BIO-key International, Inc. (NASDAQ:BKYI) Q1 2019 Earnings Conference Call May 16, 2019 10:00 AM ET
Scott Mahnken - Vice President, Marketing
Mike DePasquale - Chairman and Chief Executive Officer
Ceci Welch - Chief Financial Officer
Fred Corsentino - Chief Revenue Officer
Conference Call Participants
Nehal Chokshi - Maxim group
Good morning, ladies and gentlemen. Thank you for standing by. Welcome to BIO-key International's First Quarter 2019 Conference Call. During the presentation, all participants will be in 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, 2019. I would now like to turn the conference call over to today's host, Mr. Scott Mahnken, BIO-key's Vice President of Marketing. Mr. Mahnken, the floor is your sir.
Thank you. Good morning and thank you for joining us on today's call. With me this morning are Mike DePasquale, BIO-key's Chairman and CEO; Fred Corsentino, BIO-key's Chief Revenue 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, projects, intends, expects, anticipates, 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 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.
Thank you, Scott and good morning everyone and thank you for joining us today. I'd like to start out by reviewing a few factors that substantially impacted our results in the quarter. In addition to sales and services revenues in Q1, 2019, we had anticipated recording the receipt of two payments totaling $1.1 million related to the significant software license agreement we completed with a Chinese customer in Q4 of 2018. As you may recall, our license contract cost for monthly cash license fee payments of $550,000 each, starting in February of this year.
The first two of which were recorded as revenue in the fourth quarter of 2018 and we anticipated two additional payments in Q1 calendar 2019. Unfortunately subsequent payments have yet to be received that have been in the way and accordingly we were not able to record the revenue in Q1 as we had anticipated.
While we expect to be paid pursuant to the terms of contract, the escalating tensions in the US -China trade relations is proving to be an impediment for our customer in making the contracted payments on a timely basis. We were told that we face a particularly high hurdle because the payment relate to intangible in our case software rather than hard goods as the Chinese government seeks to manage money outflows and scrutinizes intangible based transactions more closely.
We're in dialogue with the customer and to continue to aggressively monitor the timing of these anticipated payments. In order to solidify our financial position in the absence of these monthly payments, we've taken steps in the first quarter to secure up to $1.5 million in short-term funding through above market convertible debentures and have closed on the first tranche of $550,000 and have options for two additional tranches. Looking past this situation, we had several important developments in Q1 related to customer deployments with two internationally recognized police forces in Singapore and in Dubai.
And with an aerospace defense contractor. Our ID Director for Windows solution along with our EcoID fingerprint scanners were selected to secure online and network access to critical information. That such respected law and global law enforcement organizations are entrusting BIO-key to secure their networks and devices is a very powerful endorsement of the quality and effectiveness of our solutions. We're also expanding the scope of applications for our solutions including the Q1 introduction of our ID Director for SAML solution to enable biometrics single sign-on for cloud applications.
This solution is targeted towards medium and larger enterprises as well as Identity and Access Management or IAM providers. It compares to our ID director for Windows solution which has historically been marketed towards small and medium-sized enterprises. We also introduced our smart commercial biometric lock solution early in Q to shift our focus to commercial lock applications. This new solution combines IoT management and monitoring capabilities with the security and authentication power of our biometric offerings.
Now we can not only protect the contents of a truck container or storage unit but also report its location and individual access with cloud tracking and reporting options. Additionally, we also teamed with two partners to develop and launch a smart emergency notification system for schools that leverages biometric data. Fred Corsentino will touch on how we are enhancing our sales efforts and resources to take advantage of increasing customer awareness, interest and discussions related to biometric authentication solutions for business enterprises of all sizes.
Customers and potential customers recognize the need for enhanced security and appreciate the ease of implementation and seamless integration of BIO-key solutions with Microsoft products including Windows 10, Windows Hello for Business and Active Directory. On our last call, we provided full-year revenue guidance of $11 million to $14 million. While the delay in license payments negatively impacted our Q1 performance, we continue to believe these payments will occur later in the year. As a result, we are maintaining our guidance expectations for now, but we'll update them as necessary as we be getting greater insight into the US - China situation and the timing of payments.
Based on the existing guidance revenue range, we also expect to achieve positive cash flow and net income for the full year 2019. As I mentioned, we will revisit our guidance when we report our Q2, Q3 results.
I would now like to turn the call over to Fred Corsentino to review our sales and sales channel strategies for 2019.
Thank you, Mike. Since it's only been a few weeks since our last conference call in April, I'll keep my comments brief so we can progress to Q&A. On the last conference call, I outlined our three steps go-to- market strategy. First is through our partnership with Microsoft. Being Microsoft's Windows 10 biometric partner, this relationship is a key to broadening our enterprise customer reach. Our plan to continue to market our software and hardware multi-factor authentication Enterprise Solutions which are fully compatible with all of Microsoft's application including Windows Hello for Business, Active Directory and Azure Cloud.
Second, we continue to invest in sales and marketing resources to further penetrate the commercial market with our IT Director for Windows solution. As we mentioned before, many of these commercial customers utilize the services of MSPs or Managed Service Providers to provide value-added services and to this end we are working with MSPs and targeted verticals such as healthcare to make it easy for them to provide best-in-class BIO-key authentication solutions to their customers.
Third, we will continue to grow and leverage existing reseller relationships, while expanding it to new agreements to market more our solutions to their client base. We plan on introducing a new partner program in the second half of the year. Our software products are interoperable with all major fingerprint reader and hardware manufacturers enabling application developers and value-added resellers to easily integrate BIO-key into their applications, while minimizing maintenance, upgrade and lifecycle costs. This is an attractive selling point and competitive advantage versus competing technologies.
In regards to our sales and marketing effort, our marketing team created a demand center which enables us to measure the progress of our lead generation and lead development efforts. The lead center will focus on promoting our fingerprint technologies for broad adoption and enterprise accounts, while also promoting a our biometric solutions to targeted customers and specific marketing campaigns, where we are also able to track individual enterprise customer sales journeys through active marketing campaigns and then by improved our internal sales procedures.
We have begun to see progress especially with the most recent financial services campaign. Regional banks and credit unions are utilizing our biometric authentication solutions to secure their systems. One promising campaign we have in our pipeline is to securing the upcoming elections focusing on County election organizations. We will continue to update you on our progress.
Finally, Mike mention the opportunity for IT Director for SAML to interoperate with existing and new partner solutions. We believe this will significantly expand our capabilities and opportunities to provide BIO-key solutions to midsize and larger enterprise customers. As such we are developing actionable SAML partnerships with identity access management OEMs including [Octo Fordraw, Duo, Akamai John rain CASSL, Palo Alto Networks and secure] to name a few.
SAML is a ubiquitous standard enabling identity provider authentication services to be shared across multiple service providers. BIO-key ID Director for SAML provides streamlined, cost-effective integration of fingerprint authentication for all SAML enabled application. BIO-key authentication is available as an on-premise or hosted identity provider solution in any SAML framework.
With that I'll turn the call over to Cece for her remarks regarding our Q1 financial performance.
Thank you, Fred. I'll go over some of the highlights of our quarterly results and also note that we filed our 10-Q yesterday. Q1 revenue declined $290,000 to $552,000 versus $842,000 in Q1, 2018. Most of this decline is related to lower hardware sales. For example, in the prior year we shipped $151,000 or 35% of our Hardware revenue related to our introduction of the biometric locks in 2018. While this year we recorded only $35,000 or 15% of hardware sales from lock revenue.
Service revenue was $242,000 compared to $302,000 in Q1, 2018, a decrease of $61,000 or 20%. This decrease was due to non-recurring service revenue mostly related to the end of a custom project to one customer. The decrease is partially offset by recurring maintenance and support revenue increasing $38,000 or 19%. Recurring revenue, recurring service revenue contributed 99% of the total service revenue in Q1, 2019 compared to 66% in Q1, 2018 due to the traction of our software as a service revenue model also including a large three year maintenance contract and several recent smaller orders. Gross margin improved to negative 9.5% compared to negative 40.2% in Q1, 2018 mainly due to lower amortization expense of non-cash software license rights. Adjusting for this non-cash software license amortization gross margin would have been 41% in Q1, 2019 versus 38% in Q1, 2018 with improvement due to higher proportion of software and services in Q1, 2019 revenue mix.
Operating expenses declined 6% to $1.8 million in Q1, 2019 versus $1.9 million in Q1, 2018 due to slightly lower overhead and R&D expenses due to personnel and non-cash share based compensation cost. In Q1, 2019 net loss was $1.8 million or $0.13 cents per basic share which compares to a net loss of $2.3 million or $0.30 per basic share after preferred dividends in Q1, 2018. BIO-key had a net working capital of $1.9 million at March 31, 2019 which included $459,000 of cash and cash equivalents. Subsequent to the quarter end BIO-key entered into financial aid arrangement which provides up to $1.5 million of short-term financing as needed to fund the company's short-term sales efforts and liquidity requirement.
I'll turn the call over to the operator now. Thank you.
Our first question will come from Nehal Chokshi of Maxim group. Please go ahead.
Yes. Thanks for taking my questions. I got quite a few and first designed to help investors get confidence that this delay is will hopefully prove temporal. So I guess my first question is, are the same US-based patents also followed and granted in China?
Our US-based patents for our core technology are granted in a number of countries around the world. It varies on each one of those patents. I do believe that a handful of them are issued and supported in China. We also have a collection of patents that center around our locks and the technology associated with those locks, and most of those are issued in the Asian markets. And so we have a number of patents again issued more centered around our hardware and our locks also issued in China as well.
Okay and I think you gave a lot of color to give confidence that the non-payment is indeed purely related to China-US tension, but I'm wondering if you have any additional color that you can provide perhaps usage by this customer that gives you confidence that it is indeed purely related to China-US tensions.
Well, I don't --I think we said that's a contributing factor right. We need to be transparent and clear. It's certainly not helping. As you know, the rhetoric is escalated over the last really couple of weeks. It's been the last two weeks in particular, but it's been a very difficult for any company that is selling an intangible in to China, it's always a very, very difficult scenario to get paid. And let me take you through the process. There's that an agency in China called state and it's the state agency for foreign exchange. They fundamentally review any significant contract that would require an outflow of capital or cash outside of China.
And again they pay particular attention to intangibles. And so our contract was reviewed in the fourth quarter by the agency. So it's not as if again this is something new. We've been going through this process for quite some time, but these escalated tensions have created a different dynamic. Now when and if that will change or may change I just -- I can't answer that. And I think we've provided as much information today that we can as it relates to those particular payments. In the context of the software, the software that we have sold is the standard software that we sell around the globe. That's being used by millions of clients and customers and has been used by clients and customers for many, many years.
So it is viable, vibrant, up-to-date technology that can be used in an enterprise fashion or for a consumer application in many different venues. And so the need desire and demand is there. We just have to get through the process and the facility to get paid.
Okay. Maybe you could review again how is this customer in China utilizing your technology? My understanding was that they are bundling it into another product that they are selling onto the market. If you just review that that would be helpful.
Yes. It's a number of different applications.
Okay, all right. And then for the convertible debt that was issued on April 4th and the two additional tranches that might get issued. Can you disclose who is a holder of that convertible debt? Is it one single holder or is it a multiple and then what's the origination of country for that over?
It's US and it's one holder. Yes. It's US and one holder and it was a --we always have plan A and plan B. I call it belt and suspenders and we wanted to be sure under any circumstances that we had the ability to operate our business aside from all the focus on this Chinese contract which is material and significant don't get me wrong. Our business is very vibrant and the solution that we are selling now in the market ID Director for Windows in particular and our newly introduced IT Director for SAML is in demand. And we are doing very, very well in building our pipelines since spread has come on board in the fourth quarter. We've seen just quarter-over-quarter about a 150% growth in our pipeline. And that's continuing to grow even more rapidly.
So Fred reviewed the demand center and the things that we're doing from a marketing perspective. You can see some of our videos the marketing collateral that we're publishing almost on a daily basis now is having a significant impact. And so under any circumstances we see our business now more vibrant than ever. For us, it's about scale. And there's another thing that we got to keep in mind here. We're moving to a total AAR model now. We are avoiding like the plague selling licenses to customers. So we are absolutely trying to build our recovering revenue stream. And we're taking a bit of a hit from that.
We took a hit on that in Q1, certainly our revenue was higher last quarter because we sold more straight license business, but the bottom line is we believe that's the right thing to do for the company. And it's the right thing to do for investors in building valuation long term.
Great. Because you said that the essentially said that the convertibles can be redeemed at a premium. Can you detail what that premium is?
I will have to defer to Ceci. I don't specifically know CeCe.
Yes. We have 7% original issue discount and the principal premiums; we have a different time frame. So they start at say 5% and increase up to 20%.
So it depends on the time frame when we pay it back.
Yes, understood, okay. And then for Fred, what are the targets you are using to manage your salesforce? Mike you mentioned that you're now focused on ARR. So I'm hopeful that one of the targets would be indeed incremental ARR per quarter and maybe you can talk a little bit about that, Fred?
Yes, Nehal. We have a basic quarter plan that really encompasses total end-to-end solution. So we like to bundle our readers as well so while ARR is an important focus because obviously margins and other things. We are looking at both so we're doing accordingly. Are we tracking that? Absolutely, we're driving ourselves and that's an important drive for us is where we have those opportunities to sell complete software solutions.
And how is this metric tracking relative to where you want to be?
Better. So we've --I may have talked about the machine, the lead engine machine and we called it a demand center on this call. We're starting to show some real progress with the group with such started to show some real progress in our development curve on that, and understanding what's working what's not. We expect to see continued progress as Mike pointed out. And we're quite happy with some of the responses that there is a demand out there. Many people are not aware of what we do and so it's been enlightening and we will continue to press use the right tools and build up this pipeline. As you know, that's an important step in building the top line.
Also to add to that, we added an incremental sales resource in the first quarter. We hired in other words so we hired an individual brought him onboard. So we have now five people focused on sales in various stages of our pipeline. We have a plethora of deals. There's been a very strong focus in financial services. I think we talked about that. We've done very well in the government space in particular around law enforcement and what's interesting here is that believe it or not the same solution we're selling in enterprise for commercial customers is also being widely adopted on the government side for access to portals and critical information.
So before the government business used to be dramatically different, it was much more highly secure. There were special circumstances around it, now we're finding that our core solution is selling in both venues, which is really positive for us. And our international business in general is also very strong. We do have a team in Asia. We have an office in Hong Kong; one in China. We have a joint venture partner in Singapore. We have resources in Japan. And so our pipeline there is also growing dramatically on the enterprise side.
Okay, great. And I would interpret hiring an incremental salesperson in the quarter while needing to do -- due to convertible debt as a sign of significant confidence in the business. So I view that positively. On a Q-over-Q basis it looks like you guys add $5,500 in quarterly recurring revenue from the services line. How much of that is maintenance for the professional license and how much of it as a pure ARR i.e. pure subscription?
Well, I don't know if Ceci can answer that question, but I'll throw that one over to her.
Yes. This is -- subscription is very small because it's yearly so the percentage, it's got to be like 5% or less if I was to guess. It's not big now. We're watching it grow but it's definitely not as big as we expect it to be.
But in terms of the incremental add was a big portion or was still actually a small portion? I understand of the --
It's still actually small right now.
End of Q&A
We're showing no further questions at this time. We'll go ahead and conclude our question0-answer-session. I would now like to turn the conference call back over to Mr. Mike DePasquale, Chairman and Chief Executive Officer. Sir, the floor is yours.
Great, thank you very much. I want to thank everyone for joining us today. We look forward to updating you on our business progress and outlook on our next call that will be scheduled likely in August. Please also be sure to follow us on social media and our website blog where we will provide ongoing updates on products, our activities, social media information. It is also noted at the end of today's press release or I should say press release that was issued last evening.
Again thank you for your interest in BIO-key and for your participation on today's call.
And we thank you sir and also to the rest of management team for your time also. Again, the conference call is now concluded. At this time, you may disconnect your lines. Thank you again everyone. Take care and have a great day.