SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549 FORM 10-QSB x      QUARTERY REPORT UNDER SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934 For the
quarterly period ended March 31, 2001 Commission
File Number 0-11447  DATAKEY, INC.(Exact name of small business issuer as
specified in its charter)  MINNESOTA
  41-1291472(State or other jurisdiction of
  (I.R.S. Employerincorporation or organization)
  Identification No.)
 407 WEST TRAVELERS TRAIL,
BURNSVILLE, MN  55337  Issuers telephone number:  (612) 890-6850  Former name, former address and former fiscal
year,
if changed since last report) Check
whether the issuer (1) filed all reports required to be filed by Section 13 or
15 (d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.  YesxNoo APPLICABLE ONLY TO CORPORATE ISSUERS The
number of shares outstanding of the issuers common equity, as of May 11, 2001,
is 9,907,906. Transitional
Small Business Disclosure Format (check One): YesxNoo   PART
I.  FINANCIAL INFORMATION
ITEM I.  FINANCIAL STATEMENTS
DATAKEY, INC.
BALANCE SHEETS

March
  31,
  December
  31,2001
  2000(UNAUDITED)ASSETSCURRENT ASSETSCash and
  cash equivalents
  $4,376,745
  $1,532,558Trade
  receivables, less allowance for doubtful accounts of  $30,000 and 26,000Inventories
  971,081
  513,846Prepaid
  and other
  49,452
  113,176Net assets
  of discontinued operations
  1,437,730
  1,561,999Total current assets
  8,381,485
  4,710,599OTHER ASSETSPrepaid
  licenses and patents at cost less amortization of $762,313 and 698,517
  445,795
  498,961EQUIPMENT AND
  LEASEHOLD IMPROVEMENTS, at costProduction
  tooling
  63,188
  63,188Equipment
  973,955
  954,397Furniture
  and fixtures
  284,423
  284,423Leasehold
  improvements
  224,488
  224,4881,546,054
  1,526,496Less
  accumulated depreciation
  (1,317,592)
  (1,300,268)228,462
  226,228$9,055,742
  $5,435,788LIABILITIES
  AND SHAREHOLDERS' EQUITYCURRENT LIABILITIESAccounts
  payable
  $505,703
  $386,613Accrued
  compensation
  315,925
  226,803Accrued
  expenses-other
  60,513
  74,031Deferred
  revenue
  82,290
  63,797Net
  liabilities from discontinued operations
  264,311
  480,875Total
  current liabilities
  1,228,742
  1,232,119SHAREHOLDERS' EQUITYConvertible
  preferred stock, voting, stated value $2.50 per share; authorized 
      400,000 shares; issued and outstanding 150,000
  375,000
  375,000Common
  stock, par value $.05 per share;
      authorized 20,000,000 shares; issued and outstanding
      9,885,239 in 2001 and 8,269,173 in 2000
  494,262
  413,459Additional
  paid-in capital
  18,445,776
  13,906,744Accumulated
  deficit
  (11,488,038)
  (10,491,534)7,827,000
  4,203,669$9,055,742
  $5,435,788See
Notes to Financial Statements

DATAKEY,
INC. 
STATEMENTS OF INCOME
(UNAUDITED)



Three
  Months EndedMarch
  31,
  April
  1,2001
  2000Revenue
  $1,296,638
  $458,795Cost of goods sold
  608,518
  290,734Gross
  Profit
  688,120
  168,061Operating
  expenses:Research,
  development and engineering
  600,157
  451,393Marketing
  and sales
  876,738
  350,198General
  and administrative
  210,422
  154,234Total
  operating expenses
  1,687,317
  955,825Operating
  loss
  (999,197)
  (787,764)Interest income
  2,694
  37,130Loss from continuing
  operations before income taxes
  (996,503)
  (750,634)Income tax expense
  0
  0Net loss from continuing
  operations
  ($996,503)
  ($750,634)Income from operations
  of discontinued segment
  0
  42,371Income (loss) from
  disposal of discontinued segment
  0
  0Net
  loss attributable to common stockholders
  ($996,503)
  ($708,263)Basic and
  diluted loss per share
  ($0.11)
  ($0.10)Weighted average
  number of common shares outstanding
  9,065,798
  7,304,433See
Notes to Consolidated Financial Statements

DATAKEY,
INC.
 STATEMENTS OF CASH FLOWS
 (UNAUDITED)




Three
  Months EndedMarch
  31,
  April
  1,2001
  2000CASH FLOWS FROMOPERATING ACTIVITIESNet loss
  ($996,503)
  ($708,263)Adjustments
  to reconcile net loss to net cash used in operating activities:Depreciation
  81,565
  81,610Amortization
  60,538
  55,551Change
  in assets and liabilities (Increase) decrease:Trade
  receivables
  (676,033)
  300,722Inventories
  (221,240)
  (52,683)Prepaid
  expenses and other
  63,724
  25,121Prepaid
  license fees and patent
  0
  (4,988)Increase (decrease) in:Reserve
  for loss on discontinued operations
  (57,161)
  0Accounts
  payable
  (129,447)
  (128,296)Accrued
  expenses
  126,069
  39,753Net cash used in operating activities
  (1,748,488)
  (391,473)CASH FLOWS FROM INVESTING ACTIVITIESPurchase
  of tooling and equipment
  (27,160)
  (65,416)Net cash used in investing activities
  (27,160)
  (65,416)CASH FLOWS FROM FINANCING ACTIVITIESNet
  proceeds from issuance of common stock
  4,619,835
  5,028,008Net
  cash provided by financing activities
  4,619,835
  5,028,008Increase(decrease) in cash and cash equivalents
  2,844,187
  4,571,119CASH AND CASH EQUIVALENTSBeginning
  1,532,558
  344,922Ending
  $4,376,745
  $4,916,041

See
Notes to Financial Statements

DATAKEY, INC.
NOTES TO FINANCIAL STATEMENTS

GENERAL

In
the opinion of management, the accompanying unaudited financial statements
contain all adjustments necessary to present fairly Datakeys financial
position as of March 31, 2001, and December 31, 2000, and results of its
operations and cash flows for the three-month periods ended March 31, 2001, and
April 1, 2000.  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 2000 Datakey, Inc. Annual Report and in
Form 10-KSB for the year ended December 31, 2000.

OPERATING SEGMENTS

The
Company has two reportable segments: Electronic Products (EP) and Integrated
Systems Solutions (ISS).  The Electronic
Products segment produces and markets proprietary memory keys, cards, and
custom-shaped tokens and systems that utilize these products that serve as a
convenient way to carry electronic information.  The Integrated Systems Solutions segment produces and markets
products for the information security market, which enable user identification
and authentication, secure data exchange, and information validation.

The
accounting policies of the segments are the same as those described in the
summary of significant accounting policies. 
There are no intersegment transactions. 
The Company evaluates performance based on operating earnings of the respective
segments.



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

Three Months
  Ended April 1, 2000EP
  ISS
  UNALLOCATED
  TOTALRevenue
  $1,314,582
  $458,795
  
  $1,773,377Interest Income
  
  
  37,130
  37,130Depreciation and
  amortization
  54,200
  82,961
  
  137,161Segment profit (loss)
  42,371
  (787,764)
  37,130
  (708,263)*The segment loss from the EP segment
during the period is not reflected in the Income Statement because the
estimated loss from operations of and disposition of the segment was charged to
earnings in 2000.

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 anticipates the phase down of the operations through December 31, 2001,
although it is possible the operations could be sold if a purchaser is found.  Some deliveries for orders received prior to
December 31, 2001 are expected to take place through June 30, 2002.  The financial statements have been prepared
as if the operation will be phased down.

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 and liabilities of the EP segment
as of March 31, 2001 and December 31, 2000 are as follows:

Mar. 31, 2001
  Dec. 31, 2000Trade receivables
  $616,857
  $498,281Inventories
  1,691,493
  1,927,488Equipment and leasehold improvements
  287,779
  344,418Patents
  65,440
  72,812Reserve for discontinued operations
  (1,223,839)
  (1,281,000)Net assets from discontinued operations
  $1,437,730
  $1,561,999Accounts payable
  $109,003
  $357,540Accrued expenses:Compensation
  155,308
  90,165Other
  0
  33,170Net liabilities from discontinued operations
  $264,311
  $480,875

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, 2001, increased by $838,000, or 183 percent, as compared to the
same period in 2000.  The significant
increase in revenue is due to increased acceptance of the Companys information
security product offering.  Management
believes that revenue in 2001 will continue to improve on a quarter to quarter
basis as compared to 2000 and will likely result in annual revenue that is at
least double that of 2000.

GROSS
PROFIT MARGIN Gross profit as a percentage of revenue increased to
53 percent in the three-month period ended March 31, 2001, from 37 percent in
the three-month period ended April 1, 2000. 
The increase in gross profit percentage is primarily due to favorable
product pricing during the quarter. 
Although the Company does not expect to always obtain product pricing as
favorable as was obtained in the first quarter, management expects the gross
margin percentage to continue to be favorable as compared to 2000 due to
increased revenue and technology licensing fees.

OPERATING
EXPENSES  Operating expenses increased by $731,000, or 77 percent,
due to redistribution of marketing and general and administrative expenses that
were previously shared with our discontinued operation, expenses related to
opening and staffing a European office and two additional US sales offices,
increases in product promotion expense, increases in staffing for software
development and technical support and increases in commission on the
significant increase in revenue.  
Operating expenses are expected to increase gradually for the balance of
the year as compared to the first quarter.

INTEREST
INCOME  Interest income, net of interest expense, decreased to
$2,694 in the three-month period as the balance of interest bearing accounts
was lower than in the prior year and because the Company borrowed $500,000 from
a major shareholder during the quarter as interim working capital as it was
arranging a private placement of common stock.   Interest income is expected to increase over the balance of the
year as a portion of the proceeds of the February 2001 private placement of
common stock are invested in an interest bearing money market account.

RESULTS OF
OPERATIONS
DISCONTINUED OPERATIONS

REVENUE -Revenue from
discontinued operations in the three months ended March 31, 2001 declined
$243,000 or 19 percent from the comparable period in 2000.  Revenue for the balance of 2001  is expected to be comparable to the first
quarter as the Company has scaled back the operations of the EP business
segment as it looks for a buyer of the business.



GROSS MARGIN -Gross margin from
discontinued operations in the three months ended March 31, 2001 declined
$161,000 or 31 percent from the comparable period in 2000 due, primarily to
lower revenue.  Gross margin for the
balance of 2001 is expected to be comparable to the first quarter.

OPERATING EXPENSES -Operating expenses from
discontinued operations in the three months ended March 31, 2001 declined
$61,000 or 13 percent from the comparable period in 2000 as the Company reduced
staff and scaled back operations to conserve cash while looking for a buyer for
the business segment.  Expenses for the
balance of 2001 are expected to be comparable with the first quarter.

OPERATING LOSS -Discontinued operations
reflected a loss of $57,161 during the quarter compared to a profit of $42,371
in the first quarter of 2000, primarily as a result of the reduced
revenue.  This segment loss did not
affect reported net loss as the Company provided a loss for operation of and
disposition of the discontinued business segment in 2000.  The results for the balance of 2001 are
expected to improve as the Company realizes the full quarterly effect of staff
reduction taken in February 2001.

FINANCIAL
CONDITION The Company experienced an increase in cash and cash
equivalents of $2,844,000 in the three-month period as a result of the
successful private placement of $4,620,000 (net of fees and expenses) of common
stock in February 2001 offset by $1,748,000 cash used in operations.  The statements of cash flows include
discontinued operations as well as continuing operations in the periods
presented.

Datakeys balance sheet reflects
$7,153,000 in working capital as of March 31, 2001 and a current assets to
current liabilities ratio of 6.82 to 1. 
The Company believes that its current cash and cash equivalents in
addition to its $1 million bank line of credit, which it expects to renew in
May 2001, will provide sufficient funding for at least the balance of 2001.

FORWARD LOOKING
STATEMENTS AND RISK FACTORS

The Managements Discussion and Analysis
contains certain forward-looking statements relating to the growing acceptance
of the Companys information security products, the implication that the
information security product revenue will continue to increase significantly,
that increased ISS product sales revenue and technology licensing revenue will
contribute significantly to gross margin, that the Company will be able to fund
its operations for at least the balance of 2001 and that the Company may find a
buyer for its EP segment.  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
competitive or other general market conditions; (ii) that the expected success
of current pilot programs and customer demand to convert to production programs
may not materialize; (iii) the introduction of competitive information security
products; (iv) that the Company may not be successful in developing significant
licensing arrangements to positively impact gross margin, (v) that the Company
may not be able to grow the ISS business unit fast enough to warrant the
substantial product development, sales and marketing expenditures which may
cause the Company to seek additional capital sooner than expected, (vi) the
ability of the Company to attain profitability and positive cash flows by
significantly increasing ISS product revenues while controlling expenses, (vii)
the ability of the Company to locate and successfully negotiate with a
potential buyer for the EP business segment; and (viii) recent fluctuations in
the stock market and general market conditions.



PART
II.  OTHER INFORMATION

ITEM 2.  CHANGES IN SECURITIES

On February 20,
2001, the Company sold 1,600,000 common shares and warrants to purchase an
additional 1,680,268 common shares in connection with a private placement.  For exemption from registration the Company
relied upon Section 4(6) of the Securities Act and Rule 506 of Regulation D for
such issuances.



ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

(a)         Exhibits

None.

(b)        Reports on Form 8-K

A Form 8-K dated February 20, 2001 was filed
announcing (i) completion of the Companys $4,800,000 financing; (ii) the
Companys strategic focus on its Information Security business and related
divestiture of its Electronic Products (EP) business; as well as (iii)
financial results for the fourth quarter and year ended December 31, 2000.

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 11, 2001
  Datakey,
  Inc.By:
  /s/Carl
  P. BoecherCarl
  P. BoecherPresident
  & Chief Executive Officer
  (Principal Executive Officer)By:
  /s/Alan G. ShulerAlan
  G. ShulerVice
  President & Chief Financial Officer
  (Principal Financial and  Accounting
  Officer)