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 under ending March 29, 1997

          Commission File Number 0-11447

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

       MINNESOTA                                              41-1291472
(State or other jurisdiction of                           (I.R.S. employer
incorporation or organization)                            Identification No.)

                 407 WEST TRAVELERS TRAIL, BURNSVILLE, MN 55337

                    Issuer's telephone number: (612) 890-6850

       -----------------------------------------------------------------
              (Former name, former address and former fiscal year,
                          if changed since last report)

     Check  whether  the issuer (1) filed all  reports  required  to be filed by
Section 13 or 15 (d) of the  Exchange Act during the past 12 months (or for such
shorter period that the  registrant was required to file such reports),  and (2)
has been subject to such filing requirements for the past 90 days.
                            Yes _X_     No ____

                      APPLICABLE ONLY TO CORPORATE ISSUERS

The number of shares  outstanding of the issuer's  common  equity,  as of May 9,
1997 is 2,887,235.

     Transitional small business disclosure Format (check one):
                            Yes ____   No _X_






                                        1

<PAGE>
                          PART I. FINANCIAL INFORMATION
                          ITEM I. FINANCIAL STATEMENTS
                          DATAKEY, INC. AND SUBSIDIARY
                           CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>

                                                            March 29,     December 31,
                                                               1997          1996
                                                          ------------    ------------
                                                           (UNAUDITED)                
                   ASSETS
CURRENT ASSETS
<S>                                                       <C>             <C>         
  Cash and cash equivalents                               $    682,356    $    140,030
  Investment in held-to-maturity securities                  4,050,873       5,993,228
  Trade receivables, less allowance for
    doubtful accounts of $49,701 and $45,000                   761,716         634,538
  Inventories                                                1,633,631       1,128,907
  Prepaid and other                                            105,780          46,962
                                                            ----------      ----------
                   Total current assets                      7,234,356       7,943,665
                                                            ----------      ----------

OTHER ASSETS
  Deferred taxes                                               325,000         325,000
  Prepaid licenses at cost                                     978,000         129,750
   Patents at cost, less amortization
    of $114,492 and $105,531                                    90,687          99,236
                                                            ----------      ----------
                                                             1,393,687         553,986
                                                            ----------      ----------

EQUIPMENT AND LEASEHOLD IMPROVEMENTS, at cost
  Production tooling                                         1,172,449       1,179,021
  Equipment                                                  2,834,184       2,561,659
  Furniture and fixtures                                       265,392         267,482
  Leasehold improvements                                       234,452         234,452
                                                             4,506,477       4,242,614
  Less accumulated depreciation                             (2,955,971)     (2,840,909)
                                                            ----------      ----------
                                                             1,550,506       1,401,705
                                                            ----------      ----------

                                                          $ 10,178,549    $  9,899,356
                                                            ----------      ----------

                   LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
  Accounts payable                                        $    920,335    $    559,280
  Accrued severance obligation                                 290,500         332,000
  Accrued license fees-current portion                         439,000               0
  Accrued expenses                                             559,947         315,549
                                                            ----------      ----------
                   Total current liabilities                 2,209,782       1,206,829
                                                            ----------      ----------

  Accrued license fees, less current portion                   329,250               0

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 10,000,000 shares; issued and
    outstanding 2,887,235 and 2,882,069                        144,362         144,103
  Additional paid-in capital                                 4,089,283       4,070,815
                                                            ----------      ----------
  Retained earnings                                          3,030,872       4,102,609
                                                            ----------      ----------
                                                             7,639,517       8,692,527
                                                            ----------      ----------

                                                          $ 10,178,549    $  9,899,356
                                                            ----------      ----------
</TABLE>

                 See Notes to Consolidated Financial Statements

                                        2
<PAGE>

                          DATAKEY, INC. AND SUBSIDIARY
                        CONSOLIDATED STATEMENTS OF INCOME
                                   (UNAUDITED)

<TABLE>
<CAPTION>

                                                  Three Months Ended
                                               March 29,      March 30,
                                                 1997            1996
                                              -----------    -----------
<S>                                           <C>            <C>       
Revenue                                       $ 1,409,801    $ 1,735,717
Cost of goods sold                                934,872      1,037,335
                                              -----------    -----------
                   Gross Profit                   474,929        698,382




Operating expenses:
  Research, development
   and engineering                              1,016,352        274,576
  Selling                                         394,375        282,256
  General and administrative                      211,556        208,975
                                              -----------    -----------

                   Total operating expenses     1,622,283        765,807
                                              -----------    -----------

                   Operating loss              (1,147,354)       (67,425)

Interest income                                    75,617         93,981
                                              -----------    -----------

                   Income(loss) before
                   income taxes                (1,071,737)        26,556
Income tax expense                                      0         10,000
                                              -----------    -----------

                   Net income(loss)           ($1,071,737)   $    16,556
                                              -----------    -----------


Net income(loss) per common and
  common equivalent share (Primary
  and fully diluted)                          ($     0.37)   $      0.01
                                              -----------    -----------

Weighted average number of
  common and common
  equivalent shares
  outstanding                                   2,884,769      3,063,328
                                              -----------    -----------

</TABLE>

                 See Notes to Consolidated Financial Statements

                                        3


<PAGE>

                          DATAKEY, INC. AND SUBSIDIARY
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (UNAUDITED)
<TABLE>
<CAPTION>
                                                                         Three Months Ended
                                                                        March 29,       March 30,
                                                                           1997            1996
                                                                       -----------    -----------
CASH FLOWS FROM
OPERATING ACTIVITIES
<S>                                                                    <C>            <C>        
  Net Income(loss)                                                     ($1,071,737)   $    16,556
  Adjustments to reconcile net income(loss)
  to net cash used in operating activities:
    Depreciation                                                           115,062        110,372
    Amortization                                                             8,961         34,567
    Change in assets and liabilities
    (Increase) decrease:
      Trade receivables                                                   (127,178)       (63,827)
      Inventories                                                         (504,724)       (20,965)
      Prepaid expenses and other                                           (58,818)       (42,689)
      Prepaid license fees                                                 (80,000)             0
     Increase (decrease) in:
      Accounts payable                                                     361,055        (64,494)
      Accrued expenses                                                     244,398        (45,459)
      Accrued severance                                                    (41,500)             0
      Income taxes payable                                                       0          9,586
                                                                       -----------    -----------

         Net cash used in
         operating activities                                           (1,154,481)       (66,353)
                                                                       -----------    -----------

CASH FLOWS FROM INVESTING ACTIVITIES
  Purchase of tooling and equipment                                       (263,863)       (48,419)
  Purchase of held-to-maturity
    securities                                                             (72,807)    (1,257,066)
  Proceeds from maturity of
    held-to-maturity securities                                          2,015,162      1,178,000
  Patent and license costs                                                    (412)        (6,071)
                                                                       -----------    -----------

         Net cash provided by(used in)
         investing activities                                            1,678,080       (133,556)
                                                                       -----------    -----------

CASH FLOWS FROM FINANCING ACTIVITIES
  Net proceeds from issuance of
    common stock                                                            18,727          1,812
                                                                       -----------    -----------
          Net cash provided by (used in) financing activities               18,727          1,812
                                                                       -----------    -----------

         Increase(decrease) in cash
         and cash equivalents                                              542,326       (198,097)

CASH AND CASH EQUIVALENTS
  Beginning                                                                140,030        713,230
  Ending                                                               $   682,356    $   515,133
                                                                       -----------    -----------

SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING
AND FINANCING ACTIVITIES
  Obligation recorded in connection with prepaid
  license fees                                                         $   768,250    $         0
                                                                       -----------    -----------
</TABLE>

                 See Notes to Consolidated Financial Statements

                                        4


<PAGE>


                          DATAKEY, INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

GENERAL

In the opinion of management,  the accompanying  unaudited financial  statements
contain all adjustments necessary to present fairly Datakey's financial position
as of March 29, 1997 and  December  31, 1996 and results of its  operations  and
cash flows for the three-month periods ending March 29, 1997 and March 30, 1996.
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 1996 Datakey,  Inc. Annual Report and in
Form 10-KSB for the year ended December 31, 1996.

INVESTMENT IN HELD-TO-MATURITY SECURITIES

The Company held marketable debt securities with an amortized cost of $4,050,873
as of March 29,  1997.  As it is the  intention  of the  Company  to hold  these
securities to maturity, they are accounted for as "Held-To-Maturity  Securities"
as defined in FASB  Statement  No. 115. The market value of these U.S.  Treasury
Bill securities is $4,048,385. The unrealized loss, therefore, is $2,488.

All of the  securities  have a maturity  date of less than  twelve  months.  The
Company  has  no   marketable   debt   securities   which  are   classified   as
Available-For-Sale Securities or Trading Securities.

PREPAID LICENSE FEES

Prepaid license fees were $978,000 as of March 29, 1997. This includes  $878,000
for  licenses for client and server  software to be bundled  with the  Company's
information security systems and licenses to use certain proprietary sofware and
encryption algorithms. The license agreements will be amortized to cost of goods
sold as the products  incorporating  the licensed  software and  algorithms  are
sold.  The Company has also  recorded an accrual for payment of $768,250 for the
client and server software license fees which are due in quarterly  installments
of $109,750 through October, 1998.





                                        5


<PAGE>


ITEM 2. MANAGEMENTS'S DISCUSSION AND ANALYSIS OR PLAN OR OPERATION

                          DATAKEY, INC. AND SUBSIDIARY
                  RESULTS OF OPERATIONS AND FINANCIAL CONDITION

RESULTS OF OPERATIONS

     REVENUE  - Net sales  for the  three-month  period  ended  March  29,  1997
declined  $325,916  or 19% from the  comparable  period in 1996.  The decline in
sales in 1997 is due to a  reduction  in  orders  from  some of our  larger  OEM
customers.  Revenue in the second quarter is expected to increase  slightly from
the first  quarter but is still  expected  to be below the 1996  second  quarter
revenue of $1,912,000. New end-user products being developed for the information
security  marketplace are planned for sales  introduction by mid-1997 and, based
upon current expectations, are expected to result in material revenue during the
second  half of 1997.  As with any new  product  line,  revenue  will  depend on
customer acceptance, the extent of which is difficult to assess at this time. If
this revenue meets the company's present expectations, the total revenue in 1997
will exceed the 1996 level.

     GROSS PROFIT MARGINS - Gross profit as a percentage of net sales  decreased
to 34% in the  three-month  period  ended March 29, 1997  compared to 40% in the
comparable 1996 period.  The decline in gross profit percentage is primarily due
to a lower level of revenue  compared to the prior year.  Because  approximately
half of the factory overhead is fixed or semi-fixed,  such costs combined with a
reduction of revenue create a reduction in gross profit percentage.  The Company
expects a gradual  improvement  in gross  profit  margins  during  1997  through
selective  price  increases,  effective  material  purchasing,  improvements  in
manufacturing  efficiency  and an  increase in  revenue.  Again,  an increase in
revenue depends upon customer acceptance of the Company's new products.

While  Datakey  believes  that its  strategy of  providing  token-based  product
solutions  at a  price  that  is  competitive  with  software-only  products  is
attainable,  there are no assurances that  competitive  pressures will not force
the Company to accept reduced margins to compete in the future.  Large companies
have recognized the need for information security and could enter this market as
competitors with much greater financial resources. A portion of its new end-user
products'   cost  is  royalties   and  license  fees  which  would  need  to  be
re-negotiated to maintain acceptable margins.

                                        6


<PAGE>


     OPERATING EXPENSES - Operating expenses increased $856,476, or 112%, in the
three-month  period ended March 29, 1997 as compared to the same period in 1996.
This  increase  results  primarily  from the cost of new  employees and contract
services  related to accelerated  development and product  promotion of advanced
information security products.

The Company will continue to fund new product development activities at a higher
level in 1997 than in 1996,  and may also exceed the 1996  percentage of revenue
(35%)  unless  revenue  from these new  products  in the second  half of 1997 is
substantial.

Marketing  and sales  expenses  are  expected to increase by 30 to 40 percent in
1997 to support new product  introductions and the expected increase in revenue,
but will be about the same  percent of  revenue  (20%) as in 1996  provided  the
revenue  from  new  product  sales   materializes   as  expected.   General  and
administrative  expenses in 1997 are expected to increase only slightly from the
1996 level and will remain at approximately  the quarterly rate reflected in the
first quarter.

Additional  development  work is required for the  introduction of the Company's
planned new information  security  products.  No assurance can be given that the
Company's  timetable  for  these  development  plans  will be  achieved  or that
development  efforts will be  successful.  Delays in the release of new products
will cause operational  inefficiencies,  increased development costs and reduced
revenues.

     INTEREST INCOME - Interest income during the three-month period ended March
29, 1997  decreased  $18,364,  or 20%, from the  comparable  period in 1996. The
lower level of interest  income  resulted  from a reduced level of investment in
held-to-maturity  securities  and interest  bearing  cash and cash  equivalents.
Interest income is expected to decline in 1997 as the Company intends to use the
proceeds from maturing  investments to fund continuing  product  development and
marketing  activities to support the Company's planned  introduction of advanced
information  security products.  Although the Company believes that the decision
to fund  these  new  products  is  correct,  there  are no  assurances  that the
investments already made and additional investments planned for 1997 will result
in a financial return.

     INCOME TAXES - As of December 31, 1996, the Company  recorded an income tax
asset of $325,000 related to its net operating loss  carryforwards.  The Company


                                        7


<PAGE>



has not  recorded a tax  benefit  in the  current  quarter  and does not plan to
record a tax  benefit in future  quarters  until such time as the  profitability
outlook in future periods justifies the resumption of income tax benefits.

     FINANCIAL  CONDITION - During the three-month  period ended March 29, 1997,
the  Company  had a net  increase  in cash and  cash  equivalents  of  $542,326,
compared to a decrease of $198,097 in the comparable 1996 period.  Investment in
held-to-maturity  securities decreased $1,942,355 in the 1997 period compared to
an increase of $79,066 in the 1996 period. Cash, cash equivalents and investment
in held-to-maturity securities were $4,733,229 at March 29, 1997.

Datakey's balance sheet continues to reflect a strong financial  position,  with
$5,024,574 in working capital and a current assets to current  liabilities ratio
of 3.3 to 1 as of March 29,  1997.  The Company  plans to  continue  new product
development and marketing activities during 1997 and expects to spend $4.5 to $5
million on these  activities.  Inventory levels increased  $505,000 in the first
quarter primarily as a result of acquiring  components to support expected sales
of newly developed products and purchasing inventory to meet annual requirements
to support an existing OEM customer.

The  inventory  levels are  expected  to continue to increase in 1997 to support
advanced information security products that are planned to be available for sale
in the second half of the year. 1997 investments in equipment and maintenance of
licenses  and  patents  in 1997 are  expected  to be about 2 to 3 times the 1996
level of  $515,000,  primarily  related to prepaid  license  fees for client and
server software to be bundled with the Company's  information security products.
This  spending will be funded by a reduction in the  Company's  marketable  debt
securities. The Company's working capital and investments are sufficient to fund
its planned operations and continued  development and promotional  activities in
1997.

     EXPECTED LOSS - The Company expects to report a loss in 1997.  Although the
Company expects to have new end-user  products  available for sale in the second
half of 1997,  the  marketability  of these  products will not be known until at
least late 1997.  The  extent of the  Company's  loss will  depend  directly  on
product availability and market acceptance.




                                        8


<PAGE>


                                      RISKS

As provided for under the Private Securities  Litigation Reform Act of 1995, the
Company wishes to caution investors that certain important factors identified in
this  document and in the  "Outlook and Risks"  section of Part I of the Company
1996 Form 10-KSB, in some cases have affected and in the future could affect the
Company's  actual  results of  operations.  Such factors may cause the Company's
actual results to differ  materially from those  anticipated in  forward-looking
statements  made in  this  document  relating  to (i)  the  introduction  of new
products,   (ii)  increased  revenues,   (iii)  improved  gross  margins,   (iv)
expenditures for new product  development and marketing and sales, (v) increased
inventory levels, (vi) and sufficiency of working capital.









                                        9


<PAGE>


                           PART II. OTHER INFORMATION
                    ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
                          DATAKEY, INC. AND SUBSIDIARY

(A)  Exhibits

     Exhibit 27     Financial Data schedule (only filed with electronic copy)

(B) The  Company  was not  required  to and did not file a Form 8-K  during  the
quarter ended March 29, 1997.









                                       10


<PAGE>



                                   SIGNATURES

Pursuant  to the  requirements  of Section 13 and 15 (d) of the  Securities  and
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, therunto duly authorized.

Dated May 12, 1997                          DATAKEY, INC.


                                            BY:  /s/ Carl P. Boecher
                                                 Carl P. Boecher
                                                 President & Chief Executive
                                                 Officer
                                                 (Principal Executive Officer)


                                            BY:  /s/ Alan G. Shuler
                                                 Alan G. Shuler
                                                 Vice President & Chief
                                                 Financial Officer
                                                 (Principal Financial and
                                                 Accounting Officer)




                                       11


<PAGE>


                                  DATAKEY, INC.
                          EXHIBIT INDEX TO FORM 10-QSB
                        FOR QUARTER ENDED MARCH 29, 1997

EXHIBIT NO.                   DESCRIPTION


     27                        Financial Data Schedule





                                       12