BIO-key International, Inc. (BKYI) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen. Thank you for standing by, and welcome to BIO-key International's 2019 and First Quarter 2020 Conference Call. [Operator Instructions] As a reminder, ladies and gentlemen, this conference is being recorded today, Friday, May 15, 2020. I would now like to turn the call over to Scott Mahnken, BIO-key's Vice President of Marketing. Please begin, sir.

Thank you for joining us today. With me this morning are BIO-key's Chairman and CEO, Mike DePasquale; Fred Corsentino, our Chief Revenue Officer; and Ceci Welch, Chief Financial Officer. I'd like to remind everyone that today's conference call and webcast may contain forward-looking statements that are subject to certain risks and uncertainties that may cause actual results to differ materially from those projected on the basis of these statements. The words estimate, project, intend, expect, anticipate, believe, plan, may or will and similar expressions generally identify forward-looking statements. Such forward-looking statements are made based on management's beliefs as well as assumptions made and information currently available to management pursuant to the safe harbors provision of the Private Securities Litigation Reform Act of 1995. For a complete description of these and other risk factors that may affect the future performance of BIO-key International, see risk factors in the company's annual report on Form 10-K and its other filings with the SEC. Listeners are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date made. The company also undertakes no obligation to disclose any revision to these forward-looking statements to reflect events or circumstances after the date made. At this time, I'd like to turn the call over to Mike DePasquale. Mike?

Thank you, Scott, and good morning, everyone. Thank you for joining the call today. These are unprecedented times. And for the first time since joining BIO-key, I'm hosting this call from my home. Before I start, I believe it's appropriate to pay homage to all of the first responders, doctors and nurses that have been working the front lines in supporting those impacted with coronavirus. We owe them a debt of gratitude for all they have done over the past 6 weeks. And if you live in the Greater New York area, you will know what I'm speaking to. I also want to thank all of my BIO-key teammates for remaining incredibly productive through the sudden change in our work environment. Today, we reported results for fiscal 2019 as well as the first quarter of fiscal 2020. Our 2019 results were delayed due to the impact of travel and work restrictions on the timely completion of our year-end audit and the filing of our 10-K. For similar reasons, we have requested a filing extension for our first quarter 10-Q. Rather than delay our Q1 reporting, we have provided preliminary Q1 results with our full year 2009 (sic) [ 2019 ] audited results so that we are able to discuss them on our call today. Our Form 10-K has been filed with the SEC, and finalized results for the first quarter will be filed on Form 10-Q on or before the end of the month. As you can see from our results, fiscal 2019 was both challenging and deeply disappointing relative to our expectations going into the year, as we anticipated revenues and cash flows from a significant software license that did not materialize as expected, while other business development initiatives progressed, but we did not yield meaningful revenue contributions. Our revenue shortfall created liquidity challenges for the company, which we were able to address with short-term convertible note financing as well as $1.5 million in proceeds from the exercise of warrants at $1.50 per share. But rather than dwell further on the difficulties, we managed the business through over the past year. I think it would be more constructive to focus my remarks on how BIO-key has emerged in 2020. I'm reminded of saying what doesn't kill you makes you stronger. While there are certainly some truth to it, as BIO-key has emerged from the challenges of last year with a refined focus, and without question, the most promising outlook in our history. Our enthusiasm is rooted in 2 very large initial contracts we secured earlier this year for a total of $75 million in software consulting services and hardware systems that we expect to deliver over the next 24 months for 2 customers in Africa. Recall, we first discussed our intentions to pursue opportunities in Africa during our third quarter call. And now a little over 6 months later, we've been successful in unlocking enormous opportunities and future potential. Our success in Africa has been the direct result of our channel partner program, which was designed to establish relationships with value-added resellers that have established customer relationships, region-specific market knowledge and capabilities that can play an instrumental role in bringing BIO-key into the small and large enterprise and governmental opportunities. We've long felt that Africa represents a very attractive region of opportunity, given its large size and population and how well biometric solutions are suited to solving some of the continent's most pressing security and fraud prevention challenges. We've had some success in the region in the past, such as our deployment with South Africa's Capitec Bank, but had generally found it difficult to advance our business development efforts there. In the latter part of last year, we decided to invest in building a stronger footprint in Africa, and we opened our BIO-key Africa subsidiary to provide an in-country presence, led by our highly respected IT executives, including Steve Uwazie and [ Tunde Jeje ]. Africa, like virtually every other market, is relationship-driven, and those who are known and trusted in the field are able to accomplish so much more than those who are new to the scene. Through Steve and [ Tunde ], we were introduced to the Technology Transfer Institute of Africa, a well-connected incubator of technology services and projects and a facilitator in bringing foreign technology expertise to bear in the African markets. We're very fortunate to sign TTI as our first African channel alliance partner. Since then, the team, along with TTI and growing base of relationships, have proven very effective at identifying opportunities and bringing BIO-key into the procurement discussions at a high level and efforts that have been instrumental in our early success, landing the 2 large contracts in Nigeria that we referenced in our press release. Longer term, we believe these projects are just the beginning of a very substantial opportunity to team with local partners to deliver biometric security solutions for large-scale ID and authentication needs in areas like mobile communications and payments, immigration and border security and for social welfare programs, many of which are attracting external funding from entities such as the World Bank. And though our opportunities in Africa currently dwarf those in the U.S. and elsewhere, we were extremely bullish regarding pent-up demand for enhanced multi-factor authentication and security solutions that are needed to manage the distributed workplace created virtually overnight in response to the coronavirus pandemic. Though the pandemic is causing a temporary pause and a great deal of enterprise and government activity, as we progress to more normal business conditions, we fully expect increased interest in our solutions as enterprise works to put in place a more secure infrastructure for those who are now working outside the protection of the enterprise network and its security. Fortunately, designated as an essential service, given our work in health care, defense, law enforcement and the government, BIO-key continued to operate at full staffing over the past 2 months, though most of our team have worked remotely. As a result, we have remained in contact with our partners, customers and prospects and have continued to provide excellent service and support. Through these dialogues, we are hearing a similar and encouraging refrain, namely the desire to extend biometrics and other multi-factor solutions to help secure substantially expanded remote workforces. Through these dialogues, it has become very clear the extent to which enterprises are thinking and have been altered by the coronavirus pandemic and a substantially increased importance and priority being given to identity solutions that can help companies address the demands of a distributed workforce and client base. So to better position BIO-key to compete for and win coming opportunities, we're intently focused on rounding out our suite of multi-factor authentication solutions so that we can become a one-stop shop for customers, no matter their choice of authentication methods. While our core expertise and value remains in biometric solutions, a close second in our ability to securely manage remote authentication is in the cloud. Though it would be premature to say more about our plans, I did want to underscore this is a major strategic and technology priority for BIO-key in the U.S. and around the globe. And I hope to have more to say about this in future periods. Finally, with our -- with respect to our financial outlook for the current fiscal year, I'm understandably reluctant to provide any sort of guidance. And frankly, there remain too many variables regarding timing, schedules and the path to more normal business interactions to provide a reliable outlook. However, what I can reiterate is that we have taken steps to improve our bottom line performance. At the same time, we've positioned BIO-key to execute on the 2 very large contracts. We are very confident that work will commence on these contracts, likely in our third quarter, perhaps before. And we've made it clear that we require significant advanced deposits prior to moving forward. Given the project's scale and timeliness of approximately 2 years, we believe BIO-key is well positioned to achieve substantial growth and likely profitability for the full year 2020. We also remain actively engaged in business developments here in the U.S., in Asia and in other markets, in addition to several countries in Africa. While we fully expect progress to be muted by the coronavirus situation, we're optimistic that our efforts can yield meaningful opportunities in a world that has been forced to invest in protecting their businesses and remote workers against the increased threats of a far more distributed workforce. Given their scale and expected duration, the 2 African projects alone position BIO-key for substantial revenue growth, and as I mentioned, likely profitability for the full year 2020. And we are confident that they will also allow us to pursue other large-scale opportunities across Africa, outside of just Nigeria and on a global basis. We look forward to providing more visibility into the timing and expected impact of our Africa business as final planning is completed and the projects are underway. Let me now turn the call over to Fred Corsentino to review a few specific developments in our business. Fred?

Thank you, Mike. First off, I wanted to underscore what Mike has said about our Channel Alliance Program, and its importance for positioning BIO-key to participate in a far broader base of opportunities. We were fortunate to make quick inroads with this strategy in Africa. And having proven out the program's merit, we will continue our work to expand the program in the U.S., Asia and other regions around the globe. Adding partners is the easy part. The challenge is choosing the right partners and then working openly and cooperatively to support our mutual objectives. Ensuring our partners' focus is in line with our goals, that their industry and customer reputation is strong, and that they are both committed and able to invest meaningful resources in our collaboration are key to our thought process. We are also optimistic regarding opportunities to accelerate our growth, providing authentication and access management solutions for election security and government-related engagements. We are working to build on our growing traction in the state of Florida where over the past quarter we expanded our penetration into 3 more counties, bringing our total to 8 county election boards that have chosen to deploy BIO-key solutions for their identification and authentication process for granting staff members and volunteers with secure access to voting data. Of course, it is our goal to expand this into other counties and states as we progress toward the 2020 presidential election. Finally, to amplify Mike's comments about the rapid growth in remote work, we are working to develop a SAML plug-in that would enable users of popular video conferencing tools like Zoom, WebEx, GoToMeeting and Teams to easily incorporate biometric authentication into their access control solution. This solution will extend the flexibility and strength of biometric authentication into increasingly relied-upon web applications. With that, I'll leave it there and pass the call to Ceci for the financial review. Ceci?

Thank you, Fred. BIO-key's 2019 revenues declined to $2.3 million from $4 million in 2018, mainly due to lower license fees, including the impact of BIO-key's transition into software subscription module and reduced hardware sales and service revenue. As we have stated, our transition into the subscription model substantially reduces the upfront revenue we would realize from a perpetual license. Our software license fees for 2019 reflect the acceleration of this trend. However, this subscription model provides the opportunity for recurring annual fees required for our customers to use our solution. And this ongoing revenue stream has the potential to be significantly larger over time. Our service revenue decreased during -- due to reduced nonrecurring revenue of approximately $100,000, while our maintenance revenue increased slightly with associated subscription revenues. Relative to our early expectations, 2019 was particularly impacted by the absence of the software license payments totaling $5 million that were expected in monthly installments. Despite our active collection efforts over the past year, we determined that their collection is unlikely. As a result, we also elected to take a $7 million charge to fully write-down the resalable license rights underlying the expected payments. As a result, we no longer need to record the software amortization expense related to these software license rights, which will substantially improve our report results going forward. The decline in hardware sales in 2019 primarily reflects a decrease in biometric lock sales as we've transitioned from an enterprise-only model for our smart lock technology and we exited the lower-margin U.S. and online retail markets. Reflecting lower revenue, higher software amortization expense and lower license fees as a percentage of revenue, we incurred a gross profit loss of $194,000 in 2019 compared to a gross profit loss of $120,000 in 2018. 2019 operating expenses decreased to $6.4 million from $6.7 million in 2018, reflecting lower G&A expense and lower R&D and engineering expenses. BIO-key recorded interest expense of $1.1 million in 2019 related to interest, amortization of debt discount and issuance costs for convertible debt financing, whereas our 2018 results reflected a $1.4 million deemed dividend from required repricing of outstanding warrants, most of which have since expired. For the full year 2019, BIO-key recorded a net loss of $14.6 million or $1.03 per basic share compared to a net loss of $8.5 million or $0.73 per basic year -- per basic share in 2018. The weighted average basic shares outstanding were 14.2 million and 11.6 million in 2019 and 2018, respectively. We also provided preliminary financial results for our first quarter ended March 31, 2020, in today's press release as final -- financial statements are not yet finalized for the period. Q1 '20 revenues declined slightly to $530,000 from $552,000 into Q1 '19, primarily due to lower hardware revenue related to BIO-key's exit in the retail lock business and a decrease in maintenance revenue. These were primarily offset by more than $150,000 increase in software license revenue. Gross margin improved to 67% from Q1 '20 versus a negative gross margin in Q1 '19, primarily reflecting the elimination of the $281,000 noncash software license amortization expense recorded in Q1 '19, confirming the accounting benefit of the software license write-down in 2020 and future periods. Q1 '20 operating expenses declined to $1.7 million from $1.8 million in Q1 '19, reflecting the benefit of the cost reduction efforts. Reflecting the gross profit improvement and lower operating expenses, BIO-key's operating loss was reduced to $1.3 million in Q1 '20 versus $1.8 million in Q1 '19. At March 31, 2020, BIO-key had $1.3 million of cash and accounts receivable versus just $700,000 at Q -- at December 31, 2019. Subsequently, in May, we raised $2.1 million from a convertible note financing with warrants. The note is convertible in an option -- at the option of the investor into common stock at above-market conversion price of $1.16 per share, subject to redemption at any time by BIO-key. We also received $340,000 in PPP funds via the SBA Program to support our operations through the challenges of COVID-19, and expect the bulk, if not all, of the funding to be forgiven pursuant to the program's terms. With that overview, we can now turn the call over to the investor questions. Operator, could you please start the question-and-answer session?

Thank you. [Operator Instructions] our first question comes from Roger Slotkin with RS Management.

My question has to do with overall revenues. The stories are wonderful about the African contracts. And should they all come to fruition, God bless, the company is in obviously very good shape for the future. But as things occur in the world, as we're all seeing, if there's any slippage in that, what efforts, if any, are being brought about to secure revenues of significant import on domestic soil in the United States? And what are the likelihoods of that happening as of your current state of affairs?

Roger, that's a great question. And it's one that, for sure, we're very, very focused on. Our core business outside of the recent African opportunities is providing multi-factor authentication solutions for enterprises, health care institutions, state and local government and federal government agencies. And that business -- and I'll let Fred talk to that a little bit more after I finish here, that business and our pipeline seems to be very, very robust. And we're morphing to be able to provide a full and complete solution for our customers, not just including our own biometrics, but also including other factors of authentication, like challenge response and tokens and cards and keys, things that are being used commonly. So we are very, very focused on that, and we have been building a strong pipeline of opportunities in that area. Now whether they will be highly impacted or moderately impacted by, as I mentioned in my comments, the delays associated with coronavirus is really yet to be seen. But I think it's very wise for us to focus on 2 threads of our business, right? The large-scale ID components, which, again, right now, happen to be in Africa. But the other thread, which is the core offering that we can provide for multi-factor authentication for enterprise and other agencies that I mentioned. The other thing that is emerging very rapidly is work from home, as the typical small, medium, even large enterprise has been impacted immediately to force or allow employees to access all of their corporate infrastructure and portals from home. And it's very difficult to know who's sitting behind that computer or device at home and who's accessing all that information. So we have what we consider the perfect solution for that, not only our software solution, but also our finger-scanner technologies and the finger scanners that we provide and are commonly available across the board in retail and in bulk from the company directly for our enterprise accounts. So we see that also as a very, very strong opportunity going forward. And that one may actually accelerate despite the existing issues that we're facing.

Appreciate it. Last follow up, if I may. We're going through tough times. We all operate moderate-size businesses, BIO-key is a moderate-sized business by staffing. During this -- obviously, missed revenue numbers and everything, so has the company done anything to reduce its SG&A, workforce, et cetera? Because, obviously, if the sales are off, the revenue's off, the volume of work is off, the commensurate work requirements are obviously off, what's the company's thought on that, Mr. DePasquale?

Absolutely. We're looking and have looked across the board. And as Ceci mentioned at the tail end of her comments, we did apply and did receive PPP funds to ensure that we could keep our staff onboard. And as she mentioned, that we expect that the PPP funds, which totaled about $350,000 for us, will be fully forgiven. So that's one action we took immediately. Salary reductions is the second. And clearly, we're going to look in every nook and cranny for any expense that we can reduce, including outside vendors, consulting services. So we're looking across the board, and our expenses are absolutely going to decline. We're also going to take a hard look now at our physical infrastructure offices. I think everyone is going to do that, not just BIO-key. But I think there's an opportunity to reduce footprint there. And we'll see how it goes. But the bottom line is, we have been making good progress in reducing our expenses, and we'll continue to do that if necessary.

[Operator Instructions] Our next question comes from Jack Vander Aarde with Maxim Group.

I guess I'll start with Michael. While you note you're not -- you noted you're not providing an explicit 2020 guidance outlook, but did I hear you correctly in your prepared remarks that you expect to finish 2020 with a positive operating profit?

Well, if our contracts, the ones that backlog, I'll call it backlog, not pipeline, but backlog, if our backlog of contracts begin to start up in the second half as we anticipate, we believe that will be the case.

Okay. Got you. And is there any -- can you quantify what that backlog is currently? And how that's changed from last quarter?

We haven't provided those numbers, but it's kind of intuitive with announcements that we've made recently what the overall backlog would be. As you know, we announced the $30 million contract and then a $45 million contract, a host of smaller ones as well. But if you look at that and take and transcend that across 24 months, right, the course of 2 years, you could figure it out. It's significant. So that's about all the color I can provide at this point. But that, again, is all out there and has been out there for now for over a month.

Sure. Fair enough. So if I touch on those 2 contracts in that $75 million revenue opportunity, is there anything you can share and provide more color on in terms of the logistical plan on how you will approach the implementation of the contract and what still needs to be done in terms of your preparation? I believe you're going to be targeting 3Q '20 is kind of the target for that to begin. So what will you be kind of working on, I guess, leading up to that deployment?

Well, we're going to be deploying hardware, software and services across, in particular, Nigeria, to start here. And so as soon as the environment is more open, right, which right now, again, they're experiencing in Nigeria the same scenarios we're experiencing here, a lockdown, they have fewer cases of coronavirus, but on the other hand, they have fewer tests. So we don't know what the future will hold there. But they were on full lockdown. They went to moderate lockdown last week. And the government and businesses are open from 8 in the morning until 2 in the afternoon. So they have limited opening. Quite frankly, it's a matter of the country opening up for us to begin the deployment. That is the enrollment of the individuals that will participate in the systems that we'll be building, first, for a large telecom in Nigeria. And then, second, on the second large contract beginning to enroll and to train individuals to work through the Ministry of Labor to accelerate the adoption of advanced technologies across Nigeria. So it really is right now dependent on the opening and the opening stature of the country. So we're prepared and we're ready to begin moving forward, but we can only do that when the environment is such that we can start.

Sure. That makes perfect sense to me. Is there any -- I guess, is there any bottleneck to the fact that the country has not opened up? Is this -- would this halt any sort of preliminary process leading up to -- if the country opens up at the week before Q3 or something, is there any delay that, that would be caused as a result of that, rather if the country would open up, say, next week, is there anything just in your planning and preparation, though, that would be delayed just regarding the timing of the country opening up if it opens up before the Q3 starts?

Yes. It's just hard to say. I think we have to watch it. We're watching it. We have a full team of partners and resources on the ground there that are monitoring this daily, if not hourly. So I think we just have to wait and see and see how things start up. But once they start, BIO-key, certainly, we and I believe our partners, are ready to begin. And what that will require is, again, initial deposits, and we're ready to go. We're ready to begin delivering and deploying the necessary technology to get the programs and projects underway.

Excellent. And then a follow up with gross margin. That was a positive surprise just relative to my expectations for the quarter. I know it reflects an elimination of noncash software license amortization that was recorded last year. Is there anything else that you can touch on there that would suggest that this is a -- more of a normalized gross margin go-forward level? Or where would you expect the range for that gross margin to bounce between? I know there's a lot of factors involved in that, but just because of the positive upside this quarter, I just would like to see if there's any change to the range that you would expect in gross margin.

Well, I think it's pretty straightforward. We exited -- as Ceci mentioned in her prepared comments, we exited the lower margin lock business, the biometric lock business. And that, in and of itself, was a drag on our gross margins. So that is a big factor. The second piece, as you know, is software is gross margins in the 90-plus percent range. Our typical and classic hardware, the ones that hardware that we manufacture and develop and deliver and some of the third-party hardware that we resell, our gross margins average in the probably 60% -- 50% to 60% range on that hardware. So blended, our gross margins could possibly be in the -- depending upon the software mix, should be anywhere between -- on the low end, 50% to as high as 70%, depending upon the mix. So that's typically what -- and historically what we've had prior to entering the consumer lock business, and we think we'll get back into those ranges again.

[Operator Instructions] At this time, the Q&A session has now ended. Are there any closing remarks?

Yes. I'd like to thank everyone for participating in today's call. We look forward to updating you in the next quarter. Thank you very much, everyone. Stay safe and stay healthy.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.