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 ended October 2, 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
November 16, 1999, are 5,791,772.
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>
October 2, December 31,
1999 1998
----------- -----------
(UNAUDITED)
ASSETS
CURRENT ASSETS
<S> <C> <C>
Cash and cash equivalents $ 19,835 $ 853,827
Trade receivables, less allowance for
doubtful accounts of $26,000 and $30,000 827,907 859,636
Inventories 1,474,430 1,007,948
Prepaid and other 61,439 56,237
----------- -----------
Total current assets 2,383,611 2,777,648
----------- -----------
OTHER ASSETS
Prepaid licenses at cost less amortization 537,701 554,425
of $122,626 and $95,705
Patents at cost, less amortization
of $163,754 and $133,818 101,939 120,056
----------- -----------
639,640 674,481
----------- -----------
EQUIPMENT AND LEASEHOLD IMPROVEMENTS, at cost
Production tooling 1,284,503 1,251,857
Equipment 2,781,451 3,012,184
Furniture and fixtures 304,853 304,853
Leasehold improvements 290,623 286,916
----------- -----------
4,661,430 4,855,810
Less accumulated depreciation (3,815,712) (3,771,659)
----------- -----------
845,718 1,084,151
----------- -----------
$ 3,868,969 $ 4,536,280
=========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 651,173 $ 435,873
Notes payable 15,766 0
Accrued severance obligation 0 10,687
Accrued expenses 394,344 218,186
Accrued dividends 130,055 67,023
----------- -----------
Total current liabilities 1,191,338 731,769
----------- -----------
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 6,154,243 4,793,665
Accumulated deficit (5,209,200) (2,842,958)
----------- -----------
2,677,631 3,804,511
----------- -----------
$ 3,868,969 $ 4,536,280
=========== ===========
</TABLE>
See Notes to Consolidated Financial Statements
<PAGE>
DATAKEY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
October 2, October 3, October 2, October 3,
1999 1998 1999 1998
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Revenue $ 1,486,879 $ 1,373,713 $ 4,000,869 $ 4,599,898
Cost of goods sold 948,225 859,035 2,450,417 2,798,535
----------- ----------- ----------- -----------
Gross Profit 538,654 514,678 1,550,452 1,801,363
Operating expenses:
Research, development
and engineering 501,204 401,615 1,542,161 1,213,577
Marketing and sales 475,943 500,050 1,611,895 1,478,726
General and administrative 224,406 205,066 693,216 627,911
----------- ----------- ----------- -----------
Total operating expenses 1,201,553 1,106,731 3,847,272 3,320,214
----------- ----------- ----------- -----------
Operating loss (662,899) (592,053) (2,296,820) (1,518,851)
Interest income 1,457 15,504 1,799 39,888
----------- ----------- ----------- -----------
Loss before
income taxes (661,442) (576,549) (2,295,021) (1,478,963)
Income tax expense 0 0 0 0
----------- ----------- ----------- -----------
Net loss (661,442) (576,549) (2,295,021) (1,478,963)
Net loss attributable to common stockholders:
Net loss (661,442) (576,549) (2,295,021) (1,478,963)
Preferred stock dividends (23,436) (31,599) (71,221) (442,398)
----------- ----------- ----------- -----------
Net loss attributable to
common stockholders ($ 684,878) ($ 608,148) ($2,366,242) ($1,921,361)
----------- ----------- ----------- -----------
Basic and diluted
loss per share ($ 0.19) ($ 0.21) ($ 0.72) ($ 0.66)
----------- ----------- ----------- -----------
Weighted average number of
common shares outstanding 3,651,772 2,949,066 3,308,103 2,918,782
----------- ----------- ----------- -----------
</TABLE>
See Notes to Consolidated Financial Statements
<PAGE>
DATAKEY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
October 2, October 3, October 2, October 3,
1999 1998 1999 1998
----------- ----------- ----------- -----------
CASH FLOWS FROM
OPERATING ACTIVITIES
<S> <C> <C> <C> <C>
Net loss ($ 661,442) ($ 576,549) ($2,295,021) ($1,478,963)
Adjustments to reconcile net loss
to net cash used in operating activities:
Depreciation 114,975 135,617 336,357 387,734
Amortization 22,364 12,097 56,857 35,075
Loss on sale of fixed assets 31,812 0 31,812 0
Change in assets and liabilities
(Increase) decrease:
Trade receivables (155,365) 181,466 31,729 (231,829)
Inventories (27,285) 38,920 (466,482) (37,983)
Prepaid expenses and other (17,477) 14,467 (5,202) (7,009)
Increase (decrease) in:
Accounts payable (13,538) (95,128) 215,300 140,196
Accrued expenses 134,045 171,732 176,158 83,462
Accrued severance 0 (41,500) (10,687) (149,772)
----------- ----------- ----------- -----------
Net cash used in
operating activities (571,911) (158,878) (1,929,179) (1,259,089)
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of tooling and equipment (57,706) (33,463) (164,736) (91,607)
Proceeds from sale of fixed assets 35,000 0 35,000 0
License and patent costs (9,038) (15,460) (22,015) (47,932)
----------- ----------- ----------- -----------
Net cash used in
investing activities (31,744) (48,923) (151,751) (139,539)
----------- ----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Net proceeds from issuance of
preferred stock 0 0 0 1,426,222
Increase in notes payable 15,766 0 15,766 0
Net proceeds (offering costs) from issuance of
common stock (16,651) 17,232 1,231,172 225,146
----------- ----------- ----------- -----------
Net cash provided by (used in) financing activities (885) 17,232 1,246,938 1,651,368
----------- ----------- ----------- -----------
Increase (decrease) in cash and
cash equivalents (604,540) (190,569) (833,992) 252,740
CASH AND CASH EQUIVALENTS
Beginning 624,375 1,748,701 853,827 1,305,392
----------- ----------- ----------- -----------
Ending 19,835 1,558,132 19,835 1,558,132
----------- ----------- ----------- -----------
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING
AND FINANCING ACTIVITIES
Preferred stock dividend accrual 23,436 31,599 63,032 47,398
Preferred stock dividend converted to common stock 0 0 8,190 0
Decrease in obligation recorded in connection
with prepaid license fees 0 (439,000) 0 (439,000)
Conversion of preferred stock to common 0 0 151,520 0
----------- ----------- ----------- -----------
23,436 (407,401) 222,742 (391,602)
----------- ----------- ----------- -----------
</TABLE>
See Notes to Consolidated Financial Statements
<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 October 2, 1999, and December 31, 1998, and results of its operations and
cash flows for the three-month and nine-month periods ended October 2, 1999, and
October 3, 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 - RECENT EVENTS
The Company completed, in October 1999, a $1.5 million private equity financing
with 28 accredited investors. Each investor paid $1.25 per common share, with
each share accompanied by a ten-year warrant to purchase one common share for
$1.25. A portion of the proceeds was 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 October 2, 1999 Nine Months Ended October 2, 1999
--------------------------------------------- ----------------------------------------------
EP ISS UNALLOCATED TOTAL EP ISS UNALLOCATED TOTAL
-------- ---------- ------------- ----------- --------- -------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenue............... $1,302,606 $ 184,273 $ - $1,486,879 $3,570,777 $430,092 $ - $4,000,869
Interest income
(expense)............. - - 1,457 1,457 - - 1,799 1,799
Depreciation and
amortization.......... 101,610 35,756 - 137,366 297,007 98,454 - 395,461
Segment profit (loss). 25,160 (688,059) 1,457 (661,442) 121,200 (2,418,020) 1,799 (2,295,021)
-------- ---------- ------------- ----------- --------- -------- ------------- -------------
Three Months Ended October 3, 1998 Nine Months Ended October 3, 1998
--------------------------------------------- ----------------------------------------------
-------- ---------- ------------- ----------- --------- -------- ------------- -------------
EP ISS UNALLOCATED TOTAL EP ISS UNALLOCATED TOTAL
-------- ---------- ------------- ----------- --------- -------- ------------- -------------
Revenue............... $1,161,314 $ 212,399 $ - $1,373,713 $4,224,244 $375,654 $ - $ 4,599,898
Interest
income(expense)....... - - 20,260 20,260 - - 44,647 44,647
Depreciation and
amortization.......... 118,888 23,871 - 142,759 351,191 69,511 - 420,702
Segment profit (loss). 88,956 (685,765) 20,260 (576,549) 626,362 (2,149,972) 44,647 (1,478,963)
</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 period ended October 2, 1999,
increased by $113,000, or 8 percent, compared to the same period in 1998. The
increase in revenue is due both to resumption in shipments to Electronic
Products (EP) customers during the quarter who had stopped shipments in the
second quarter, and an increase in shipments to Information Security Systems
(ISS) customers.
Two major EP customers resumed shipments during the quarter and have
recently indicated their requirements for the year may exceed the total for
1998. Additionally, other EP customers are expected to increase shipments during
the fourth quarter of 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 for the 1999 fiscal year may equal or
exceed that achieved in 1998. The Company continues to expect an operating loss
for 1999, however, as the R&D and sales and marketing expenses related to the
ISS business unit will substantially exceed its revenue for at least several
quarters.
GROSS PROFIT MARGIN - Gross profit as a percentage of revenue decreased
to 36 percent in the three-month period ended October 2, 1999 compared to 37
percent for the same period in 1998 and remained at 39 percent in the nine-month
period ended October 2, 1999. The reduction in margin in the three-month period
ended October 2, 1999, is primarily the result of unfavorable product mix. 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 $95,000 or 9
percent, and $527,000 or 16 percent in the three-month and nine-month periods,
ended October 2, 1999, respectively compared to the same periods in 1998. The
increases principally relate to a year to date increase of $133,000 in sales and
marketing expense to continue advertising and promoting the Company's ISS
product line. Research and development expense also increased $100,000 in the
three-month period and $329,000 in the nine-month period, as the Company
continued to develop more features and enhancements to its information security
products. Other expense increases result primarily from general inflationary
increases in rent, corporate insurance, and salaries.
The Company expects to continue spending on product promotional and
product developmental activities at a rate that will trend upward on a quarterly
basis. General and administrative expenses are expected to remain at about the
level incurred in the third quarter.
INTEREST INCOME - Interest income declined from $16,000 to $1,000 in
the three-month periods and from $40,000 to $2,000 in the nine-month periods,
ended October 2, 1999, compared to 1998 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 increase in the fourth quarter as the
Company has invested a portion of the proceeds of its recent private equity
placement in an interest-bearing account.
FINANCIAL CONDITION - The Company experienced a decrease in cash and
cash equivalents of $834,000 for the nine-month period ended October 2, 1999.
The decreases in cash in 1999 resulted primarily from an increase in the
operating losses in the period.
Datakey's balance sheet reflects $1,192,000 in working capital as of
October 2, 1999 and a current assets to current liabilities ratio of 2.00 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 its $1.5 million private equity financing,
which closed in late October 1999, in addition to its $1 million bank line of
credit, renewed in April 1999 for an additional year, will be sufficient to fund
its operation until at least mid 2000. Beyond that point, the Company's need for
additional financing depends largely on its success in selling more pilot units
to customers and converting ISS customers from the pilot to the production
phase. There is no assurance that a significant increase in ISS sales will occur
or that any necessary capital will be available on terms satisfactory to the
Company, or at all.
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 materially
compliant.
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 November 30, 1999. The Company has also formed a team to
develop contingency plans 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.
<PAGE>
FORWARD-LOOKING STATEMENTS AND RISKS
As provided for under the Private Securities Litigation Reform Act of 1995, the
Company wishes to caution investors that the following important factors, among
others, in some cases have affected and in the future could affect the Company's
actual results of operations and cause such results to differ materially from
those anticipated in forward-looking statements made in this document.
o The expectations that the Company's revenues may equal or exceed those of
1998 due to (i) EP customers increasing shipments during the remainder of
1999; (ii) new pilot programs emerging within the ISS business unit; and
(iii) the conversion of current pilot programs to the production deployment
phase depends on the new products performing as currently anticipated,
market acceptance of the products in general, the potential introduction of
competitive products, the sales cycle and timing of commitments from
potential customers, in addition to general competitive and market
conditions.
o The expectation of gross profit margin remaining at current level or
improving slightly depends on the Company's ability to control costs as
necessary.
o The expectation that interest income will increase for the fourth quarter
of 1999 depends on the interest rates in the market and other general
market conditions, as well as the ability to retain the recently acquired
funds in an interest bearing account as long as possible.
o The ability of the Company to fund operations as least through mid-2000
depends in large part on the Company's ability to sell more pilot units
within its ISS segment and on current ISS customers converting from the
pilot to the production phase.
o The impact of Year 2000 issues on its business depends on the accuracy,
reliability, and effectiveness of the Company's and its suppliers' and
customers' assessment and remediation of Year 2000 issues.
<PAGE>
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On October 29, 1999, the Company issued an aggregate of 1,200,000 shares of
common stock at $1.25 per share and ten-year warrants to purchase 1,200,000
shares of common stock at $1.25 for gross proceeds of $1,500,000. The shares
were sold with the assistance of Miller, Johnson & Kuehn, Incorporated (MJK) to
28 accredited investors. MJK received commissions equal to $144,000 plus
accountable expenses as part of the offering, and ten-year warrants to purchase
120,000 shares of Common Stock, with an exercise price of $1.375 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 will file, by November 30,
1999, 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.
On November 11, 1999 the Company issued an aggregate of 940,000 shares of Common
Stock to Special Situations Private Equity Fund, L.P. and Special Situations
Technology Fund, L.P. (the "Special Situations Funds") in exchange for the
Special Situations Funds (i) surrendering all outstanding 74,367 shares of the
Company's Series A Convertible Preferred Stock (with such shares issuable upon
exercise included in the aggregate 940,000), and releasing the Company of any
dividend obligations and antidilution adjustments, and (ii) surrendering all
warrants held by the Special Situations Funds to the Company, again forfeiting
any antidilution or other adjustments that may result due to the October 1999
financing. As additional consideration for the issuance of the Common Stock, the
Special Situations Funds executed a waiver of any and all rights they have or
might have to bring any action against the Company and its affiliates, whether
for damages or equitable remedies, arising out of either their purchase of
securities in the May 1998 offering or relating to Datakey's 1999 private
offerings of Common Stock and warrants.
<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 did not file a Form 8-K during the quarter ended
October 2, 1999. Subsequently, the Company filed a Form 8-K
dated October 25, 1999, that disclosed the third quarter
revenue and loss, and described its need for additional cash,
and an additional Form 8-K dated October 29, 1999, that fully
described the details of the private placement of common stock
and warrants, which was completed on October 29, 1999.
<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 November 16, 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)
<PAGE>
Datakey, Inc.
EXHIBIT INDEX TO FORM 10-QSB
FOR QUARTER ENDED October 2, 1999
EXHIBIT NO. DESCRIPTION
27 Financial Data Schedule
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1
<CURRENCY> U.S. Dollars
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> OCT-02-1999
<EXCHANGE-RATE> 1
<CASH> 19,835
<SECURITIES> 0
<RECEIVABLES> 853,907
<ALLOWANCES> 26,000
<INVENTORY> 1,474,430
<CURRENT-ASSETS> 2,383,611
<PP&E> 4,661,430
<DEPRECIATION> 3,815,712
<TOTAL-ASSETS> 3,868,969
<CURRENT-LIABILITIES> 1,191,338
<BONDS> 0
0
1,549,999
<COMMON> 182,589
<OTHER-SE> 945,043
<TOTAL-LIABILITY-AND-EQUITY> 3,868,969
<SALES> 4,000,869
<TOTAL-REVENUES> 4,000,869
<CGS> 2,450,417
<TOTAL-COSTS> 2,450,417
<OTHER-EXPENSES> 3,847,272
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (2,295,021)
<INCOME-TAX> 0
<INCOME-CONTINUING> (2,295,021)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,295,021)
<EPS-BASIC> (0.72)
<EPS-DILUTED> (0.72)
</TABLE>
