10QSB 1 0001.txt FORM 10-QSB FOR THIRD QUARTER SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-QSB (X) QUARTERY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2000 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 November 14, 2000, is 8,269,173. Transitional Small Business Disclosure Format (check One): Yes No X
PART I. FINANCIAL INFORMATION ITEM I. FINANCIAL STATEMENTS DATAKEY, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS September 30, December 31, 2000 1999 ------------- ------------ (UNAUDITED) ASSETS CURRENT ASSETS Cash and cash equivalents $2,663,421 $344,922 Trade receivables, less allowance for doubtful accounts of $26,000 1,455,806 1,474,480 Inventories 2,203,648 1,328,991 Prepaid expenses and other 50,832 29,981 ------------- ------------ Total current assets 6,373,707 3,178,374 ------------- ------------ OTHER ASSETS Prepaid licenses and patents, at cost less amortization 691,428 668,036 of $595,128 and $364,832 EQUIPMENT AND LEASEHOLD IMPROVEMENTS, at cost Production tooling 1,304,663 1,306,260 Equipment 2,858,656 2,768,214 Furniture and fixtures 319,649 317,103 Leasehold improvements 278,371 278,371 4,761,339 4,669,948 Less accumulated depreciation (4,175,614) (3,917,996) ------------- ------------ 585,725 751,952 ------------- ------------ $7,650,860 $4,598,362 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES Accounts payable $808,147 $803,887 Accrued compensation 433,918 197,335 Accrued expenses-other 197,458 97,144 ------------- ------------ Total current liabilities 1,439,523 1,098,366 ------------- ------------ 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 8,269,073 in 2000 and 6,322,285 in 1999 413,453 316,114 Additional paid-in capital 13,894,512 8,501,543 Accumulated deficit (8,471,628) (5,692,661) ------------- ------------ 6,211,337 3,499,996 ------------- ------------ $7,650,860 $4,598,362 ============ ============ See Notes to Consolidated Financial Statements
DATAKEY, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) Three Months Ended Nine Months Ended September 30, October 2, September 30, October 2, 2000 1999 2000 1999 ---- ---- ---- ---- Revenue $1,616,092 $1,486,879 $5,226,169 $4,000,869 Cost of goods sold 1,058,188 948,225 3,041,617 2,450,417 ---------- ---------- ---------- ---------- Gross Profit 557,904 538,654 2,184,552 1,550,452 Operating expenses: Research, development and engineering 763,264 501,204 2,032,607 1,542,161 Marketing and sales 890,487 475,943 2,206,275 1,617,895 General and administrative 289,745 224,406 862,404 687,216 ---------- ---------- ---------- ---------- Total operating expenses 1,943,496 1,201,553 5,101,286 3,847,272 ---------- ---------- ---------- ---------- Operating loss (1,385,592) (662,899) (2,916,734) (2,296,820) Interest income (expense) 39,915 1,457 137,772 1,799 ---------- ---------- ---------- ---------- Loss before income taxes (1,345,677) (661,442) (2,778,962) (2,295,021) Income tax expense 0 0 0 0 ---------- ---------- ---------- ---------- - - - - Net loss ($1,345,677) ($661,442) ($2,778,962) ($2,295,021) Net loss attributable to common stockholders: Net loss (1,345,677) (661,442) (2,778,962) (2,295,021) Preferred stock dividends 0 (23,436) 0 (71,221) ---------- ---------- ---------- ---------- Net loss attributable to common stockholders ($1,345,677) ($684,878) ($2,778,962) ($2,366,242) =========== =========== =========== =========== Basic and diluted loss per share ($0.16) ($0.19) ($0.35) ($0.72) =========== =========== =========== =========== Weighted average number of common shares outstanding 8,229,178 3,651,772 7,879,276 3,308,103 =========== =========== =========== =========== See Notes to Consolidated Financial Statements
DATAKEY, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) Three Months Ended Nine Months Ended September 30, October 2, September 30, October 2, 2000 1999 2000 1999 ---- ---- ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES Net loss ($1,345,677) ($661,442) ($2,778,967) ($2,295,021) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation 75,854 114,975 257,618 336,357 Amortization 75,525 22,364 230,296 56,857 Loss on sale of fixed assets 0 31,812 0 31,812 Change in assets and liabilities (Increase) decrease: Trade receivables 186,689 (155,365) 18,674 31,729 Inventories (300,116) (27,285) (874,657) (466,482) Prepaid expenses and other 44,780 (17,477) (20,851) (5,202) Prepaid license fees and patent (246,533) (9,038) (253,688) (22,015) Increase (decrease) in: Accounts payable 169,104 (13,538) 4,260 215,300 Accrued expenses 279,696 134,045 336,897 176,158 Accrued severance 0 0 0 (10,687) Net cash used in operating activities (1,060,678) (580,949) (3,080,418) (1,951,194) ----------- --------- ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from sale of fixed assets 0 35,000 0 35,000 Purchase of tooling and equipment (15,411) (57,706) (91,391) (164,736) -------- -------- -------- --------- Net cash used in investing activities (15,411) (22,706) (91,391) (129,736) -------- -------- -------- --------- CASH FLOWS FROM FINANCING ACTIVITIES Increase in notes payable 15,766 15,766 Net proceeds (offering costs)from issuance of common stock 223,302 (16,651) 5,490,308 1,231,172 ------- -------- --------- --------- Net cash provided by financing activities 223,302 (885) 5,490,308 1,246,938 ------- -------- --------- --------- Increase (decrease) in cash and cash equivalents (852,787) (604,540) 2,318,499 (833,992) CASH AND CASH EQUIVALENTS Beginning 3,516,208 624,375 344,922 853,827 --------- ------- ------- ------- Ending 2,663,421 19,835 2,663,421 19,835 ========= ====== ========= ====== SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES Preferred stock dividend accrual 0 23,436 0 63,032 Preferred stock dividend converted to common stock 0 0 0 8,190 Conversion of preferred stock to common 0 0 0 151,520 0 23,436 0 222,742 See Notes to Consolidated Financial Statements
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 September 30, 2000, and December 31, 1999, and results of its operations and cash flows for the three-month and nine-month periods ended September 30, 2000, and October 2, 1999. The adjustments that have been made are of a normal recurring nature. The accounting policies followed by the Company are set forth in Note 1 to the Company's financial statements in the 2000 Datakey, Inc. Annual Report and in Form 10-KSB for the year ended December 31, 1999. REVENUE RECOGNITION In 1999, the staff of the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101, (SAB 101) "Revenue Recognition in Financial Statements". SAB 101 summarizes some of the staff's interpretations of the application of generally accepted accounting principles to revenue recognition. The Company will adopt SAB 101 when required in the fourth quarter of 2000. Management believes the adoption of SAB No. 101 will not have a significant affect on its financial statements. OPERATING SEGMENTS The Company adopted SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information, for the year ended December 31, 1998. This statement requires public enterprises to report selected information about operating segments in annual and interim reports issued to shareholders. The adoption of this statement had no impact on the Company's financial condition or results of operations. The Company's reportable segments are strategic business units that offer different products and services. They are managed separately because each business requires different technology and marketing strategies. The Company has two reportable segments: Electronic Products (EP) and Integrated Systems Solutions (ISS). The Electronic Products segment produces and markets proprietary memory keys, cards, and custom-shaped tokens and systems that utilize these products that serve as a convenient way to carry electronic information. The Integrated Systems Solutions segment produces and markets products for the information security market, which enable user identification and authentication, secure data exchange, and information validation. The accounting policies of the segments are the same as those described in the summary of significant accounting policies. There are no intersegment transactions. The Company evaluates performance based on operating earnings of the respective segments.
-------------------------------------------- ---------------------------------------------- Three Months Ended September 30, 2000 Nine Months Ended September 30, 2000 -------------------------------------------- ---------------------------------------------- EP ISS UNALLOCATED TOTAL EP ISS UNALLOCATED TOTAL -------- ---------- -------- ---------- ---------- ---------- -------- ----------- Revenue............... $773,548 $ 842,544 $ - $1,616,092 $2,985,318 $2,240,851 $ - $ 5,226,169 Interest income (expense)............. - - 39,915 39,915 - - 137,772 137,772 Depreciation and amortization.......... 50,129 101,250 - 151,379 176,602 311,312 - 487,914 Segment profit (loss). (294,548)(1,051,129) 39,915 (1,345,677) ( 364,412) (2,552,322) 137,772 (2,778,962) -------- ---------- -------- ---------- ---------- ---------- -------- ----------- Three Months Ended October 2, 1999 Nine Months Ended October 2, 1999 --------------------------------------------- ---------------------------------------------- EP ISS UNALLOCATED TOTAL EP ISS UNALLOCATED TOTAL -------- ---------- -------- ---------- ---------- ---------- -------- ----------- Revenue...............$1,302,606 $ 184,273 $ - $1,486,879 $3,570,777 $ 430,092 $ - $ 4,000,869 Interest income (expense)............. - - 1,457 1,457 - - 1,799 1,799 Depreciation and amortization.......... 101,583 35,756 - 137,339 294,760 98,454 - 393,214 Segment profit (loss). 25,160 (688,059) 1,457 (661,442) 121,200 (2,418,020) 1,799 (2,295,021) -------- ---------- -------- ---------- ---------- ---------- -------- -----------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION DATAKEY, INC. AND SUBSIDIARY RESULTS OF OPERATIONS AND FINANCIAL CONDITION RESULTS OF OPERATIONS REVENUE - Revenue for the three-month period ended September 30, 2000, increased by $129,000, or 9 percent, and increased by $1,225,000 or 31% in the nine-month period ended September 30, 2000 as compared to the same periods in 1999. The increase in revenue is due to a significant increase in revenue in the Company's ISS business unit, offset by a decline in EP revenue, as customer and licensee acceptance of the Company's ISS product offering grows. Revenue in the EP business segment declined $530,000 in the three-month period and $586,000 in the nine-month period ending September 30, 2000 as compared to the same periods in 1999. The decline in revenue is due to a reduction in component orders from a few of the Company's major customers. The Company has introduced system level products for the EP unit in an attempt to revitalize revenue growth. GROSS PROFIT MARGIN - Gross profit as a percentage of revenue decreased to 35 percent in the three-month period ended September 30, 2000, and increased to 42 percent in the nine-month period ended September 30, 2000. The decrease in margin in the three-month period is due to absence of license fee revenue, which carries a higher gross margin. The increase in margin in the nine-month period is due to realization of significant license fee revenue in the first two quarters. The Company continues to work on licensing relationships and expects licensing fee revenue to make a significant contribution to gross margin, although not necessarily on a regular quarterly basis. OPERATING EXPENSES - Operating expenses increased by $742,000, or 62 percent, and $1,254,000, or 33 percent in the three-month and nine-month periods, respectively, ended September 30, 2000, when compared to those periods of 1999. The increases are principally related to staffing the rapidly expanding ISS business unit, opening a European office, and trade shows and other forms of product promotion expense. INTEREST INCOME - Interest income increased to $40,000 in the three-month period and $138,000 in the nine-month period, ended September 30, 2000, as the Company invested the proceeds from the sale of securities in late 1999 and early 2000 in interest bearing accounts. Interest income is expected to trend down over the balance of 2000 as a portion of the interest bearing accounts will be used to fund the continuing investment in product development and product promotion activities. FINANCIAL CONDITION - The Company experienced a decrease in cash and cash equivalents of $853,000 in the three-month period and an increase of $2,318,000 for the nine-month period ended September 30, 2000, compared to a decrease of $605,000 in the three-month period and a decrease of $834,000 for the nine-month period in 1999. The additional increase in cash in the nine-month period is primarily attributable to the sale of common stock in a private placement during February 2000 and from the sale of securities upon exercise of warrants and stock options during the first three quarters of 2000. The additional decrease in cash in the third quarter of 2000 was due to the operating loss and an increase in inventory in anticipation of higher future sales in the EP business unit which may or may not be realized. Datakey's balance sheet reflects $4,934,000 in working capital as of September 30, 2000 and a current assets to current liabilities ratio of 4.43 to 1. The Company believes that its current cash and cash equivalents in addition to its $1 million bank line of credit, renewed in May 2000 will provide sufficient funding for the balance of 2000. The Company anticipates that it will be seeking additional private equity capital within six months. CAUTIONARY STATEMENTS The Management's Discussion and Analysis contains certain forward-looking statements relating to the growing acceptance of the Company's ISS product, the implication that the ISS product revenue will continue to increase significantly, the expectation that recently-introduced system level products for the EP unit will revitalize EP revenue growth, that licensing revenue will contribute significantly to gross margin, and that the Company will be able to fund its operations for the next six months. These statements are subject to certain risks and uncertainties which may cause actual results to differ materially from those projected. These risks and uncertainties include: (i) that market acceptance and demand for the Company's ISS products may decrease due to competitive or other general market conditions; (ii) that the expected success of current pilot programs and customer demand to convert to production programs may not materialize; (iii) the introduction of competitive information security products; (iv) that the new EP products do not perform as expected or do not bring revenue growth, (v) that the Company may not be successful in developing significant licensing arrangements to positively impact gross margin, (vi) that the Company may not be able to grow the ISS business unit fast enough to warrant the substantial product development, sales and marketing expenditures which may cause the Company to seek additional capital sooner than expected, and (vii) the ability of the Company to attain profitability and positive cash flows by significantly increasing ISS product revenues while controlling expenses. The Company anticipates that it will be seeking additional private equity capital in the near future, and there is no guaranty that its fund raising activity will be successful. PART II. OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K Exhibits (a) Exhibit 27 Financial Data Schedule (only filed with electronic copy) (b) Reports on Form 8-K None 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 November 14, 2000 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) DATAKEY, INC. EXHIBIT INDEX TO FORM 10-QSB FOR QUARTER ENDED SEPTEMBER 30, 2000 EXHIBIT NO. DESCRIPTION 27 Financial Data Schedule