##### Table of Contents



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 March 31, 2003
| |  |  | ---------------------------------------------
|
| |  |  | 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
incorporation or organization) |  | (I.R.S. Employer
Identification No.)

|                                              
|----------------------------------------------
|407 WEST TRAVELERS TRAIL, BURNSVILLE, MN 55337
|                                              
|(Address of Principal Executive Offices)      

Issuers telephone number: (952) 890-6850



---

APPLICABLE ONLY TO CORPORATE ISSUERS

The number of shares outstanding of the issuers common equity as of April
21, 2003 is 10,125,032.

Transitional Small Business Disclosure Format (check One):

Yes o      No x






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TABLE OF CONTENTS



|                                                                    |                                                                   |                               |  |  |  |  |  | 
|------------------------------------------------------------------- | ----------------------------------------------------------------- | ----------------------------- |  |  |  |  |  | 
|PART I. FINANCIAL INFORMATION                                      
|                                                                    | ITEM I. FINANCIAL STATEMENTS                                     
|                                                                    |                                                                   | BALANCE SHEETS               
|                                                                    |                                                                   | STATEMENTS OF INCOME         
|                                                                    |                                                                   | STATEMENTS OF CASH FLOWS     
|                                                                    |                                                                   | NOTES TO FINANCIAL STATEMENTS
|                                                                    | ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
|                                                                    | ITEM 3. CONTROLS AND PROCEDURES                                  
|PART II. OTHER INFORMATION                                         
|                                                                    | ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K                         
|SIGNATURES                                                         
|SARBANES-OXLEY SECTION 302 CERTIFICATION OF CHIEF EXECUTIVE OFFICER
|SARBANES-OXLEY SECTION 302 CERTIFICATION OF CHIEF FINANCIAL OFFICER
|EXHIBIT INDEX TO FORM 10-QSB                                       
|EX-99.1 Certification of Chief Executive Officer                   
|EX-99.2 Certification of Chief Financial Officer                   



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| |  | PART I. FINANCIAL INFORMATION
ITEM I. FINANCIAL STATEMENTS
DATAKEY, INC.
BALANCE SHEETS
| |  | ---------------------------------------------------------------------------------------

|                                              |                                                                                                                                       |   |                                      |             |             |           |              |             |   |           | 
|--------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------- | - | ------------------------------------ | ----------- | ----------- | --------- | ------------ | ----------- | - | --------- | 
|                                              |                                                                                                                                       |   |                                      |             | March 31,   |           | December 31,
|                                              |                                                                                                                                       |   |                                      |             | 2003        |           | 2002        
|                                              |                                                                                                                                       |   |                                      |             |             |           |             
|                                              |                                                                                                                                       |   |                                      |             | (UNAUDITED) |           |              |             |  
|                                              |                                                                                                                                       |   | ASSETS                               |             |             |           |              |             |   |           | 
|CURRENT ASSETS                                |                                                                                                                                       |   |                                      |             |             |           |              |            
|                                              | Cash                                                                                                                                  |   | $                                    | 2,158,039   |             |           | $            | 2,562,611   |  
|                                              | Trade receivables, less allowance for
doubtful accounts of $30,000 and $55,000                                                        |   |                                      | 707,053     |             |           |              | 1,700,434   |  
|                                              | Inventories, less reserves for obsolescence
of $154,000 and $164,000                                                                  |   |                                      | 786,062     |             |           |              | 996,532     |  
|                                              | Prepaid expenses and other                                                                                                            |   |                                      | 92,048      |             |           |              | 65,259      |  
|                                              |                                                                                                                                       |   |                                      |             |             |           |              |            
|                                              |                                                                                                                                       |   | Total current assets                 |             |             | 3,743,202 |              |             |   | 5,324,836 | 
|                                              |                                                                                                                                       |   |                                      |             |             |           |              |            
|OTHER ASSETS                                  |                                                                                                                                       |   |                                      |             |             |           |              |            
|                                              | Prepaid licenses at cost less amortization of $316,230 and $309,183                                                                   |   |                                      | 285,021     |             |           |              | 236,817     |  
|EQUIPMENT AND LEASEHOLD IMPROVEMENTS, at cost |                                                                                                                                       |   |                                      |             |             |           |              |            
|                                              | Production tooling                                                                                                                    |   |                                      | 30,230      |             |           |              | 23,650      |  
|                                              | Equipment                                                                                                                             |   |                                      | 735,745     |             |           |              | 735,916     |  
|                                              | Furniture and fixtures                                                                                                                |   |                                      | 166,520     |             |           |              | 166,520     |  
|                                              | Leasehold improvements                                                                                                                |   |                                      | 310,912     |             |           |              | 310,912     |  
|                                              |                                                                                                                                       |   |                                      |             |             |           |              |            
|                                              |                                                                                                                                       |   | 1,243,407                            |             |             |           | 1,236,998    |            
|                                              | Less accumulated depreciation                                                                                                         |   |                                      | (968,227    | )           |           |              | (927,844    | )
|                                              |                                                                                                                                       |   |                                      |             |             |           |              |            
|                                              |                                                                                                                                       |   | 275,180                              |             |             |           | 309,154      |            
|                                              |                                                                                                                                       |   |                                      |             |             |           |              |            
|                                              |                                                                                                                                       | $ | 4,303,403                            |             |             | $         | 5,870,807    |            
|                                              |                                                                                                                                       |   |                                      |             |             |           |              |            
|                                              |                                                                                                                                       |   | LIABILITIES AND SHAREHOLDERS EQUITY |             |             |           |              |             |   |           | 
|CURRENT LIABILITIES                           |                                                                                                                                       |   |                                      |             |             |           |              |            
|                                              | Accounts payable                                                                                                                      |   | $                                    | 369,826     |             |           | $            | 574,266     |  
|                                              | Accrued compensation                                                                                                                  |   |                                      | 372,824     |             |           |              | 287,718     |  
|                                              | Accrued expenses-other                                                                                                                |   |                                      | 125,361     |             |           |              | 154,267     |  
|                                              | Deferred revenue                                                                                                                      |   |                                      | 434,089     |             |           |              | 355,338     |  
|                                              |                                                                                                                                       |   |                                      |             |             |           |              |            
|                                              |                                                                                                                                       |   | Total current liabilities            |             |             | 1,302,100 |              |             |   | 1,371,589 | 
|                                              |                                                                                                                                       |   |                                      |             |             |           |              |            
|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 20,000,000 shares; issued and outstanding
10,082,750 in 2002 and 9,974,012 in 2001 |   |                                      | 506,251     |             |           |              | 504,138     |  
|                                              | Additional paid-in capital                                                                                                            |   |                                      | 18,970,198  |             |           |              | 18,921,150  |  
|                                              | Accumulated deficit                                                                                                                   |   |                                      | (16,850,146 | )           |           |              | (15,301,070 | )
|                                              |                                                                                                                                       |   |                                      |             |             |           |              |            
|                                              |                                                                                                                                       |   | 3,001,303                            |             |             |           | 4,499,218    |            
|                                              |                                                                                                                                       |   |                                      |             |             |           |              |            
|                                              |                                                                                                                                       | $ | 4,303,403                            |             |             | $         | 5,870,807    |            
|                                              |                                                                                                                                       |   |                                      |             |             |           |              |            

See Notes to Financial Statements

2



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DATAKEY, INC.
STATEMENTS OF INCOME
(UNAUDITED)

|                                                                       |                                                               |                                              |             |                    |             |           |            |         |           |  
|---------------------------------------------------------------------- | ------------------------------------------------------------- | -------------------------------------------- | ----------- | ------------------ | ----------- | --------- | ---------- | ------- | --------- | -
|                                                                       |                                                               |                                              |             | Three Months Ended
|                                                                       |                                                               |                                              |             | March 31,          |             | March 30,
|                                                                       |                                                               |                                              |             | 2003               |             | 2002     
|                                                                       |                                                               |                                              |             |                    |             |          
|Revenue                                                                |                                                               | $                                            | 794,368     |                    |             | $         | 2,492,894  |        
|Cost of goods sold                                                     |                                                               |                                              | 605,873     |                    |             |           | 1,500,634  |        
|                                                                       |                                                               |                                              |             |                    |             |           |            |        
|                                                                       |                                                               | Gross Profit                                 |             |                    | 188,495     |           |            |         | 992,260   |  
|Operating expenses:                                                    |                                                               |                                              |             |                    |             |           |            |        
|                                                                       | Research, development, technical support
and engineering      |                                              |             | 548,558            |             |           |            | 582,109 |          
|                                                                       | Marketing and sales                                           |                                              |             | 775,717            |             |           |            | 882,177 |          
|                                                                       | General and administrative                                    |                                              |             | 418,293            |             |           |            | 197,139 |          
|                                                                       |                                                               |                                              |             |                    |             |           |            |        
|                                                                       |                                                               | Total operating expenses                     |             |                    | 1,742,568   |           |            |         | 1,661,425 |  
|                                                                       |                                                               |                                              |             |                    |             |           |            |        
|                                                                       |                                                               | Operating loss                               |             |                    | (1,554,073  | )         |            |         | (669,165  | )
|Interest income                                                        |                                                               |                                              | 4,997       |                    |             |           | 12,726     |        
|                                                                       |                                                               |                                              |             |                    |             |           |            |        
|Loss from continuing operations
before income taxes                    |                                                               |                                              | (1,549,076  | )                  |             |           | (656,439   | )      
|Income tax expense                                                     |                                                               |                                              | 0           |                    |             |           | 0          |        
|                                                                       |                                                               |                                              |             |                    |             |           |            |        
|Net loss from continuing operations                                    |                                                               |                                              | ($1,549,076 | )                  |             |           | ($656,439  | )      
|                                                                       |                                                               |                                              |             |                    |             |           |            |        
|Profit from operations of discontinued segment                         |                                                               |                                              | 0           |                    |             |           | 0          |        
|Gain(loss) from disposal of discontinued segment                       |                                                               |                                              | 0           |                    |             |           | (10,722    | )      
|                                                                       |                                                               |                                              |             |                    |             |           |            |        
|                                                                       |                                                               | Net loss attributable to common stockholders |             |                    | ($1,549,076 | )         |            |         | ($667,161 | )
|                                                                       |                                                               |                                              |             |                    |             |           |            |        
|                                                                       | Basic and diluted loss per share
from continuing operations   |                                              |             | ($0.15             | )           |           |            | ($0.07  | )        
|                                                                       |                                                               |                                              |             |                    |             |           |            |        
|                                                                       | Basic and diluted loss per share
from discontinued operations |                                              |             |                   |             |           |            |        |          
|                                                                       | Basic and diluted
loss per share                              |                                              |             | ($0.15             | )           |           |            | ($0.07  | )        
|                                                                       |                                                               |                                              |             |                    |             |           |            |        
|Weighted average number of common
shares outstanding-basic and diluted |                                                               |                                              | 10,114,491  |                    |             |           | 10,050,436 |        
|                                                                       |                                                               |                                              |             |                    |             |           |            |        

See Notes to Financial Statements

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DATAKEY, INC.
STATEMENTS OF CASH FLOWS
(UNAUDITED)

|                                     |                                                                             |                                  |   |                                           |        |                    |          |           |        |  |          |  
|------------------------------------ | --------------------------------------------------------------------------- | -------------------------------- | - | ----------------------------------------- | ------ | ------------------ | -------- | --------- | ------ |  | -------- | -
|                                     |                                                                             |                                  |   |                                           |        | Three Months Ended
|                                     |                                                                             |                                  |   |                                           |        | March 31,          |          | March 30,
|                                     |                                                                             |                                  |   |                                           |        | 2003               |          | 2002     
|                                     |                                                                             |                                  |   |                                           |        |                    |          |          
|CASH FLOWS FROM
OPERATING ACTIVITIES |                                                                             |                                  |   |                                           |        |                    |          |          
|                                     | Net loss                                                                    |                                  |   | ($1,549,076                               | )      |                    |          | ($667,161 | )     
|                                     | Adjustments to reconcile net loss
to net cash used in operating activities: |                                  |   |                                           |        |                    |          |           |       
|                                     |                                                                             | Depreciation                     |   |                                           | 40,383 |                    |          |           | 30,417 | 
|                                     |                                                                             | Amortization                     |   |                                           | 7,047  |                    |          |           | 22,554 | 
|                                     |                                                                             | Change in assets and liabilities |   |                                           |        |                    |          |           |        | 
|                                     |                                                                             | (Increase) decrease in assets:   |   |                                           |        |                    |          |           |        | 
|                                     |                                                                             |                                  |   | Trade receivables                         |        |                    | 993,381  |           |        |  | (218,315 | )
|                                     |                                                                             |                                  |   | Inventories                               |        |                    | 210,470  |           |        |  | (263,101 | )
|                                     |                                                                             |                                  |   | Prepaid expenses and other                |        |                    | (82,040  | )         |        |  | 26,477   |  
|                                     |                                                                             | Increase (decrease) in:          |   |                                           |        |                    |          |           |        | 
|                                     |                                                                             |                                  |   | Accounts payable                          |        |                    | (204,440 | )         |        |  | 214,567  |  
|                                     |                                                                             |                                  |   | Accrued expenses                          |        |                    | 56,200   |           |        |  | 70,431   |  
|                                     |                                                                             |                                  |   | Deferred revenue                          |        |                    | 78,751   |           |        |  | 23,927   |  
|                                     |                                                                             |                                  |   |                                           |        |                    |          |          
|                                     |                                                                             |                                  |   | Net cash used in
operating activities     |        |                    | (449,324 | )         |        |  | (760,204 | )
|                                     |                                                                             |                                  |   |                                           |        |                    |          |          
|CASH FLOWS FROM INVESTING ACTIVITIES |                                                                             |                                  |   |                                           |        |                    |          |          
|                                     | Purchase of equipment and leasehold improvements                            |                                  |   | (6,409                                    | )      |                    |          | (61,583   | )     
|                                     |                                                                             |                                  |   |                                           |        |                    |          |          
|                                     |                                                                             |                                  |   | Net cash used in
investing activities     |        |                    | (6,409   | )         |        |  | (61,583  | )
|                                     |                                                                             |                                  |   |                                           |        |                    |          |          
|CASH FLOWS FROM FINANCING ACTIVITIES |                                                                             |                                  |   |                                           |        |                    |          |          
|                                     | Net proceeds from issuance of
common stock                                  |                                  |   | 51,161                                    |        |                    |          | 346,298   |       
|                                     |                                                                             |                                  |   |                                           |        |                    |          |          
|                                     |                                                                             |                                  |   | Net cash provided by financing activities |        |                    | 51,161   |           |        |  | 346,298  |  
|                                     |                                                                             |                                  |   |                                           |        |                    |          |          
|                                     |                                                                             |                                  |   | Decrease in cash                          |        |                    | (404,572 | )         |        |  | (475,489 | )
|CASH AND CASH EQUIVALENTS            |                                                                             |                                  |   |                                           |        |                    |          |          
|                                     | Beginning                                                                   |                                  |   | 2,562,611                                 |        |                    |          | 4,112,264 |       
|                                     |                                                                             |                                  |   |                                           |        |                    |          |          
|                                     | Ending                                                                      |                                  | $ | 2,158,039                                 |        |                    | $        | 3,636,775 |       
|                                     |                                                                             |                                  |   |                                           |        |                    |          |          

See Notes to Financial Statements

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DATAKEY, INC.
NOTES TO FINANCIAL STATEMENTS

Note 1. 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, in 2000, a
segment 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.

Note 2. BASIS OF PRESENTATION
In the opinion of management, the accompanying unaudited financial statements
contain all adjustments necessary to present fairly Datakeys financial
position as of March 31, 2003, and December 31, 2002, and results of its
operations and cash flows for the three-month periods ended March 31, 2003, and
March 30, 2002. 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 2002 Datakey, Inc. Annual Report and in
Form 10-KSB for the year ended December 31, 2002.

Note 3. 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. No amounts have been capitalized due to
uncertainties about the market acceptance of the underlying products.

Note 4. STOCK BASED COMPENSATION
The Company regularly grants options to its employees under various plans. 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. Compensation expense recorded for employee grants
for the quarters ended March 31, 2003 and March 30, 2002 was $5,500 and $0,
respectively.

The Company also grants options and warrants to non-employees 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.

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|                                                                                                                   |                     |  |                |             |                |  |           |           |  
|------------------------------------------------------------------------------------------------------------------ | ------------------- |  | -------------- | ----------- | -------------- |  | --------- | --------- | -
|                                                                                                                   |                     |  | March 31, 2003 |             | March 30, 2002
|                                                                                                                   |                     |  |                |             |               
|Net loss, as reported                                                                                              |                     |  | ($1,549,076    | )           |                |  | ($667,161 | )        
|Deduct total stock-based employee
compensation
expense determined under the fair
value-based
method for all awards |                     |  | (192,793       | )           |                |  | (173,942  | )        
|                                                                                                                   |                     |  |                |             |                |  |           |          
|                                                                                                                   | Net loss, pro forma |  |                | ($1,741,869 | )              |  |           | ($841,103 | )
|Basic and diluted loss per share, as reported                                                                      |                     |  | ($.15          | )           |                |  | ($.07     | )        
|Basic and diluted loss per share, pro forma                                                                        |                     |  | ($.17          | )           |                |  | ($.08     | )        

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.

Note 5. 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. The warranty accrual was reduced in late 2002
to reflect the occurrence of fewer warranty claims.

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

|                               |                            |   |       |     |      |   |        |     | 
|------------------------------ | -------------------------- | - | ----- | --- | ---- | - | ------ | --- | 
|                               |                            |   | 2003  |     | 2002
|                               |                            |   |       |     |     
|Balances, Beginning of quarter |                            | $ | 4,175 |     |      | $ | 26,894 |    
|                               | Accruals for products sold |   |       | 0   |      |   |        | 0   | 
|                               | Payments made              |   |       | 672 |      |   |        | 324 | 
|                               |                            |   |       |     |      |   |        |    
|Balances, End of quarter       |                            | $ | 3,503 |     |      | $ | 26,570 |    
|                               |                            |   |       |     |      |   |        |    

Note 6. 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.

|                         |  |                |          |                   |  |   |          |  
|------------------------ |  | -------------- | -------- | ----------------- |  | - | -------- | -
|Licenses:                |  | March 31, 2003 |          | December 31, 2002
|                         |  |                |          |                  
|Gross carrying amount    |  | $              | 601,251  |                   |  | $ | 546,000  |  
|Accumulated amortization |  |                | (316,230 | )                 |  |   | (309,183 | )
|                         |  |                |          |                   |  |   |          |  
|Net carrying amount      |  | $              | 285,021  |                   |  | $ | 236,817  |  
|                         |  |                |          |                   |  |   |          |  

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Aggregate amortization expense is as follows:

|                             |  |   |         | 
|---------------------------- |  | - | ------- | 
|Quarter ended March 31, 2003 |  | $ | 7,047   | 
|Quarter ended March 30, 2002 |  | $ | 22,554  | 
|Year ended December 31, 2002 |  | $ | 182,847 | 

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, and amended the agreement
in 2003, under which it purchased licenses for $195,000 and agreed to minimum
future purchase of licenses for $325,000 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 $84,000 during the
quarter ended March 31, 2003, $12,167 during the quarter ended March 30, 2002
and $48,667 for the year ended December 31, 2002 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.

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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
DATAKEY, INC.
RESULTS OF OPERATIONS AND FINANCIAL CONDITION

RESULTS OF OPERATIONS
CONTINUING OPERATIONS

REVENUE
Revenue for the three-month period ended March 31, 2003, decreased by
$1,699,000, or 68 percent, as compared to the same period in 2002. The
significant decrease in revenue in the three-month period resulted from delays
in our customers production delivery schedules created by the slowdown in IT
spending and budgetary issues.

GROSS PROFIT MARGIN
Gross profit, as a percentage of revenue, decreased to 24 percent in the
three-month period ended March 31, 2003, from 40 percent in the three-month
period ended March 30, 2002. The decrease in gross profit percentage in the
three-month period related primarily to fixed overhead being spread over the
significant reduction in revenue and a write-down of the book value of prepaid
license fees due to a successful contractual reduction in the unit price paid
for these licenses. The gross margin percentage for the balance of 2003 is
expected to increase if the Company is successful in increasing quarterly
revenue and selling products with more software content that contain a high
margin.

OPERATING EXPENSES
Operating expenses increased by $81,000 in the three-month period ended March
31, 2003, primarily as the result of accruals, in the amount of $278,000, for
severance pay and other expenses related to a reduction in staff. Operating
expenses during the balance of 2003 are expected to decrease significantly from
the first quarter level.

INTEREST INCOME
Interest income, net of interest expense, decreased to $5,000 from $13,000 in
the three-month period, reflecting a lower rate of interest. Interest income
is expected to decrease slightly over the balance of the year due to an
expected decrease in cash.

OUTLOOK
There is continuing evidence of a worldwide slowdown in IT spending in the
commercial market as well as in the government market which has resulted in a
stretching-out of our customers production delivery schedules. This
stretching out of delivery schedules was first observed in 2002 and continued
in recent months to a greater extent than we thought would occur. We are,
therefore, uncertain as to when more traditional delivery schedules will
resume. Accordingly, we are not providing revenue guidance at this time.

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LIQUIDITY AND FINANCIAL CONDITION
The Company experienced a decrease in cash of $405,000 in the three-month
period ended March 31, 2003. The decrease in cash during the three-month
period ended March 31, 2003 related to the operating loss, a $204,000 decrease
in accounts payable and a $82,000 increase in prepaid license fees. The cash
decrease was offset by a $993,000 decrease in trade receivables and $51,000 in
proceeds received from the sale of common stock pursuant to the employee stock
purchase plan. The statements of cash flows include discontinued operations as
well as continuing operations in the periods presented.

Accounts receivable declined $993,000 during the three-month period ended March
31, 2003 primarily as a result of lower revenue in the quarter ended March 31,
2003. Accounts payable, likewise, declined $204,000 during the three-month
period as a result of a reduction in inventory purchases in the quarter ended
March 31, 2003. Inventory decreased by $210,000 during the three-month period
ended March 31, 2003 as the Company curtailed inventory purchases in light of
the reduction in revenue.

Deferred revenue increased $79,000 during the three-month period ended March
31, 2003 as the additional deferred revenue booked exceeded the amortization of
deferred revenue during the three-month period. Deferred revenue consists of
extended maintenance contracts from which the Company typically charges a fixed
percentage of revenue from the sale of products, and are amortized over the
term of the contracts.

Datakeys balance sheet reflects $2,441,000 in working capital as of March 31,
2003 and a current assets to current liabilities ratio of 2.9 to 1. The
Company believes that its current level of cash will provide sufficient
liquidity to fund operations for at least the next twelve months.

CONTRACTUAL CASH OBLIGATIONS
The Company presently has no long-term debt outstanding and its contractual
cash obligations are those from minimum payments under a software license
agreement and operating lease obligations. These obligations total $738,000 as
shown below:

|           |  |   |         |  |  |                         |  | 
|---------- |  | - | ------- |  |  | ----------------------- |  | 
|2003       |  | $ | 472,000 |  |  | (remaining nine months)
|2004*      |  |   | 236,000 |  |  |                         |  | 
|2005       |  |   | 21,000  |  |  |                         |  | 
|thereafter |  |   | 9,000   |  |  |                         |  | 

*The lease on the Companys primary facility expires June 30, 2004.

OPERATING SEGMENTS
Through July 31, 2001, the Company had two reportable segments: Electronic
Products (EP) and Information Security Solutions (ISS). As discussed in the
following notes, the EP segment has been shown as discontinued operations
beginning in December 2000. The Electronic Products segment produced and
marketed proprietary memory keys, cards, and custom-shaped tokens and systems
that utilize these products that serve as a convenient way to carry electronic
information. The assets related to the ongoing business of the EP business
segment were sold in August 2001 and the final EP contract was fulfilled in
2002. The 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.

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.

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|                              |  |                                   |   |     |  |             |            |       |  |  |       |  |  |   |            |  
|----------------------------- |  | --------------------------------- | - | --- |  | ----------- | ---------- | ----- |  |  | ----- |  |  | - | ---------- | -
|                              |  | Three Months Ended March 31, 2003
|                              |  |                                  
|                              |  | EP                                |   | ISS |  | UNALLOCATED |            | TOTAL
|                              |  |                                   |   |     |  |             |            |      
|Revenue                       |  | $                                 | 0 |     |  | $           | 794,368    |       |  |  |       |  |  | $ | 794,368    |  
|Interest income (expense)     |  |                                   |   |     |  |             |            |       |  |  | 4,997 |  |  |   | 4,997      |  
|Depreciation and
amortization |  |                                   | 0 |     |  |             | 47,430     |       |  |  |       |  |  |   | 47,430     |  
|Segment profit (loss)         |  |                                   | 0 |     |  |             | (1,554,073 | )     |  |  | 4,997 |  |  |   | (1,549,076 | )

|                              |  |                                   |         |     |  |             |           |       |  |  |        |  |  |   |           |  
|----------------------------- |  | --------------------------------- | ------- | --- |  | ----------- | --------- | ----- |  |  | ------ |  |  | - | --------- | -
|                              |  | Three Months Ended March 30, 2002
|                              |  |                                  
|                              |  | EP                                |         | ISS |  | UNALLOCATED |           | TOTAL
|                              |  |                                   |         |     |  |             |           |      
|Revenue                       |  | $                                 | 18,450  |     |  | $           | 2,492,894 |       |  |  |        |  |  | $ | 2,511,344 |  
|Interest income (expense)     |  |                                   |         |     |  |             |           |       |  |  | 12,726 |  |  |   | 12,726    |  
|Depreciation and
amortization |  |                                   | 0       |     |  |             | 52,971    |       |  |  |        |  |  |   | 52,971    |  
|Segment profit (loss)         |  |                                   | (10,722 | )   |  |             | (669,165  | )     |  |  | 12,726 |  |  |   | (667,161  | )

DISCONTINUED OPERATIONS
In February 2001 the Companys Board of Directors approved managements plan to
discontinue the operations of the EP segment. The plan anticipated the phase
down of the operations through December 31, 2001, although the Company
continued to pursue the possibility of selling the operations.

The estimated loss, taken in 2000, on the phase down of the EP segment included
the write-off of inventory, patents, and equipment anticipated to remain at the
date of closedown and expenses associated with the phase down, net of estimated
operating income through that date. The phase down of the segment was
accounted for as discontinued operations and, accordingly, its net assets and
net liabilities have been segregated from continuing operations in the balance
sheets and the results of operations have been excluded from continuing
operations for all periods presented. There were no net assets of the EP
segment as of March 31, 2003 and December 31, 2002.

SALE OF DISCONTINUED BUSINESS SEGMENT
On August 3, 2001, the Company completed the sale of the EP business segment
fixed assets, inventory, patents and prepaid expense along with customer lists,
assignment of certain customer contracts and all intellectual property required
to operate the EP business segment. The Company retained certain customer
contracts, and all EP accounts receivable, accounts payable and accrued expense
as of July 31, 2001. The Company received $550,000 in cash on the date of
closing, and recorded the cash difference between accounts receivable and
accounts payable and accrued expense and profit on the customer contracts
retained. Due to the nature of the transaction, the Company recorded a loss of
$492,000 during the year ended December 31, 2001 from the disposal of
discontinued operations because the loss on disposal of the selected assets and
the loss from discontinued operations exceeded the $1,281,000 reserve that was
established for these losses in 2000.

Under terms of the primary contract retained upon sale of the EP segment, the
customer was required to provide certain components that are necessary to
complete the manufacture and shipment of the final product, provide necessary
test fixtures and must also approve the final test results prior to shipping
the product. Due to a delay in delivery of the customer provided materials and
a delay in providing the necessary test fixtures, the completion date of the
contract extended beyond the date that was initially expected at the time the
EP segment was sold.

During the second quarter of 2002 the Company completed the final delivery
under the contract retained at the time of sale of the EP segment and realized
a profit of $361,767. This amount was reflected on the Income Statement as
gain on disposition of discontinued operation. This completed the sale of the
EP segment and no further gain or loss from discontinued operations is
expected.

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FORWARD LOOKING STATEMENTS AND RISK FACTORS

The Managements Discussion and Analysis contains certain forward-looking
statements including that: (i) annual revenues in 2003 will increase; (ii)
gross margins will increase and (iii) the Company will have sufficient
financial resources to fund its operations for at least 12 months. These
statements are subject to certain risks and uncertainties which may cause
actual results to differ materially from those projected. These risks and
uncertainties include that: (i) market acceptance and demand for the Companys
information security products may not increase at the rate expected or may
decrease due to economic, competitive or other market conditions; (ii) that the
Companys sales may continue to be negatively impacted, and perhaps to a
greater extent, due to the overall slowdown in the Information Technology
market; (iii) that the Companys sales may not continue to reflect a favorable
product mix seen in past quarters, and the Companys expected sales of products
with more software content may not materialize depending on the actual demand
and timing of its customers; and (iv) the Companys overall funding depends on
actual sales given the state of the economy as well as its ability to
effectively control expenses.




ITEM 3. CONTROLS AND PROCEDURES

In response to recent legislation and additional requirements, we reviewed our
internal control structure and our disclosure controls and procedures. As a
result of such review we implemented changes primarily to formalize and
document the procedures. We have designed our disclosure controls and
procedures to ensure that material information related to Datakey is made known
to our principal executive officer and principal financial officer on a regular
basis, in particular during the period in which the quarterly reports are being
prepared. As required, we will evaluate the effectiveness of these disclosure
controls and procedures on a quarterly basis, and did so on April 16, 2003, a
date within 90 days prior to the filing of this quarterly report. We believe
as of that date, such controls and procedures are operating effectively as
designed.

We presented the results of our most recent evaluation to our independent
auditors, McGladrey & Pullen, and the Audit Committee of the Board of
Directors. Based on such evaluation, the Companys management concluded that
the Companys disclosure controls and procedures are adequate to ensure the
clarity and material completeness of the Companys disclosure in its periodic
reports required to be filed with the SEC and there are no significant
deficiencies or material weaknesses in the design or operation of internal
controls which could significantly affect our ability to record, process,
summarize and report financial data.

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PART II. OTHER INFORMATION




ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K



| | (a) |  | Reports on Form 8-K                                                                                                                                                                                                    
| | --- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |     |  | A Form 8-K was filed on March 4, 2003 announcing the resignation of Carl
P. Boecher as Chief Executive Officer and appointment of Timothy L.
Russell as Chief Executive Officer of the Company effective March 3, 2003.
|
| | (b) |  | Exhibits                                                                                                                                                                                                               
|
| |     |  | See Exhibit Index following Certifications.                                                                                                                                                                            

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SIGNATURES

In accordance with the requirements of the Exchange Act of 1934, the Registrant
has duly caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.

|                    |  |               |  |     |  |                        |  |                                                                                                      | 
|------------------- |  | ------------- |  | --- |  | ---------------------- |  | ---------------------------------------------------------------------------------------------------- | 
|Dated: May 12, 2003 |  | Datakey, Inc.
|                    |  |               |  |     |  |                        |  |                                                                                                     
|                    |  |               |  | By: |  | /s/ Timothy L. Russell
|                    |  |               |  |     |  |                       
|                    |  |               |  |     |  |                        |  | Timothy L. Russell
Chief Executive Officer
(Principal Executive Officer)                            
|                    |  |               |  |     |  |                        |  |                                                                                                     
|                    |  |               |  | By: |  |                        |  | /s/Alan G. Shuler                                                                                   
|                    |  |               |  |     |  |                       
|                    |  |               |  |     |  |                        |  | Alan G. Shuler
Vice President & Chief Financial Officer
(Principal Financial and Accounting Officer)

13



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SARBANES-OXLEY SECTION 302 CERTIFICATION
OF CHIEF EXECUTIVE OFFICER

I, Timothy L. Russell, Chief Executive Officer of Datakey, Inc., certify that:

1.     I have reviewed this quarterly report on Form 10-QSB of Datakey, Inc.
for the period ended March 31, 2003;

2.     Based on my knowledge, this quarterly 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
quarterly report;

3.     Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;

4.     The registrant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 registrant and have:



| | (a) |  | designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;
| | --- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | (b) |  | evaluated the effectiveness of the registrants disclosure controls
and procedures as of a date within 90 days prior to the filing date of
the quarterly report (the Evaluation Date); and                                                                                                   
|
| | (c) |  | presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;                                                                                                                        

5.     The registrants other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrants auditors and the audit
committee of the registrants board of directors (or persons performing the
equivalent functions):



| | (a) |  | all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrants ability to
record, process, summarize and report financial data and have identified
for the registrant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 registrants internal
controls; and                                                                                                                                      

6.     The registrants other certifying officer and I have indicated in this
quarterly 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: May 12, 2003 |  |            |  |                                                                  
|                   |  | Signature: |  | /s/ Timothy L. Russell
Timothy L. Russell
Chief Executive Officer





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##### Table of Contents






SARBANES-OXLEY SECTION 302 CERTIFICATION
OF CHIEF FINANCIAL OFFICER

I, Alan G. Shuler, Chief Financial Officer of Datakey, Inc., certify that:

1.     I have reviewed this quarterly report on Form 10-QSB of Datakey, Inc.
for the period ended March 31, 2003;

Based on my knowledge, this quarterly 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 quarterly
report;

2.     Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;

3.     The registrant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 registrant and have:



| | (a) |  | designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;
| | --- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | (b) |  | evaluated the effectiveness of the registrants disclosure controls
and procedures as of a date within 90 days prior to the filing date of
the quarterly report (the Evaluation Date); and                                                                                                   
|
| | (c) |  | presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;                                                                                                                        

4.     The registrants other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrants auditors and the audit
committee of the registrants board of directors (or persons performing the
equivalent functions):



| | (a) |  | all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrants ability to
record, process, summarize and report financial data and have identified
for the registrant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 registrants internal
controls; and                                                                                                                                      

5.     The registrants other certifying officer and I have indicated in this
quarterly 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: May 12, 2003 |  | Signature: |  | /s/ Alan G. Shuler
Alan G. Shuler
Chief Financial Officer





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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549




EXHIBIT INDEX TO FORM 10-QSB

|                             |  |                            
|---------------------------- |  | ---------------------------
|For the fiscal quarter ended |  | Commission File No. 0-11447
|March 31, 2003               |  |                            



---

DATAKEY, INC.



---

|            |  |                                         
|----------- |  | ----------------------------------------
|Exhibit No. |  | Description                             
|            |  |                                         
|            |  |                                         
|99.1        |  | Certification of Chief Executive Officer
|            |  |                                         
|99.2        |  | Certification of Chief Financial Officer