- --------- -------- ----------- -----------
Revenue............... $1,697,636 $ 44,994 $ - $1,742,630 $3,062,930 $ 163,255 $ - $ 3,226,185
Interest
income(expense)....... - - 12,843 12,843 - - 24,384 24,384
Depreciation and
amortization.......... 117,031 23,034 - 140,065 232,303 45,640 - 277,943
Segment profit (loss). 335,732 (768,399) 12,843 (419,824) 537,409 (1,464,207) 24,384 (902,414)
</TABLE>
6
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
DATAKEY, INC. AND SUBSIDIARY
RESULTS OF OPERATIONS AND FIANANCIAL CONDITION
RESULTS OF OPERATIONS
REVENUE - Revenue for the three-month period ended July 3, 1999,
decreased by $589,000, or 34 percent, compared to the comparable 1998 period.
The decline in revenue is due to a reduction in shipments to a few major
Electronic Products (EP) customers during the first half of 1999. Shipments to
Information Security Systems (ISS) customers increased only marginally.
Two major EP customers have resumed shipments during the second quarter
and now indicate their requirements for the year will exceed the total for 1998.
Additionally, other EP customers are expected to increase shipments during 1999
and the Company expects to secure several new pilot programs in the ISS business
units, as well as convert a few pilot programs to production deployment phase
during the balance of 1999. Should the Company be successful in arranging new
ISS pilot programs and production deployments, as management currently expects,
revenue in 1999 is expected to exceed that achieved in 1998.
GROSS PROFIT MARGIN - Gross profit as a percentage of revenue decreased
to 39 percent in the three-month period ended July 3, 1999, and remained at 40
percent in the six-month period ended July 3, 1999. The reduction in margin in
the three-month period ended July 3, 1999, is primarily the result of
unfavorable factory utilization due to the reduction in revenue. The Company
expects the gross profit margin as a percentage of revenue to remain at the
current levels, or improve slightly, for the balance of 1999.
OPERATING EXPENSES - Operating expenses increased by $223,000 or 20
percent, and $432,000 or 20 percent in the three-month and six-month periods,
respectively, ended July 3, 1999, compared to the comparable 1998 periods. The
increases are principally related to an increase of $44,000 in the three-month
period and $157,000 in the six-month period in sales and marketing expense to
continue advertising and promoting the Company's ISS product line. Research and
development expense also increased $151,000 in the three-month period and
$229,000 in the six-month period, as the Company continued to develop more
features and enhancements to its information security products. Other expense
increases are primarily general inflationary increases in rent, corporate
insurance, and salaries.
The Company expects to continue spending on product promotional and
product developmental activities in 1999 at a rate that will trend upward on a
quarterly basis. Spending on general and administrative expenses are expected to
remain at about the level incurred in the second quarter.
INTEREST INCOME (EXPENSE) - Interest income (expense) declined from
$13,000 income to $4,000 expense in the three-month periods and from $24,000
income to $300 income in the six-month periods, ended July 3, 1999, compared to
the comparable 1998 period as proceeds from interest bearing accounts were
utilized to fund new product development and product promotion activities, and
the Company began borrowing on its working capital line of credit. Interest
income is expected to resume in the third quarter as the Company has invested
the proceeds of its recent private equity placement in an interest-bearing
account.
7
<PAGE>
FINANCIAL CONDITION - The Company experienced an increase in cash and
cash equivalents of $229,000 in the three-month period ended July 3, 1999, and a
decrease of $229,000 for the six-month period ended July 3, 1999, compared to
increases of $1,134,000 and $443,000 for the comparable three and six-month
periods in 1998. The additional decreases in cash in 1999, versus the comparable
1998 periods, result from an increase in the operating losses in the three and
six-month periods, compared to 1998, and because proceeds from a private equity
placement in 1999 were approximately $207,000 lower than in 1998.
Datakey's balance sheet reflects $1,756,000 in working capital as of
July 3, 1999 and a current assets to current liabilities ratio of 2.70 to 1. The
Company expects to continue spending on R&D and on marketing and sales
activities at an increased amount compared to 1998. Inventory and accounts
receivable levels are expected to increase during the balance of 1999 to support
the expected ramp-up in revenue from the Company's new information security
products. The Company believes that in addition to its $1 million bank line of
credit, renewed in April 1999 for an additional year, it likely will need to
obtain equity financing in addition to the amount secured in June 1999 to be
able to fund its operations, and has engaged an investment banker to seek such
financing. The Company's ability to obtain such financing may depend on the
progress it makes in significantly increasing ISS product sales. There is no
assurance that a significant increase in ISS sales will occur or that the
Company will be able to obtain the required equity financing.
YEAR 2000 - The Company began addressing the Year 2000 issue in 1997
using a multi-step approach, including inventory and assessment, remediation and
testing, and contingency planning. The Company, with the assistance of outside
consultants, began by analyzing and testing its major internal software programs
to determine the level of compliance with the changeover in Year 2000. At this
point the Company believes all "mission critical" systems are either materially
compliant or will be materially compliant by September 30, 1999, with minor
software upgrades.
The Company is currently seeking assurances from key suppliers and
customers regarding their Year 2000 readiness. The Company has not yet completed
this part of the assessment phase and cannot predict the outcomes of other
companies' remediation efforts.
The Company currently plans to substantially complete its Year 2000
compliance efforts by September 30, 1999. The Company has also formed a team to
develop contingency plans by September 30, 1999; in the event certain suppliers
are unable to deliver critical parts and components in early 2000. At this time,
the Company believes that its most reasonably likely worst case scenario is that
the Company could experience delays in delivery of critical parts and supplies
and/or key customers could experience a delay in delivery of needed Datakey
parts. In the event that either of these scenarios occurs, the Company expects
that it would have a material adverse effect on the Company's financial
condition and results of operations.
The Company estimates that the total cost of efforts, in 1999, to make
hardware and software Year 2000 compliant, will be approximately $20,000.
8
<PAGE>
CAUTIONARY STATEMENTS
The Management's Discussion and Analysis contains certain forward-looking
statements relating primarily to the introduction of the Company's information
security products, the anticipated generation of significant revenue from such
products, an increase in sales of its electronic products, and its ability to
fund its operations in 1999. 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, and (iv) market acceptance of the new products.
9
<PAGE>
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On June 21, 1999, the Company issued an aggregate of 540,513 shares of common
stock at $2.50 per share and five-year warrants to purchase 540,513 shares of
common stock at $2.50 for gross proceeds of $1,350,000. The shares were sold
with the assistance of Miller, Johnson & Kuehn, Incorporated (MJK) to 35
accredited investors. MJK received commissions equal to $99,053 plus accountable
expenses as part of the offering, and ten-year warrants to purchase 54,052
shares of Common Stock, with an exercise price of $2.70 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 Company has filed a Registration Statement on Form
S-3 covering the resale of the shares of Company Common Stock issued in
connection with the offering and those shares issuable upon exercise of the
agent and investor warrants.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY SHAREHOLDERS
The Company held its Annual Meeting on Wednesday, May 26, 1999.
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 2,804,460 votes in favor, with 16,240 votes opposed, and 2,806 votes
abstaining, the shareholders set the number of directors to be elected at five
(5).
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
Terrence W. Glarner 2,805,374 18,132
Thomas R. King 2,805,374 18,132
Gary R. Holland 2,805,374 18,132
Eugene W. Courtney 2,805,374 18,132
Carl P. Boecher 2,805,374 18,132
The shareholders approved, by 2,749,761 votes for, 60,772 against, 4,250
abstaining, and 8,723 broker non-votes, the Company's 1998 Employee Stock
Purchase 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,
1999, by 2,807,345 votes in favor, 11,647 opposing and 4,514 abstaining.
10
<PAGE>
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 June 28, 1999, that
fully described the details of the private placement
of common stock and warrants, which was completed on
June 21, 1999.
11
<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 17, 1999 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)
12
<PAGE>
Datakey, Inc.
EXHIBIT INDEX TO FORM 10-QSB
FOR QUARTER ENDED JULY 3, 1999
EXHIBIT NO. DESCRIPTION
27 Financial Data Schedule
13
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1
<CURRENCY> U.S. Dollars
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUL-03-1999
<EXCHANGE-RATE> 1
<CASH> 624,375
<SECURITIES> 0
<RECEIVABLES> 702,542
<ALLOWANCES> 30,000
<INVENTORY> 1,447,145
<CURRENT-ASSETS> 2,788,024
<PP&E> 4,801,104
<DEPRECIATION> 3,831,305
<TOTAL-ASSETS> 6,423,810
<CURRENT-LIABILITIES> 1,031,629
<BONDS> 0
0
1,549,999
<COMMON> 182,589
<OTHER-SE> 1,646,572
<TOTAL-LIABILITY-AND-EQUITY> 4,410,789
<SALES> 2,513,990
<TOTAL-REVENUES> 2,513,990
<CGS> 1,502,192
<TOTAL-COSTS> 1,502,192
<OTHER-EXPENSES> 2,645,719
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 0
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,633,579)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,633,579)
<EPS-BASIC> (.53)
<EPS-DILUTED> (.53)
</TABLE>
