##### Table of Contents



SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-QSB

| |  |                                                                                   
| |  | ----------------------------------------------------------------------------------
| |  | QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT OF 1934

| |  |                                              
| |  | ---------------------------------------------
| |  | For the quarterly period ended March 30, 2002
| |  |                                              
| |  | 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

Issuers telephone number: (952) 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 |  | No

APPLICABLE ONLY TO CORPORATE ISSUERS

The number of shares outstanding of the issuers common equity, as of May
10, 2002, is 10,082,750.

Transitional Small Business Disclosure Format (check One):

|    |  |    |  | 
|--- |  | -- |  | 
|Yes |  | No |  | 





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TABLE OF CONTENTS



|                                              |  |  |  |  |  |  |  | 
|--------------------------------------------- |  |  |  |  |  |  |  | 
|PART I. FINANCIAL INFORMATION                
|ITEM I. FINANCIAL STATEMENTS                 
|STATEMENTS OF INCOME                         
|STATEMENTS OF CASH FLOWS                     
|NOTES TO FINANCIAL STATEMENTS                
|RESULTS OF OPERATIONS AND FINANCIAL CONDITION
|FORWARD LOOKING STATEMENTS AND RISK FACTORS  
|PART II. OTHER INFORMATION                   
|SIGNATURES                                   



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##### Table of Contents









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

|                                              |                                                                                                                                       |                          |                                      |             |             |           |           |              |   |           | 
|--------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------- | ------------------------ | ------------------------------------ | ----------- | ----------- | --------- | --------- | ------------ | - | --------- | 
|                                              |                                                                                                                                       |                          |                                      |             | March 30,   |           |           | December 31, |  
|                                              |                                                                                                                                       |                          |                                      |             | 2002        |           |           | 2001         |  
|                                              |                                                                                                                                       |                          |                                      |             |             |           |           |              |  
|                                              |                                                                                                                                       |                          |                                      |             | (UNAUDITED) |           |           |              |   |          
|                                              |                                                                                                                                       |                          | ASSETS                               |             |             |           |           |              |   |           | 
|CURRENT ASSETS                                |                                                                                                                                       |                          |                                      |             |             |           |           |             
|                                              | Cash                                                                                                                                  |                          | $                                    | 3,636,775   |             |           | $         | 4,112,264    |  
|                                              | Trade receivables, less allowance for
doubtful accounts of $31,000 and $28,000                                                        |                          |                                      | 2,432,773   |             |           |           | 2,154,723    |  
|                                              | Inventories                                                                                                                           |                          |                                      | 1,189,129   |             |           |           | 926,028      |  
|                                              | Prepaid expenses and other                                                                                                            |                          |                                      | 57,956      |             |           |           | 84,433       |  
|                                              | Net assets of discontinued operations                                                                                                 |                          |                                      | 22,342      |             |           |           | 82,077       |  
|                                              |                                                                                                                                       |                          |                                      |             |             |           |          
|                                              |                                                                                                                                       |                          | Total current assets                 |             |             | 7,338,975 |           |              |   | 7,359,525 | 
|                                              |                                                                                                                                       |                          |                                      |             |             |           |          
|OTHER ASSETS                                  |                                                                                                                                       |                          |                                      |             |             |           |           |             
|                                              | Prepaid licenses and patents at cost less amortization                                                                                |                          |                                      | 169,285     |             |           |           | 191,839      |  
|                                              |                                                                                                                                       | of $854,928 and $832,374 |                                      |             |             |           |           |              |   |          
|EQUIPMENT AND LEASEHOLD IMPROVEMENTS, at cost |                                                                                                                                       |                          |                                      |             |             |           |           |             
|                                              | Production tooling                                                                                                                    |                          |                                      | 23,650      |             |           |           | 23,650       |  
|                                              | Equipment                                                                                                                             |                          |                                      | 756,459     |             |           |           | 701,326      |  
|                                              | Furniture and fixtures                                                                                                                |                          |                                      | 166,520     |             |           |           | 166,520      |  
|                                              | Leasehold improvements                                                                                                                |                          |                                      | 309,259     |             |           |           | 302,809      |  
|                                              |                                                                                                                                       |                          |                                      |             |             |           |          
|                                              |                                                                                                                                       |                          | 1,255,888                            |             |             |           | 1,194,305 |             
|                                              | Less accumulated depreciation                                                                                                         |                          |                                      | (833,965    | )           |           |           | (803,548     | )
|                                              |                                                                                                                                       |                          |                                      |             |             |           |           |              |  
|                                              |                                                                                                                                       |                          | 421,923                              |             |             |           | 390,757   |             
|                                              |                                                                                                                                       |                          |                                      |             |             |           |          
|                                              |                                                                                                                                       | $                        | 7,930,183                            |             |             | $         | 7,942,121 |             
|                                              |                                                                                                                                       |                          |                                      |             |             |           |          
|                                              |                                                                                                                                       |                          | LIABILITIES AND SHAREHOLDERS EQUITY |             |             |           |           |              |   |           | 
|CURRENT LIABILITIES                           |                                                                                                                                       |                          |                                      |             |             |           |           |             
|                                              | Accounts payable                                                                                                                      |                          | $                                    | 780,912     |             |           | $         | 566,345      |  
|                                              | Accrued compensation                                                                                                                  |                          |                                      | 416,809     |             |           |           | 313,098      |  
|                                              | Accrued expenses-other                                                                                                                |                          |                                      | 84,839      |             |           |           | 118,119      |  
|                                              | Deferred revenue                                                                                                                      |                          |                                      | 498,824     |             |           |           | 474,897      |  
|                                              |                                                                                                                                       |                          |                                      |             |             |           |          
|                                              |                                                                                                                                       |                          | Total current liabilities            |             |             | 1,781,384 |           |              |   | 1,472,459 | 
|                                              |                                                                                                                                       |                          |                                      |             |             |           |          
|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 |                          |                                      | 504,137     |             |           |           | 498,701      |  
|                                              | Additional paid-in capital                                                                                                            |                          |                                      | 18,921,150  |             |           |           | 18,580,288   |  
|                                              | Accumulated deficit                                                                                                                   |                          |                                      | (13,651,488 | )           |           |           | (12,984,327  | )
|                                              |                                                                                                                                       |                          |                                      |             |             |           |          
|                                              |                                                                                                                                       |                          | 6,148,799                            |             |             |           | 6,469,662 |             
|                                              |                                                                                                                                       |                          |                                      |             |             |           |          
|                                              |                                                                                                                                       | $                        | 7,930,183                            |             |             | $         | 7,942,121 |             
|                                              |                                                                                                                                       |                          |                                      |             |             |           |          

See Notes to Financial Statements

2



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DATAKEY, INC.
STATEMENTS OF INCOME
(UNAUDITED)

|                                                     |                                                             |                                              |            |                    |           |   |           |         |           |  
|---------------------------------------------------- | ----------------------------------------------------------- | -------------------------------------------- | ---------- | ------------------ | --------- | - | --------- | ------- | --------- | -
|                                                     |                                                             |                                              |            | Three Months Ended |          
|                                                     |                                                             |                                              |            |                    |          
|                                                     |                                                             |                                              |            | March 30,          |           |   | March 31, |        
|                                                     |                                                             |                                              |            | 2002               |           |   | 2001      |        
|                                                     |                                                             |                                              |            |                    |           |   |           |        
|Revenue                                              |                                                             | $                                            | 2,492,894  |                    |           | $ | 1,296,638 |        
|Cost of goods sold                                   |                                                             |                                              | 1,500,634  |                    |           |   | 608,518   |        
|                                                     |                                                             |                                              |            |                    |           |  
|                                                     |                                                             | Gross Profit                                 |            |                    | 992,260   |   |           |         | 688,120   |  
|Operating expenses:                                  |                                                             |                                              |            |                    |           |   |           |        
|                                                     | Research, development, technical support
and engineering    |                                              |            | 582,109            |           |   |           | 600,157 |          
|                                                     | Marketing and sales                                         |                                              |            | 882,177            |           |   |           | 876,738 |          
|                                                     | General and administrative                                  |                                              |            | 197,139            |           |   |           | 210,422 |          
|                                                     |                                                             |                                              |            |                    |           |  
|                                                     |                                                             | Total operating expenses                     |            |                    | 1,661,425 |   |           |         | 1,687,317 |  
|                                                     |                                                             |                                              |            |                    |           |  
|                                                     |                                                             | Operating loss                               |            |                    | (669,165  | ) |           |         | (999,197  | )
|Interest income                                      |                                                             |                                              | 12,726     |                    |           |   | 2,694     |        
|                                                     |                                                             |                                              |            |                    |           |  
|Loss from continuing operations
before income taxes  |                                                             |                                              | (656,439   | )                  |           |   | (996,503  | )      
|Income tax expense                                   |                                                             |                                              | 0          |                    |           |   | 0         |        
|                                                     |                                                             |                                              |            |                    |           |  
|Net loss from continuing operations                  |                                                             |                                              | ($656,439  | )                  |           |   | ($996,503 | )      
|                                                     |                                                             |                                              |            |                    |           |  
|Loss from operations of discontinued segment         |                                                             |                                              | 0          |                    |           |   | 0         |        
|Loss from disposal of discontinued segment           |                                                             |                                              | (10,722    | )                  |           |   | 0         |        
|                                                     |                                                             |                                              |            |                    |           |  
|                                                     |                                                             | Net loss attributable to common stockholders |            |                    | ($667,161 | ) |           |         | ($996,503 | )
|                                                     |                                                             |                                              |            |                    |           |  
|                                                     | Basic and diluted loss per share
from continuing operations |                                              |            | ($0.07             | )         |   |           | ($0.11  | )        
|                                                     |                                                             |                                              |            |                    |           |  
|                                                     | Basic and diluted
loss per share                            |                                              |            | ($0.07             | )         |   |           | ($0.11  | )        
|                                                     |                                                             |                                              |            |                    |           |  
|Weighted average number of
common shares outstanding |                                                             |                                              | 10,050,436 |                    |           |   | 9,065,798 |        
|                                                     |                                                             |                                              |            |                    |           |  

See Notes to Financial Statements

3



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DATAKEY, INC.
STATEMENTS OF CASH FLOWS
(UNAUDITED)

|                                     |                                                                             |                                  |                         |                                               |        |                    |          |           |           |  |            |  
|------------------------------------ | --------------------------------------------------------------------------- | -------------------------------- | ----------------------- | --------------------------------------------- | ------ | ------------------ | -------- | --------- | --------- |  | ---------- | -
|                                     |                                                                             |                                  |                         |                                               |        | Three Months Ended |         
|                                     |                                                                             |                                  |                         |                                               |        |                    |         
|                                     |                                                                             |                                  |                         |                                               |        | March 30,          |          |           | March 31, | 
|                                     |                                                                             |                                  |                         |                                               |        | 2002               |          |           | 2001      | 
|                                     |                                                                             |                                  |                         |                                               |        |                    |          |           |           | 
|CASH FLOWS FROM
OPERATING ACTIVITIES |                                                                             |                                  |                         |                                               |        |                    |          |          
|                                     | Net loss                                                                    |                                  |                         | ($667,161                                     | )      |                    |          | ($996,503 | )        
|                                     | Adjustments to reconcile net loss
to net cash used in operating activities: |                                  |                         |                                               |        |                    |          |           |          
|                                     |                                                                             | Depreciation                     |                         |                                               | 30,417 |                    |          |           | 81,565    | 
|                                     |                                                                             | Amortization                     |                         |                                               | 22,554 |                    |          |           | 60,538    | 
|                                     |                                                                             |                                  |                         |                                               |        |                    |         
|                                     |                                                                             | Change in assets and liabilities |                         |                                               |        |                    |          |           |           | 
|                                     |                                                                             | (Increase) decrease in assets:   |                         |                                               |        |                    |          |           |           | 
|                                     |                                                                             |                                  |                         | Trade receivables                             |        |                    | (218,315 | )         |           |  | (676,033   | )
|                                     |                                                                             |                                  |                         | Inventories                                   |        |                    | (263,101 | )         |           |  | (221,240   | )
|                                     |                                                                             |                                  |                         | Prepaid expenses and other                    |        |                    | 26,477   |           |           |  | 63,724     |  
|                                     |                                                                             |                                  | Increase (decrease) in: |                                               |        |                    |          |           |           |  |           
|                                     |                                                                             |                                  |                         | Reserve for loss from discontinued operations |        |                    |          |           |           |  | (57,161    | )
|                                     |                                                                             |                                  |                         | Accounts payable                              |        |                    | 214,567  |           |           |  | (129,447   | )
|                                     |                                                                             |                                  |                         | Accrued expenses                              |        |                    | 94,358   |           |           |  | 126,069    |  
|                                     |                                                                             |                                  |                         |                                               |        |                    |         
|                                     |                                                                             |                                  |                         | Net cash used in
operating activities         |        |                    | (760,204 | )         |           |  | (1,748,488 | )
|                                     |                                                                             |                                  |                         |                                               |        |                    |         
|CASH FLOWS FROM INVESTING ACTIVITIES |                                                                             |                                  |                         |                                               |        |                    |          |          
|                                     | Purchase of equipment and leasehold improvements                            |                                  |                         | (61,583                                       | )      |                    |          | (27,160   | )        
|                                     |                                                                             |                                  |                         |                                               |        |                    |         
|                                     |                                                                             |                                  |                         | Net cash used in
investing activities         |        |                    | (61,583  | )         |           |  | (27,160    | )
|                                     |                                                                             |                                  |                         |                                               |        |                    |         
|CASH FLOWS FROM FINANCING ACTIVITIES |                                                                             |                                  |                         |                                               |        |                    |          |          
|                                     | Net proceeds from issuance of
common stock                                  |                                  |                         | 346,298                                       |        |                    |          | 4,619,835 |          
|                                     |                                                                             |                                  |                         |                                               |        |                    |         
|                                     |                                                                             |                                  |                         | Net cash provided by financing activities     |        |                    | 346,298  |           |           |  | 4,619,835  |  
|                                     |                                                                             |                                  |                         |                                               |        |                    |         
|                                     |                                                                             |                                  |                         | Increase (decrease) in cash                   |        |                    | (475,489 | )         |           |  | 2,844,187  |  
|CASH AND CASH EQUIVALENTS            |                                                                             |                                  |                         |                                               |        |                    |          |          
|                                     | Beginning                                                                   |                                  |                         | 4,112,264                                     |        |                    |          | 1,532,558 |          
|                                     |                                                                             |                                  |                         |                                               |        |                    |         
|                                     | Ending                                                                      |                                  | $                       | 3,636,775                                     |        |                    | $        | 4,376,745 |          
|                                     |                                                                             |                                  |                         |                                               |        |                    |         

See Notes to Financial Statements

4



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DATAKEY, INC.
NOTES TO FINANCIAL STATEMENTS

GENERALIn the opinion of management, the accompanying unaudited financial statements
contain all adjustments necessary to present fairly Datakeys financial
position as of March 30, 2002, and December 31, 2001, and results of its
operations and cash flows for the three-month periods ended March 30, 2002, and
March 31, 2001. 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 2001 Datakey, Inc. Annual Report and in
Form 10-KSB for the year ended December 31, 2001.

ACCOUNTING STANDARDS RECENTLY ADOPTED AND NOT YET ADOPTEDRecently Adopted:Effective January 1, 2002 the Company adopted FASB Statement No. 141,
Business Combinations which eliminates the pooling method of accounting for
business combinations and Statement No. 142, Goodwill and Other Intangible
Assets which eliminates the amortization of goodwill and other intangibles that
are determined to have an indefinite life and requires, at a minimum, annual
impairment tests of goodwill and other intangible assets that are determined to
have an indefinite life. The adoption of these new standards had no
significant effect on the financial statements for the three months ended March
30, 2002.

Not Yet Adopted:In September 2001, the FASB issued Statement 143, Asset Retirement Obligations.
This Statement addresses financial accounting and reporting for obligations
associated with the retirement of tangible long-lived assets and the associated
asset retirement costs. The Statement will be effective for the Companys
fiscal year ending December 2003. The Company does not believe that the
adoption of this pronouncement will have a material effect on its financial
statements.

In August 2001, the FASB issued Statement 144, Accounting for Impairment or
Disposal of Long-Lived Assets. This Statement addresses financial accounting
and reporting for the impairment or disposal of long-lived assets. The
Company has not yet completed its full assessment of the effect of these new
standard on its financial statements but believes its impact will not be
significant. The Statement will be effective for the Companys fiscal year
ending December 2002.

OPERATING SEGMENTSThrough 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 was 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. 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.

|                              |  |                                   |         |   |     |   |           |             |  |   |        |  |  |   |           |  
|----------------------------- |  | --------------------------------- | ------- | - | --- | - | --------- | ----------- |  | - | ------ |  |  | - | --------- | -
|                              |  | 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  | )

|                              |  |                                   |           |   |     |   |           |             |  |   |       |  |  |  |       |  |  |   |            |  
|----------------------------- |  | --------------------------------- | --------- | - | --- | - | --------- | ----------- |  | - | ----- |  |  |  | ----- |  |  | - | ---------- | -
|                              |  | Three Months Ended March 31, 2001 |          
|                              |  |                                   |          
|                              |  | EP                                |           |   | ISS |   |           | UNALLOCATED |  |   | TOTAL | 
|                              |  |                                   |           |   |     |   |           |             |  |   |       | 
|Revenue                       |  | $                                 | 1,071,630 |   |     | $ | 1,296,638 |             |  | $ |       |  |  |  |      |  |  | $ | 2,368,268  |  
|Interest income (expense)     |  |                                   |          |   |     |   |          |             |  |   |       |  |  |  | 2,694 |  |  |   | 2,694      |  
|Depreciation and amortization |  |                                   | 45,286    |   |     |   | 96,817    |             |  |   |       |  |  |  |      |  |  |   | 142,103    |  
|Segment profit (loss)         |  |                                   | *(57,161  | ) |     |   | (999,197  | )           |  |   |       |  |  |  | 2,694 |  |  |   | (1,053,664 | )



| |                                                                                                                                                              
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------
| | * EP loss during first quarter of 2001 was not reflected in the income
statement because a provision for loss on disposal of $1,281,000 was
provided in 2000.

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DISCONTINUED OPERATIONSIn 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 it was
possible the operations could be sold if a purchaser was found. (See Sale of
Discontinued Business Segment).

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 is being
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. Net assets of the EP segment as of March
30, 2002 and December 31, 2001 are as follows:

|                                        |  |                |        |  |               |   |        | 
|--------------------------------------- |  | -------------- | ------ |  | ------------- | - | ------ | 
|                                        |  | March 30, 2002 |        |  | Dec. 31, 2001 |  
|                                        |  |                |        |  |               |  
|Trade receivables                       |  | $              | 22,342 |  |               | $ | 82,077 | 
|Net assets from discontinued operations |  | $              | 22,342 |  |               | $ | 82,077 | 
|                                        |  |                |        |  |               |  

SALE OF DISCONTINUED BUSINESS SEGMENTOn 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, will record the cash difference between accounts receivable and
accounts payable and accrued expense and profit on the customer contracts
retained when realized. Due to the nature of the transaction, the final
accounting is not complete but 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 has extended beyond the date that was initially expected at the time
the EP segment was sold. The Company has now received all necessary customer
provided materials and test fixtures to complete the final manufacture of the
finished goods, and shipment is expected to occur during the second quarter of
2002. A profit from disposition of discontinued operation of approximately
$450,000 to $500,000 is expected upon shipment. A loss from disposal of
discontinued operations of $10,722 was recorded during the first quarter of
2002 because the Company obtained only nominal revenue during the quarter and
incurred expenses related to the discontinuation of the EP segment.

6



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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

REVENUEISS revenue for the three-month period ended March 30, 2002, increased by
$1,196,000, or 92 percent, as compared to the same period in 2001. The
significant increase in revenue is primarily due to a significant sale to a
foreign government agency during the quarter. Revenue in the second quarter of
2002 is expected to be less than the first quarter of 2002 but more than the
second quarter of 2001.

GROSS PROFIT MARGINGross profit, as a percentage of revenue, decreased to 40 percent in the
three-month period ended March 30, 2002, from 53 percent in the three-month
period ended March 31, 2001. The decrease in gross profit percentage was
primarily due to a significant portion of the first quarter revenue consisting
of USB tokens that are re-sold by Datakey which carry a much lower margin than
Datakeys standard products.

OPERATING EXPENSESOperating expenses decreased by $26,000, or 2 percent, in the three-month
period ended March 30, 2002 as management continued to control discretionary
spending in light of lower than normal gross profit margin. Operating expenses
during the balance of 2002 are expected to increase modestly from the quarterly
rate experienced in the first quarter with the total expense in 2002 at about
6% higher than 2001.

INTEREST INCOMEInterest income, net of interest expense, increased to $13,000 in the
three-month period reflecting a lower rate of interest on the Companys money
market account than in the 2001 three-month period. Interest income is
expected to decrease slightly over the balance of the year primarily due to use
of cash to fund the Companys operations.

OUTLOOKAlthough there is evidence of a worldwide slowdown in information security
spending, we continue to see a solid level of activity, as evidenced by growth
in our evaluation, pilot and production programs, with regard to upgrading
their information security systems with Datakey solutions. In many cases,
however, the additional customers effort to install new or upgraded system and
application software, as well as other upgrades while our products are being
integrated, has extended our production rollouts over what we expected a few
months ago. Accordingly, we are revising our revenue guidance for the year to
a range between $10 million and $12 million with the expectation that the
deferred production rollouts will take place in 2003. While our quarterly
results are subject to significant fluctuations and are difficult to project,
we currently expect second-quarter revenues to be less than first quarter
revenues, but greater than second-quarter revenues in 2001. We now expect to
achieve profitability in the second half of the year rather than the entire
year.

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RESULTS OF OPERATIONS
DISCONTINUED OPERATIONS
(Also See Sale of Discontinued Business Segment in Notes to Financial Statements)

REVENUERevenue from discontinued operations in the three-month period ended March 30,
2002 was a decrease of $1,053,000 compared to the same period in 2001 because
the majority of the discontinued business was sold in August 2001.

OPERATING INCOME AND LOSSDiscontinued operations reflected a loss of $11,000 during the quarter,
compared to no loss in the same quarter last year because the Company recorded,
in 2000, a provision for loss on disposition that included the estimated first
quarter 2001 loss from operations. (See Sale of Discontinued Business
Segment in Notes to Financial Statements).

LIQUIDITY AND FINANCIAL
CONDITIONThe Company experienced a decrease in cash of $475,000 in the three-month
period ended March 30, 2002 as a result of the operating loss and increases in
receivables and inventory, offset in part by increases in accounts payable and
accrued expenses and $346,000 in proceeds received from the sale of common
stock upon the exercise of certain warrants and pursuant to the employee stock
purchase plan. The statements of cash flows include discontinued operations as
well as continuing operations in the periods presented.

Datakeys balance sheet reflects $5,558,000 in working capital as of March 30,
2002 and a current assets to current liabilities ratio of 4.12 to 1. The
Company believes that its current cash will provide sufficient funding for at
least the next twelve months.

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FORWARD LOOKING STATEMENTS AND RISK FACTORS

The Managements Discussion and Analysis contains certain forward-looking
statements relating to the implication that the information security product
revenue will continue to improve, that second quarter revenue in 2002, though
less than that of the first quarter, will exceed second quarter revenue in
2001, that gross margins will improve, that annual revenue in 2002 will be
between $10 million and $12 million, that the Company will achieve
profitability in the second half of 2002, and that the Company will be able to
fund its operations for at least twelve 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: (i) that 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 may not be able to obtain continued favorable
pricing for its ISS products; (iii) the introduction of competitive information
security products, (iv) the ability of the Company to attain profitability and
positive cash flows by significantly increasing ISS product revenues while
controlling expenses; and (v) the uncertain market conditions created by the
current economic downturn.

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PART II. OTHER INFORMATION

ITEM 2. CHANGES IN SECURITIESOn January 29, 2002, the Company sold 80,268 common shares, for $276,122,
pursuant to the exercise of a warrant which was issued to a selling agent in
connection with a private placement completed on February 20, 2001. The
Company relied upon Section 4(2) of the Securities Act, which provides an
exemption for transactions not involving a public offering.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

| | (a) |  | Reports on Form 8-K
| | --- |  | -------------------
|
| |     |  | None.              
|
| | (b) |  | Exhibits           
|
| |     |  | None.              

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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 10, 2002 |  | Datakey, Inc. |  |                                             
|                   
|                    |  | By:           |  | /s/Alan G. Shuler                           
|                    |  |               | 
|                    |  |               |  | Alan G. Shuler                              
|                    |  |               |  | Vice President & Chief Financial
Officer    
|                    |  |               |  | (Principal Financial and
Accounting Officer)

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