##### 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 June 29, 2002
| | --------------------------------------------



| | Commission File Number 0-11447
| | ------------------------------

DATAKEY, INC.
(Exact name of small business issuer as specified in its charter)

|                                                                         |  |                                                
|------------------------------------------------------------------------ |  | -----------------------------------------------
|MINNESOTA
(State or other jurisdiction of
incorporation or organization) |  | 41-1291472
(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 X No

APPLICABLE ONLY TO CORPORATE ISSUERS

The number of shares outstanding of the issuers common equity, as of
August 9, 2002, is 10,082,750.

Transitional Small Business Disclosure Format (check One):

Yes  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
|RESULTS OF OPERATIONS AND FINANCIAL CONDITION                    
|FORWARD LOOKING STATEMENTS AND RISK FACTORS                      
|PART II. OTHER INFORMATION                                       
|SIGNATURES                                                       
|EXHIBIT INDEX                                                    
|EX-99.1 Certification of Chief Executive Officer                 
|EX-99.2 Certification of Chief Financial Officer                 



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##### Table of Contents












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

|                                              |                                                                                                                                       |                          |                                      |             |             |           |           |              |   |           | 
|--------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------- | ------------------------ | ------------------------------------ | ----------- | ----------- | --------- | --------- | ------------ | - | --------- | 
|                                              |                                                                                                                                       |                          |                                      |             | June 29,    |           |           | December 31, |  
|                                              |                                                                                                                                       |                          |                                      |             | 2002        |           |           | 2001         |  
|                                              |                                                                                                                                       |                          |                                      |             |             |           |           |              |  
|                                              |                                                                                                                                       |                          |                                      |             | (UNAUDITED) |           |           |              |   |          
|                                              |                                                                                                                                       |                          | ASSETS                               |             |             |           |           |              |   |           | 
|CURRENT ASSETS                                |                                                                                                                                       |                          |                                      |             |             |           |           |             
|                                              | Cash                                                                                                                                  |                          | $                                    | 3,680,828   |             |           | $         | 4,112,264    |  
|                                              | Trade receivables, less allowance for
doubtful accounts of $31,000 and $28,000                                                        |                          |                                      | 1,780,110   |             |           |           | 2,154,723    |  
|                                              | Inventories, less reserves for obsolescence
of $267,000 and $185,000                                                                  |                          |                                      | 1,068,520   |             |           |           | 926,028      |  
|                                              | Prepaid expenses and other                                                                                                            |                          |                                      | 98,753      |             |           |           | 84,433       |  
|                                              | Net assets of discontinued operations                                                                                                 |                          |                                      | 0           |             |           |           | 82,077       |  
|                                              |                                                                                                                                       |                          |                                      |             |             |          
|                                              |                                                                                                                                       |                          | Total current assets                 |             |             | 6,628,211 |           |              |   | 7,359,525 | 
|                                              |                                                                                                                                       |                          |                                      |             |             |          
|OTHER ASSETS                                  |                                                                                                                                       |                          |                                      |             |             |           |           |             
|                                              | Prepaid licenses and patents at cost less amortization                                                                                |                          |                                      | 138,181     |             |           |           | 191,839      |  
|                                              |                                                                                                                                       | of $886,032 and $832,374 |                                      |             |             |           |           |              |   |          
|EQUIPMENT AND LEASEHOLD IMPROVEMENTS, at cost |                                                                                                                                       |                          |                                      |             |             |           |           |             
|                                              | Production tooling                                                                                                                    |                          |                                      | 23,650      |             |           |           | 23,650       |  
|                                              | Equipment                                                                                                                             |                          |                                      | 740,267     |             |           |           | 701,326      |  
|                                              | Furniture and fixtures                                                                                                                |                          |                                      | 166,520     |             |           |           | 166,520      |  
|                                              | Leasehold improvements                                                                                                                |                          |                                      | 309,259     |             |           |           | 302,809      |  
|                                              |                                                                                                                                       |                          |                                      |             |             |          
|                                              |                                                                                                                                       |                          | 1,239,696                            |             |             |           | 1,194,305 |             
|                                              | Less accumulated depreciation                                                                                                         |                          |                                      | (841,651    | )           |           |           | (803,548     | )
|                                              |                                                                                                                                       |                          |                                      |             |             |          
|                                              |                                                                                                                                       |                          | 398,045                              |             |             |           | 390,757   |             
|                                              |                                                                                                                                       |                          |                                      |             |             |          
|                                              |                                                                                                                                       | $                        | 7,164,437                            |             |             | $         | 7,942,121 |             
|                                              |                                                                                                                                       |                          |                                      |             |             |          
|                                              |                                                                                                                                       |                          | LIABILITIES AND SHAREHOLDERS EQUITY |             |             |           |           |              |   |           | 
|CURRENT LIABILITIES                           |                                                                                                                                       |                          |                                      |             |             |           |           |             
|                                              | Accounts payable                                                                                                                      |                          | $                                    | 388,845     |             |           | $         | 566,345      |  
|                                              | Accrued compensation                                                                                                                  |                          |                                      | 278,842     |             |           |           | 313,098      |  
|                                              | Accrued expenses-other                                                                                                                |                          |                                      | 154,489     |             |           |           | 118,119      |  
|                                              | Deferred revenue                                                                                                                      |                          |                                      | 359,451     |             |           |           | 474,897      |  
|                                              |                                                                                                                                       |                          |                                      |             |             |          
|                                              |                                                                                                                                       |                          | Total current liabilities            |             |             | 1,181,627 |           |              |   | 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                                                                                                                   |                          |                                      | (13,817,477 | )           |           |           | (12,984,327  | )
|                                              |                                                                                                                                       |                          |                                      |             |             |          
|                                              |                                                                                                                                       |                          | 5,982,810                            |             |             |           | 6,469,662 |             
|                                              |                                                                                                                                       |                          |                                      |             |             |          
|                                              |                                                                                                                                       | $                        | 7,164,437                            |             |             | $         | 7,942,121 |             
|                                              |                                                                                                                                       |                          |                                      |             |             |          

See Notes to Financial Statements

2



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##### Table of Contents






DATAKEY, INC.
STATEMENTS OF INCOME
(UNAUDITED)

|                                                     |                                                             |                                              |            |                    |           |   |                  |         |           |          |             |           |            |   |             |           |             |  
|---------------------------------------------------- | ----------------------------------------------------------- | -------------------------------------------- | ---------- | ------------------ | --------- | - | ---------------- | ------- | --------- | -------- | ----------- | --------- | ---------- | - | ----------- | --------- | ----------- | -
|                                                     |                                                             |                                              |            | Three Months Ended |           |   | Six Months Ended |        
|                                                     |                                                             |                                              |            |                    |           |   |                  |        
|                                                     |                                                             |                                              |            | June 29,           |           |   | June 30,         |         |           | June 29, |             |           | June 30,   |  
|                                                     |                                                             |                                              |            | 2002               |           |   | 2001             |         |           | 2002     |             |           | 2001       |  
|                                                     |                                                             |                                              |            |                    |           |   |                  |         |           |          |             |           |            |  
|Revenue                                              |                                                             | $                                            | 1,869,522  |                    |           | $ | 1,054,909        |         |           | $        | 4,362,416   |           |            | $ | 2,351,547   |          
|Cost of goods sold                                   |                                                             |                                              | 826,118    |                    |           |   | 433,512          |         |           |          | 2,326,752   |           |            |   | 1,042,030   |          
|                                                     |                                                             |                                              |            |                    |           |   |                  |         |           |          |             |          
|                                                     |                                                             | Gross Profit                                 |            |                    | 1,043,404 |   |                  |         | 621,397   |          |             |           | 2,035,664  |   |             |           | 1,309,517   |  
|Operating expenses:                                  |                                                             |                                              |            |                    |           |   |                  |         |           |          |             |           |            |   |             |          
|                                                     | Research, development, technical support
and engineering    |                                              |            | 590,020            |           |   |                  | 579,520 |           |          |             | 1,172,129 |            |   |             | 1,179,677 |            
|                                                     | Marketing and sales                                         |                                              |            | 794,849            |           |   |                  | 820,096 |           |          |             | 1,677,026 |            |   |             | 1,696,834 |            
|                                                     | General and administrative                                  |                                              |            | 198,288            |           |   |                  | 193,345 |           |          |             | 395,427   |            |   |             | 403,767   |            
|                                                     |                                                             |                                              |            |                    |           |   |                  |         |           |          |             |          
|                                                     |                                                             | Total operating expenses                     |            |                    | 1,583,157 |   |                  |         | 1,592,961 |          |             |           | 3,244,582  |   |             |           | 3,280,278   |  
|                                                     |                                                             |                                              |            |                    |           |   |                  |         |           |          |             |          
|                                                     |                                                             | Operating loss                               |            |                    | (539,753  | ) |                  |         | (971,564  | )        |             |           | (1,208,918 | ) |             |           | (1,970,761  | )
|Interest income                                      |                                                             |                                              | 11,997     |                    |           |   | 37,482           |         |           |          | 24,723      |           |            |   | 40,176      |          
|                                                     |                                                             |                                              |            |                    |           |   |                  |         |           |          |             |          
|Loss from continuing operations
before income taxes  |                                                             |                                              | (527,756   | )                  |           |   | (934,082         | )       |           |          | (1,184,195  | )         |            |   | (1,930,585  | )        
|Income tax expense                                   |                                                             |                                              | 0          |                    |           |   | 0                |         |           |          | 0           |           |            |   | 0           |          
|                                                     |                                                             |                                              |            |                    |           |   |                  |         |           |          |             |          
|Net loss from continuing operations                  |                                                             |                                              | ($527,756  | )                  |           |   | ($934,082        | )       |           |          | ($1,184,195 | )         |            |   | ($1,930,585 | )        
|                                                     |                                                             |                                              |            |                    |           |   |                  |         |           |          |             |          
|Profit from operations of discontinued segment       |                                                             |                                              | 0          |                    |           |   | 0                |         |           |          | 0           |           |            |   | 0           |          
|Gain from disposal of discontinued segment           |                                                             |                                              | 361,767    |                    |           |   | 0                |         |           |          | 351,045     |           |            |   | 0           |          
|                                                     |                                                             |                                              |            |                    |           |   |                  |         |           |          |             |          
|                                                     |                                                             | Net loss attributable to common stockholders |            |                    | ($165,989 | ) |                  |         | ($934,082 | )        |             |           | ($833,150  | ) |             |           | ($1,930,585 | )
|                                                     |                                                             |                                              |            |                    |           |   |                  |         |           |          |             |          
|                                                     | Basic and diluted loss per share
from continuing operations |                                              |            | ($0.05             | )         |   |                  | ($0.09  | )         |          |             | ($0.12    | )          |   |             | ($0.20    | )          
|                                                     |                                                             |                                              |            |                    |           |   |                  |         |           |          |             |          
|                                                     | Basic and diluted
loss per share                            |                                              |            | ($0.02             | )         |   |                  | ($0.09  | )         |          |             | ($0.08    | )          |   |             | ($0.20    | )          
|                                                     |                                                             |                                              |            |                    |           |   |                  |         |           |          |             |          
|Weighted average number of
common shares outstanding |                                                             |                                              | 10,082,750 |                    |           |   | 9,902,730        |         |           |          | 10,066,772  |           |            |   | 9,486,576   |          
|                                                     |                                                             |                                              |            |                    |           |   |                  |         |           |          |             |          

See Notes to Financial Statements

3



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##### Table of Contents






DATAKEY, INC.
STATEMENTS OF CASH FLOWS
(UNAUDITED)

|                                     |                                                                             |                                                                 |                         |                                                     |        |                    |          |           |                  |  |          |           |        |  |          |             |         |  |            |  
|------------------------------------ | --------------------------------------------------------------------------- | --------------------------------------------------------------- | ----------------------- | --------------------------------------------------- | ------ | ------------------ | -------- | --------- | ---------------- |  | -------- | --------- | ------ |  | -------- | ----------- | ------- |  | ---------- | -
|                                     |                                                                             |                                                                 |                         |                                                     |        | Three Months Ended |          |           | Six Months Ended | 
|                                     |                                                                             |                                                                 |                         |                                                     |        |                    |          |           |                  | 
|                                     |                                                                             |                                                                 |                         |                                                     |        | June 29,           |          |           | June 30,         |  |          | June 29,  |        |  | June 30, |            
|                                     |                                                                             |                                                                 |                         |                                                     |        | 2002               |          |           | 2001             |  |          | 2002      |        |  | 2001     |            
|                                     |                                                                             |                                                                 |                         |                                                     |        |                    |          |           |                  |  |          |           |        |  |          |            
|CASH FLOWS FROM                      |                                                                             |                                                                 |                         |                                                     |        |                    |          |           |                  |  |          |           |        |  |          |            
|OPERATING ACTIVITIES                 |                                                                             |                                                                 |                         |                                                     |        |                    |          |           |                  |  |          |           |        |  |          |            
|                                     | Net loss                                                                    |                                                                 |                         | ($165,989                                           | )      |                    |          | ($934,082 | )                |  |          | ($833,150 | )      |  |          | ($1,930,585 | )      
|                                     | Adjustments to reconcile net loss
to net cash used in operating activities: |                                                                 |                         |                                                     |        |                    |          |           |                  |  |          |           |        |  |          |             |        
|                                     |                                                                             | Depreciation                                                    |                         |                                                     | 32,318 |                    |          |           | 90,503           |  |          |           | 62,735 |  |          |             | 159,198 | 
|                                     |                                                                             | Amortization                                                    |                         |                                                     | 31,104 |                    |          |           | 90,899           |  |          |           | 53,658 |  |          |             | 151,437 | 
|                                     |                                                                             | Change in assets and liabilities
(Increase) decrease in assets: |                         |                                                     |        |                    |          |           |                  |  |          |           |        |  |          |             |         | 
|                                     |                                                                             |                                                                 |                         | Trade receivables                                   |        |                    | 675,005  |           |                  |  | 546,012  |           |        |  | 456,690  |             |         |  | (130,021   | )
|                                     |                                                                             |                                                                 |                         | Inventories                                         |        |                    | 120,609  |           |                  |  | (806,026 | )         |        |  | (142,492 | )           |         |  | (1,027,266 | )
|                                     |                                                                             |                                                                 |                         | Prepaid expenses and other                          |        |                    | (40,797  | )         |                  |  | (37,786  | )         |        |  | (14,320  | )           |         |  | 25,938     |  
|                                     |                                                                             |                                                                 | Increase (decrease) in: |                                                     |        |                    |          |           |                  |  |          |           |        |  |          |             |         |  |           
|                                     |                                                                             |                                                                 |                         | Reserve for loss from discontinued operations       |        |                    | 0        |           |                  |  | 167,309  |           |        |  | 0        |             |         |  | 110,148    |  
|                                     |                                                                             |                                                                 |                         | Accounts payable                                    |        |                    | (392,067 | )         |                  |  | 180,539  |           |        |  | (177,500 | )           |         |  | 51,092     |  
|                                     |                                                                             |                                                                 |                         | Accrued expenses                                    |        |                    | (68,317  | )         |                  |  | (79,688  | )         |        |  | 2,114    |             |         |  | 4,206      |  
|                                     |                                                                             |                                                                 |                         | Deferred revenue                                    |        |                    | (139,373 | )         |                  |  | 18,493   |           |        |  | (115,446 | )           |         |  | 60,668     |  
|                                     |                                                                             |                                                                 |                         |                                                     |        |                    |          |           |                  |  |          |          
|                                     |                                                                             |                                                                 |                         | Net cash provided by (used in)
operating activities |        |                    | 52,493   |           |                  |  | (763,827 | )         |        |  | (707,711 | )           |         |  | (2,525,185 | )
|                                     |                                                                             |                                                                 |                         |                                                     |        |                    |          |           |                  |  |          |          
|CASH FLOWS FROM INVESTING ACTIVITIES |                                                                             |                                                                 |                         |                                                     |        |                    |          |           |                  |  |          |           |        |  |          |            
|                                     | Purchase of equipment and leasehold improvements                            |                                                                 |                         | (8,440                                              | )      |                    |          | (198      | )                |  |          | (70,023   | )      |  |          | (14,488     | )      
|                                     |                                                                             |                                                                 |                         |                                                     |        |                    |          |           |                  |  |          |          
|                                     |                                                                             |                                                                 |                         | Net cash used in
investing activities               |        |                    | (8,440   | )         |                  |  | (198     | )         |        |  | (70,023  | )           |         |  | (14,488    | )
|                                     |                                                                             |                                                                 |                         |                                                     |        |                    |          |           |                  |  |          |          
|CASH FLOWS FROM FINANCING ACTIVITIES |                                                                             |                                                                 |                         |                                                     |        |                    |          |           |                  |  |          |           |        |  |          |            
|                                     | Net proceeds from issuance of
common stock                                  |                                                                 |                         | 0                                                   |        |                    |          | (11,323   | )                |  |          | 346,298   |        |  |          | 4,608,512   |        
|                                     |                                                                             |                                                                 |                         |                                                     |        |                    |          |           |                  |  |          |          
|                                     |                                                                             |                                                                 |                         | Net cash provided by (used in) financing activities |        |                    | 0        |           |                  |  | (11,323  | )         |        |  | 346,298  |             |         |  | 4,608,512  |  
|                                     |                                                                             |                                                                 |                         |                                                     |        |                    |          |           |                  |  |          |          
|                                     |                                                                             |                                                                 |                         | Increase (decrease) in cash                         |        |                    | 44,053   |           |                  |  | (775,348 | )         |        |  | (431,436 | )           |         |  | 2,068,839  |  
|CASH AND CASH EQUIVALENTS            |                                                                             |                                                                 |                         |                                                     |        |                    |          |           |                  |  |          |           |        |  |          |            
|                                     | Beginning                                                                   |                                                                 |                         | 3,636,775                                           |        |                    |          | 4,376,745 |                  |  |          | 4,112,264 |        |  |          | 1,532,558   |        
|                                     |                                                                             |                                                                 |                         |                                                     |        |                    |          |           |                  |  |          |          
|                                     | Ending                                                                      |                                                                 | $                       | 3,680,828                                           |        |                    | $        | 3,601,397 |                  |  | $        | 3,680,828 |        |  | $        | 3,601,397   |        
|                                     |                                                                             |                                                                 |                         |                                                     |        |                    |          |           |                  |  |          |          

See Notes to Financial Statements

4



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##### Table of Contents






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 June 29, 2002, and December 31, 2001, and results of its
operations and cash flows for the three-month and six-month periods ended June
29, 2002, and June 30, 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.

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. 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 June 29, 2002 |         |  | Six Months Ended June 29, 2002 |  
|                              |  |                                  |         |  |                                |  
|                              |  | EP                               |         |  | ISS                            |   |           | UNALLOCATED |  |  | TOTAL  |  |  | EP |           |   | ISS |   |         | UNALLOCATED |  |   | TOTAL      |  
|                              |  |                                  |         |  |                                |   |           |             |  |  |        |  |  |    |           |   |     |   |         |             |  |   |            |  
|Revenue                       |  | $                                | 851,601 |  |                                | $ | 1,869,522 |             |  |  |        |  |  | $  | 2,721,123 |   |     | $ | 870,051 |             |  | $ | 4,362,416  |   |  | $ |        |  |  | $ | 5,232,467 |  
|Interest income
(expense)     |  |                                  |         |  |                                |   |           |             |  |  | 11,997 |  |  |    | 11,997    |   |     |   |         |             |  |   |            |   |  |   | 24,723 |  |  |   | 24,723    |  
|Depreciation and
amortization |  |                                  | 0       |  |                                |   | 63,422    |             |  |  |        |  |  |    | 63,422    |   |     |   | 0       |             |  |   | 116,393    |   |  |   |        |  |  |   | 116,393   |  
|Segment profit (loss)         |  |                                  | 361,767 |  |                                |   | (539,753  | )           |  |  | 11,997 |  |  |    | (165,989  | ) |     |   | 351,045 |             |  |   | (1,208,918 | ) |  |   | 24,723 |  |  |   | (833,150  | )

|                              |  |                                  |           |  |                                |   |           |             |  |  |        |  |  |    |           |   |     |   |           |             |  |   |            |   |  |   |        |  |  |   |            |  
|----------------------------- |  | -------------------------------- | --------- |  | ------------------------------ | - | --------- | ----------- |  |  | ------ |  |  | -- | --------- | - | --- | - | --------- | ----------- |  | - | ---------- | - |  | - | ------ |  |  | - | ---------- | -
|                              |  | Three Months Ended June 30, 2001 |           |  | Six Months Ended June 30, 2001 |  
|                              |  |                                  |           |  |                                |  
|                              |  | EP                               |           |  | ISS                            |   |           | UNALLOCATED |  |  | TOTAL  |  |  | EP |           |   | ISS |   |           | UNALLOCATED |  |   | TOTAL      |  
|                              |  |                                  |           |  |                                |   |           |             |  |  |        |  |  |    |           |   |     |   |           |             |  |   |            |  
|Revenue                       |  | $                                | 1,049,382 |  |                                | $ | 1,054,909 |             |  |  |        |  |  | $  | 2,104,291 |   |     | $ | 2,121,012 |             |  | $ | 2,351,547  |   |  | $ |        |  |  | $ | 4,472,559  |  
|Interest income
(expense)     |  |                                  |           |  |                                |   |           |             |  |  | 37,482 |  |  |    | 37,482    |   |     |   |           |             |  |   |            |   |  |   | 40,176 |  |  |   | 40,176     |  
|Depreciation and
amortization |  |                                  | 61,527    |  |                                |   | 119,480   |             |  |  |        |  |  |    | 181,007   |   |     |   | 106,812   |             |  |   | 213,570    |   |  |   |        |  |  |   | 320,382    |  
|Segment profit (loss)         |  |                                  | *167,309  |  |                                |   | (971,564  | )           |  |  | 37,482 |  |  |    | (766,773  | ) |     |   | *110,148  |             |  |   | (1,970,761 | ) |  |   | 40,176 |  |  |   | (1,820,437 | )



| |  | *EP profit during the first six months 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 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 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 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. Net assets of the EP segment as of June
29, 2002 and December 31, 2001 are as follows:

|                                        |  |               |   |  |               |   |        | 
|--------------------------------------- |  | ------------- | - |  | ------------- | - | ------ | 
|                                        |  | June 29, 2002 |   |  | Dec. 31, 2001 |  
|                                        |  |               |   |  |               |  
|Trade receivables                       |  | $             | 0 |  |               | $ | 82,077 | 
|Net assets from discontinued operations |  | $             | 0 |  |               | $ | 82,077 | 
|                                        |  |               |   |  |               |  

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 is 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
with regard to this sale.

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##### Table of Contents









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

ISS revenue for the three-month period ended June 29, 2002, increased by
$815,000, or 77 percent, as compared to the same period in 2001. Revenue in
the six-month period ended June 29, 2002, increased by $2,011,000, or 86
percent. The significant increase in revenue in the three-month and six-month
periods results from increasing acceptance of and demand for the Companys
smart token based information security products.

GROSS PROFIT MARGIN

Gross profit, as a percentage of revenue, decreased to 56 percent in the
three-month period ended June 29, 2002, from 59 percent in the three-month
period ended June 30, 2001, and decreased to 47 percent from 56 percent in the
six-month period. The decrease in gross profit percentage in the three-month
period related to a significant contribution from technology licensing revenue
in the prior year which did not reoccur in 2002. The reduction in percentage
in the six-month period is primarily due to a significant portion of the first
quarter 2002 revenue consisting of USB tokens that are re-sold by Datakey and
carry a much lower margin than Datakeys standard products. The gross margin
percentage for the balance of 2002 is expected to remain in the mid to high 50
percent range as the Company expects to ship products with more software
content and intends to reduce the cost of products that are expected to be
re-sold.

OPERATING EXPENSES

Operating expenses decreased by $10,000 in the three-month period ended June
29, 2002, and decreased by $36,000 in the six-month period, as management
continued to control discretionary spending. Operating expenses during the
balance of 2002 are expected to increase modestly.

INTEREST INCOME

Interest income, net of interest expense, decreased to $12,000 from $37,000 in
the three-month period and decreased to $25,000 from $40,000 in the six-month
period, reflecting a lower rate of interest. Interest income is expected to
decrease slightly over the balance of the year due to a decrease in cash.

OUTLOOK

Although 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. In many cases, however,
additional customer efforts to install new or upgraded system and application
software, as well as other upgrades while our products are being integrated,
have extended our production rollouts over what we expected a few months ago.
This stretching out of delivery schedules was observed during the first
quarter and has not changed materially in recent months. Accordingly, we are
affirming our revenue guidance for the year to a range between $10 million and
$12 million. We continue to expect to achieve profitability in the second half
of the year.

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



REVENUE

Revenue from discontinued operations in the three-month period ended June 29,
2002 was $852,000, compared to $1,049,00 the same period in 2001. The majority
of the discontinued business was sold in August 2001. The Company completed
the final delivery under the final contract retained upon sale of the
discontinued operation during the quarter and will not report any revenue from
discontinued operations going forward.

OPERATING INCOME AND LOSS

Discontinued operations reflected a gain of $362,000 during the quarter, and
$351,000 in the six-month period ended June 29, 2002. The Company does not
expect to report any further gain or loss from the sale of EP business segment
from this point forward.

LIQUIDITY AND FINANCIAL CONDITION

The Company experienced an increase in cash of $44,000 in the three-month
period ended June 29, 2002 and a decrease in cash of $431,000 in the six-month
period. The increase in cash during the most recent three-month period is due
to a reduction in the operating loss and settlement of the final delivery under
the only contract retained upon sale of the EP segment. The decrease in cash
during the six-month period was due to the operating loss, an increase in
inventory, and decreases in accounts payable and accrued expenses. This
decrease was offset by $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 during the first quarter. The statements of cash flows include
discontinued operations as well as continuing operations in the periods
presented.

Accounts receivable declined $457,000 during the six-month period ended June
29, 2002 primarily as a result of lower revenue in the quarter ended June 29,
2002. Accounts payable, likewise, declined $178,000 during the six-month
period as a result of a reduction in inventory purchases in the quarter ended
June 29, 2002. Inventory increased by $142,000 during the six-month period
ended June 29, 2002 as the Company acquired additional parts and finished goods
in preparation for an expected increase in revenue during the second half of
2002.

Deferred revenue decreased $115,000 during the six-month period ended June 29,
2002 as the amortization of deferred revenue during the six-month period
exceeded the additional deferred revenue booked. The decline is attributable to
a decline in revenue during the six-month period ended June 29, 2002 compared
to the six-month period ended December 31, 2001. Deferred revenue consists of
extended maintenance contracts that are, typically, a percentage of revenue
from the sale of products, and are amortized over the term of the contracts.

Datakeys balance sheet reflects $5,447,000 in working capital as of June 29,
2002 and a current assets to current liabilities ratio of 5.6 to 1. The
Company believes that its current cash will provide sufficient funding for at
least the next twelve months.

CONTRACTUAL CASH OBLIGATIONS

The Company presently has no long-term debt outstanding and its only
contractual cash obligations are those from operating lease obligations. These
lease obligations total $660,000 as shown below:

|                           |  |  |                                 |                        |  | 
|-------------------------- |  |  | ------------------------------- | ---------------------- |  | 
|2002
2003
*2004
thereafter |  |  | $165,000
310,000
157,000
28,000 | (remaining six months)



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

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FORWARD LOOKING STATEMENTS AND RISK FACTORS

The Managements Discussion and Analysis contains certain forward-looking
statements including that: (i) revenues will increase in the second half of
2002 and will be between $10 million and $12 million for the year; (ii) the
second half of 2002 will be profitable; (iii) gross margins will improve; (iv)
and the Company will be able 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) the
Company may not be able to obtain continued favorable pricing for its ISS
products; and all of such forward-looking statements depend on the ability of
the Company to attain profitability and positive cash flows by significantly
increasing ISS product revenues while controlling expenses.

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##### Table of Contents






PART II. OTHER INFORMATION

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY SHAREHOLDERS

The Company held its Annual Meeting on Wednesday, May 22, 2002.

Proxies for the Annual Meeting were solicited pursuant to Regulation 14 under
the Securities Exchange Act of 1934. There was no solicitation in opposition
to managements nominees as listed in the Companys proxy statement, and all
nominees were elected.

By 8,157,130 votes in favor, with 111,534 votes opposed, and 6,042 votes
abstaining, the shareholders set the number of directors at five (5).

The shareholders elected the nominee named below for Class I Director, to serve
a three year term, pursuant to the following votes:

|               |  |           |           |  |                 |  |         | 
|-------------- |  | --------- | --------- |  | --------------- |  | ------- | 
|               |  | NUMBER OF |           |  | NUMBER OF VOTES | 
|NOMINEE        |  | VOTES FOR |           |  | WITHHELD        | 
|               |  |           |           |  |                 | 
|Thomas R. King |  |           | 7,808,379 |  |                 |  | 466,327 | 

The terms of Gary Holland, Eugene Courtney, Terrence Glarner and Carl Boecher,
as directors of the Company, continued after the meeting.

The shareholders approved, by a vote of 7,444,222 in favor, with 797,477
against and 33,007 abstaining, an increase in the shares under the 1997 Stock
Option Plan from 1,400,000 to 1,800,000.

The shareholders also ratified the appointment of McGladrey and Pullen, LLP, as
independent auditors for the Company, for the fiscal year ending December 31,
2002, by 8,133,271 votes in favor, 129,088 opposing and 12,347 abstaining.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a)  Reports on Form 8-K

None.

(b)  Exhibits

|     |  |                                         
|---- |  | ----------------------------------------
|99.1 |  | Certification of Chief Executive Officer
|99.2 |  | Certification of Chief Financial Officer

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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: August 9, 2002 |  | Datakey, Inc. |  |                                                                                                                       
|                     
|                      |  | By:           |  | /s/ Alan G. ShulerAlan G. Shuler
Vice President & Chief Financial Officer
(Principal Financial and
Accounting Officer)

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EXHIBIT INDEX
DATAKEY, INC.
FORM 10-QSB FOR QUARTER ENDED JUNE 29, 2002

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