BIO-Key International's (BKYI) CEO Michael Depasquale On Q1 2016 Results - Earnings Call Transcript

| About: BIO-key International, (BKYI)

BIO-key International, Inc. (OTCQB:BKYI) Q1 2016 Results Earnings Conference Call May 16, 2016 10:00 AM ET

Executives

Scott Mahnken - VP of Marketing

Michael DePasquale - Chairman and CEO

Cecilia Welch - CFO

Analysts

Dan Kamhis- Private Investor

Operator

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the BIO-key International Inc. First Quarter 2016 Conference Call. During the presentation, all participants will be in a listen-only mode. After the speakers' remarks, you will be invited to participate in a question-and-answer session. As a reminder, ladies and gentlemen, this conference is being recorded today, May 16, 2016.

I would now like to turn the call over to today's host, Scott Mahnken, BIO-key's Vice President of Marketing. You may begin, sir.

Scott Mahnken

Thank you, Chad. Good morning, everyone and thank you for joining us today for our 2016 first quarter conference call and webcast. With me this morning are Mike DePasquale, BIO-key's Chairman and Chief Executive Officer, and Ceci Welch, BIO-key's 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, intends, expects, believes, and similar expressions are intended to identify forward-looking statements.

Such forward-looking statements are made based on management's beliefs as well as assumptions made by and information currently available to management, pursuant to the Safe Harbor provisions 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 Securities and Exchange Commission.

Readers 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.

Michael DePasquale

Thank you, Scott. And thank you all for joining us today. I’ll give you an overview of highlights that are crucial to understanding where we are as a company and where we are headed.

Let me first state that for several quarters and more recently on our year-end call in March, we continue to underscore the potential volatility of our quarterly revenues based on the difficulty of predicting the timing of medium and larger size deals that we are pursuing.

In fact, there are one or two opportunities in our sites that could have transformed the Q1 performance and certainly they remain on our probable list for the current quarter, that’s Q2 or later of the year.

Whilst disappointing the start of the year with a downward revenue comparison, we made solid progress advancing a number of revenue driving initiatives during the quarter and remained fully confident in our full year guidance provided just the few weeks ago.

Accepting cases of focused ID or authentication solutions for Board of Control law enforcement or fraud prevention biometric authentication represents a component of a larger solution or an application.

Given this dynamic, our path to revenue growth remains heavily focused on partnerships with application providers who incorporate our technology into our broader solution. For this reason, the timing of a good proportion of our deals progresses largely outside the direct influence of our sales and marketing efforts and control.

We are very active in building our base of partnerships and working to ensure that biometric authentication remains high in their priorities and sales effort. However, as you could imagine, this partner emphasis makes it much harder for us to handicap the timing and size of deals given the range of additional factors that are outside our visibility of control.

The good news is we remain in the earlier stages of the broad enterprise engagements of biometrics and the sale cycles are certainly extended with customer prospects requiring significant support in their consideration of new modes of authentication security.

As I mentioned much of our effort during the quarter was advancing longer term initiatives such as the staffing at our team in Hong Kong which is focused on the developing the broader market at Asia, the continued development in testing of our mobile payment solution utilizing the technology that we license back in the fourth quarter, expanding our base of distribution partners and channels and the active sales in marketing of our fingerprint readers within a support from Microsoft Windows 10 operating platforms.

Also we are building a center of excellence in China that will focus on the design, development, manufacturing and distribution of our advanced hardware and software offerings for mass markets. This is expected to play a significant role in driving future revenue growth.

To be more specific on a vertical basis, clearly, the healthcare represents one of the most available markets for biometric deployments and remains a top priority target for us. A range of federal mandates require a healthcare providers to protect the privacy of patient records and now as we’ve mentioned many times electronic prescriptions have been mandated along with the use of two factor authentication.

We believe our biometric solutions offer the most convenient, secure and cost effective means to enable compliance. And we are seeing growth, growing recognition and engagement for biometrics in this function and have a number of market reference accounts that have been using our technology for some time.

To further develop this market, we have selectively forged partnerships with leading healthcare technology solution providers that have extended networks and established healthcare providers across the country.

We’re seeing growing benefits from these efforts such as modest sized recent customer win through our strategic partnership with healthcare firm Caradigm and after several quarters of development this represents our first new joint customer win, which is always the hardest, but we now anticipate more opportunities to deliver identity and access management solutions to their network of healthcare customers will come up.

We also secured a new contract with a large national healthcare institution through our partnership with HealthCast. HealthCast creates software authentication and access management solutions for healthcare providers and we partnered with them to deliver biometric authentication solution to comply with the electronic prescription or control substance regulations.

Switching to telecom, the telecommunication’s industry represents another emerging area of opportunity. And we are currently in advance negotiations with a telecommunication conglomerate interested in deploying WEB-key our patented biometric authentication solution for cloud services and data protection for their hundreds of thousands of employee.

They are considering our solution to protect their enterprise cloud network recognizing the significant security and authentication benefits of moving biometric matching to a centralized database in the cloud rather than relying strictly on device-based authentication which is very prevalent today in the mobile arena.

As more enterprises transition their corporate networks and databases to the cloud and an effort to streamline their overhead and processes, we expect to see ramping demand for our cloud user authentication solutions.

Our WEB-key technology delivers enhanced security and greater productivity with the additional benefit of reducing overall cost. These advantages are essential to enterprises seeking to tap the value proposition of today’s cloud environment.

On the international front, our Hong Kong based team continues to lay the groundwork to expand our visibility across multiple new channels with the objective of building a strong base of customers and revenue in the Asia Pacific region. We’ve already closed a number of agreements from this initiative and are now working to build upon these initial sales and expand our base.

Outside of the Asia, we recently partnered with Arthur & Company, a Moroccan-based technology services company to expand our sales reach in the Middle East and North Africa. This initiative was driven by the growing volume of enquires that we are seeing in these regions.

Turning to our hardware offerings. Today, we announce that our fingerprint readers SideSwipe and EcoID are now available on Amazon.com. This initiative is focused on supporting the awareness and adoption of our solutions in the enterprise community. Amazon provides a broadly accessible and cost effective fulfillment function for small orders and products sampling effectively outsourcing this function with a global leader.

We are launching with the three-pack also in an effort to keep the focus on enterprise sales but down the road we do intent to provide a consumer focused offering as well as bringing on an additional retail distribution relationships to address the consumer mass market. You’ll be hearing more of this -- more about this in the coming quarters.

We also continue to progress our sales efforts with the hundreds of small medium and large enterprise customer opportunities that we develop through our marketing efforts with Microsoft. While advancing any enterprise sales dialogue takes time and persistence, we do expect these efforts to progress more quickly and we have the benefit of the visibility by actively leading these engagements.

We’ve completed or are in process of proof of concept engagements with several companies so far somewhat user basis well over 100,000. We remained confident to our solutions offer significant value and ease of deployment that should turn into meaningful sales this year.

To expand our global reach and expertise, we expanded our board with the appointment of Pieter Knook. He brings to the board valuable experience in leading mobility and software technology businesses in Europe, Asia and America. And most recently he served as a Director of Internet Services at Vodafone U.K., following 18 years at Microsoft where he was one of the top 25 executives. We’re honored to have him on our board and will benefit from his perspective insights and base of relationships.

I hope I have conveyed some of the excitement and optimism we have for BIO-key’s prospect this year and beyond. And while our license revenue was not where we would like it in Q1 we are encouraged by the steady growth and interest in our solutions as well as the growing base of underlying maintenance revenue we are creating as our installed base grows.

We are reiterating our confidence in achieving 2016 performance objectives within our full year revenue guidance range of $7.5 million to $9 million, based on the initiatives that I just described and that we have undertaken.

With that, I'd like to ask Ceci to provide a quick overview of our financial performance in Q1 2016 as well as our current financial position. Ceci?

Cecilia Welch

Thank you, Mike. Our total Q1 2016 revenue was $430,592, a decrease from $648,826 in Q1 2015 to the lower license and other revenue offset by continued growth in our maintenance revenue year-over-year. Q1 2016 gross margin declined to 74% as compared to 79% in Q1 2015 principally due to a decrease in the software license revenue.

Q1 2016 operating expenses increased 2.3% to approximately $1.5 million as compared to approximately $1.4 million in Q1 2015 reflecting a modest increase in R&D personnel expenses. Our Q1 2016 net loss worth $1,163,214 compared to a net loss of $924,103 in Q1 2015.

Now, let me turn to our 2016 revenue guidance. As Mike referenced, our 2016 revenue guidance which we’re reiterating and generally expects revenues to build as the year progresses. From a profitability standpoint, our gross margin targets are in a range from 59% to 75% depending on the mix of services, software and hardware sales during the period.

The midpoint of this assuming market range and our current operating plan, we estimate our annual revenue breakeven run rate to be approximately $7.5 million.

And finally, with respect to our balance sheet, BIO-key remained strongly positioned with $3.5 million cash and cash equivalent.

And now Operator, let’s start our question-and-answer session. Chad?

Question-and-Answer Session

Operator

Thank you very much. We will now begin the question-and-answer session. [Operator Instructions]

The first question comes from Dan Kamhis, a Private Investor. Please go ahead.

Dan Kamhis

Good morning.

Michael DePasquale

Good morning, Dan.

Dan Kamhis

I saw Microsoft is adding fingerprint censor capabilities to Windows 10 Mobile. Is this any kind of significant development for BIO-key? And are you working with any of their customers on any phones?

Michael DePasquale

Okay, great question. Yeah, that was announced just a few days ago. I think the good news here is that Microsoft is recognizing that finger biometrics provide a much stronger authentication auction for consumers than the other modes of biometrics including face, that’s number one.

Number two, they are building in the capability within an SDK to incorporate finger biometrics into applications which is very good for BIO-key because as you know we are working very closely with Microsoft on the backend -- I'll call it the server end and the device end of Windows 10 and the capabilities that Hello passport and other authentication options within Edge will be available. So the phone will be in extension of the desktop and to server backend.

So we see this is very positive and very good for us and very good for them and perhaps competing against Android and ultimately Apple. So I think what they are trying to do is build this entire cohesive ecosystem, which they’ve had mobile options before they weren’t really closely integrated with their desktop or backend options.

Now they are creating a real cohesive ecosystem and biometrics is front and center for them on all of those venues and platforms server, desktop device as well as mobile now, so all good.

Dan Kamhis

I see. So are you working with the likes of HP on Elite x3 or anything or is it too early?

Michael DePasquale

We don’t really work directly with the handset players, the mobile device manufacturers. Our partners do that. So for example, IDEX is out attempting to sale finger scanners or censors to the handset providers or next biometric is selling finger censors to the likes of Dell and HP.

So, we are not out selling directly to the OEMs or to the handset providers. Our partners are doing that and will get pulled along if it’s appropriate we’ll get pulled along for the software for either device matching or perhaps even server-based matching.

Dan Kamhis

Alright. I saw report also in the biometric research that indicates biometrics in mobile devices inclusion of biometrics in mobile devices will generate by 9 billion by 2018 and they claimed multi factor than occasional product payments and “bring your own device” trend for the enterprises would be the causes. Are you involved in any current industry efforts to standardize biometric authentication or are there such efforts which you know?

Michael DePasquale

Interesting to say that, yeah, our Industry Association and the International Biometrics and Identification Association is heavily involved in those types of activities. First of all, logging and insuring that biometrics get their fair shot as it relates to privacy and as it relates to of course security and more dominant use across the government. So we are heavily involved in that.

The interesting thing about standards is there are quite a few standards for example, template standards or fingerprint matching that have been out there for years. So there is a kind of a standard across the industry from a technology perspective that’s available, but those standards generally haven’t produced products at work as well as some of the proprietary products that companies bring to bear our break to the table.

So I think that’s going to continue to evolve, but one of the advantages that BIO-key has had for many years is our interoperability. The fact that we can work with virtually any finger censor and with any device and with any platform and make these things interoperable for our customers. We’ve been doing this for a long time.

And that's one of kind of the components that's making Microsoft and some other very large technology companies, very interested in what we do and making them very interested and incorporating our technology into their backbones, so that they don't have to support 20 different devices or 20 different platforms. So, that's something that we're very, very well aware of and very well entrenched with.

Dan Kamhis

All right. One more question -- housekeeping question. I noticed your AR your accounts receivable were down about $1.2 million, can you say -- was that a big contract that was collected? Or is it a bunch of little contracts? Can you give some color?

Michael DePasquale

Combination. So, we collected well over $1.2 million in the quarter and it’s a mix.

Dan Kamhis

Okay. I'll get back in the queue.

Operator

[Operator Instructions]

The next question is from Frank [Indiscernible], a Private Investor. Please go ahead.

Unidentified Analyst

Hey, Mike. I was wondering can you give us a -- are you guys still talking to Alibaba? And are you guys thinking about for the SideSwipe? And are you guys thinking about doing a bundle with Dell and HP for your SideSwipe, can you give us a little more detail on that please? Thanks.

Michael DePasquale

Yeah. The answer to that question is that absolutely yes. We are, as I mentioned in my prepared remarks, we're looking at other outlets, channels, and distribution for the SideSwipe, the EcoID, and our soon to be available in volume SideTouch device, which we think is going to be exceptionally popular.

So, we started out with Amazon and we're starting slow. We intentionally put them online in a three pack because we want to focus on the enterprise customer base right now. We want to relieve ourselves from the fulfillment responsibility because we're shipping orders every single day and some of them are onesie, twosies, very -- its very time consuming and expensive.

And so we're looking to reduce our cost, make the product more available. We're also waiting on -- Microsoft is going to be introducing the anniversary edition of Windows 10 in the early summer. I believe its late July. That edition is going to offer significantly more functionality, biometric functionality for consumers and the mass market. And we'll then rollover to selling single units to consumers and to the mass market through our distribution channel.

So, we're starting slowly, you're going to see this evolve over the next quarter and we expect to be able to move large volumes of these products through multiple channels over the next two to three quarters. That's our goal and objective.

Unidentified Analyst

And just a quick follow-up. I mean is Microsoft really kind of pushing this, because it's probably in their best interest to those out there with Windows 10, can you elaborate on that?

Michael DePasquale

Yeah, they really are. They have been exceptionally supportive. You've seen the press releases that we've introduced over the last really two quarters. In Q1, we had a follow-up to our significant response to the event that we did with them, the 12-city tour introducing Windows 10 Enterprise and the all the functionality at biometrics make available there.

They are really looking to eliminate the password and having this capability within their product is good. The beauty about what we provide is that we can retrofit back to any device that has a USB and provide that functionality. They have upgraded the latest statistics. We've seen 300 million customers to Windows 10.

So, every one of those customers is a potential prospect to eliminate their PIN or password to access their device and then with the additional functionality that Hello and Edge and Passport are going to provide to use biometrics to access virtually everything that they access.

So, at an enterprise level, it's intuitive, right, accessing the corporate jewels. For consumers, it will be everything from accessing your social media accounts to your banking, to your healthcare, whatever you're doing today the 30, 40 or 50 passwords that you have can be eliminated with the use of biometrics.

Unidentified Analyst

All right. Thank you.

Operator

The next question is a follow-up from Dan Kamhis. Please go ahead, sir.

Dan Kamhis

Yeah. My understanding was as of December, I guess, that the $12 million was used to buy licenses and of that $5 million is considered current and I believe $7 million is long-term. I guess -- I'm wondering if that $5 million is expected undoubtedly sold, I guess, would be in the next nine months. And I have a couple our questions on that after that question.

Michael DePasquale

Yeah. Our goal -- I think Ceci could answer the accounting question, but I don't think you’re asking solely an accounting question, you're asking if our goal and objective is to begin to sell these licenses that incorporate the software that we license into products that get into the marketplace. And the answer to that question is yes.

Dan Kamhis

Okay. Can we assume that the 2017 sales of licenses, I'm talking about the long-term licenses now, can we assume those 2017 sales the same rate as 2016 level or are those spread out over more years?

Michael DePasquale

Dan, I think we'll see. Our goal and objective, right, is to get our initial sales moving. We're working with very large payment. We've incorporated the software into the platform that we're providing for them. We've got a whole series of hosts, targets, and opportunities that we're pursuing.

So, obviously, we want to consume and deliver that software, that technology as fast as we can. So, this will be the first year, right, that we -- although we delivered some of that software in the fourth quarter of 2015, we'll see that accelerated as we get through the year. But I think we'll have a better feel for that as we evolve through the year.

Dan Kamhis

All right. Any order of magnitude you can give us on the margins on that, I guess what you're calling inventory, those licenses?

Michael DePasquale

Well, anything related to software is going to have a very, very high margin, right. You've seen our -- you followed us for years and quarters, and you know that when we sell a large component of software, our gross margin is going to be as high as 90%, but they generally hover in the 80s.

We expect the gross margins on our software to remain very, very high. As it relates to hardware, I think it really depends. Right now, we expect the gross margins to be able to hover in the 60% range, that's our goal and objective.

So, when you blend the software and the hardware, Ceci mentioned our target was to be somewhere between 60% and the high 70s and that our goal and objective and it will be driven by volume.

Dan Kamhis

Okay. I guess I'm on that inventory, I'm more looking at the operating margins after you take out the expense in the inventory, I guess--

Michael DePasquale

They will be very--

Dan Kamhis

That would be 90%.

Michael DePasquale

It will be very high. It will be very high. Because remember we're not reselling the license, we're incorporating that software. We have purchased a number of user licenses, a high volume number. But we're incorporating that software into an offering that we're making available.

So, it could cut across -- in a year to come, it could cut across virtually everything that we deliver. So, as a mobile client component of that software that could be part and parcel of everything that we sell. So, the margins will be considerable.

Dan Kamhis

Okay. To make the low end of your guidance, you'll need an average of $2.2 million a quarter about for the next three quarters. Should we expect the revenue spread somewhat evenly over the next three quarters or are you looking like at a $6 million fourth quarter or something like that? Or just some color on that?

Michael DePasquale

I'm going to repeat what I said 30 or 45 days ago. Our revenue is going to be variable. Its -- I cannot predict if it will be linear, if it will be consistent across the quarters. That's why we provided annual guidance.

We've got a number of initiatives, I described them in my prepared comments that are ramping and as they ramp, our revenue is going to grow. Do I believe that the majority of our revenue will come in the second half? Yes, I do. But it won't be evenly based between the three quarters. It will certainly be variable.

Dan Kamhis

Okay. Thanks.

Michael DePasquale

You're welcome.

Operator

[Operator Instructions]

At this time, the Q&A session has now ended. Are there any closing remarks Sir?

Michael DePasquale

Thank you. And thank you all for participating in today's call. We will hope that you will join us again for our second quarter conference call in back in the summer, in likely in late July or August. So, thank you everyone.

Operator

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

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