BIO-key International, Inc. (NASDAQ:BKYI) Q2 2019 Earnings Conference Call August 15, 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
Nehal Chokshi - Maxim group
Good morning, ladies and gentlemen. Thank you for standing by. And welcome to BIO-key International Second 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, Thursday, August 15, 2019.
I would now like to turn the conference over to Scott Mahnken, BIO-key's Vice President of Marketing. You may begin, sir.
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, believe, plan, may or will and similar expressions are generally 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 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?
Yes. Thank you, Scott. And good morning, everyone and thank you for joining us today. As I’ve mentioned in the past, the given BIO-key's relatively small size, and our quarterly performance could be variable on a sequential or year-over-year basis due to the timing, scope, and revenue recognition related to customer orders and factors which are generally out of control.
We are also in the process of transitioning our business largely to a software-as-a-service or a SaaS model. And as a result, rather than recording a large upfront software license fee, we are now recognizing most of our software agreements on a recurring yearly subscription basis. While investors appreciate the value of more predictable and sustainable annual software license revenues, this approach does reduce the size of initial contracts and spreads the value over longer periods of time.
With that in mind, our Q2 revenue increased over that in the first quarter but declined slightly over the year ago second quarter period. While the pace of adoption of biometric authentication technologies for enterprise continues to progress, we are encountering increasing interest and conversations regarding our solutions. This growing level of interest underscores our continued confidence in our outlook for 2019 and future years.
From our advantage point, we are seeing a very clear trend of organizations that no longer have faith in passwords. And this change in view is compelling them to consider the deployment of alternative authentication methods such as biometrics to meet the security, user identification, efficiency, and convenience needs of their organizations. Reflecting the recognition of the vulnerabilities of password-based authentication, our greatest source of new revenue traction is from customers operating in highly sensitive environments where customer data or financial information is stored and regularly accessed such as in banks, telecommunications, or other financial services companies.
As a result, such customer prospects are increasingly requesting demonstrations and proof of concepts so they can evaluate the potential to incorporate biometric security into their existing workflows. Illustrating this trend during the second quarter, we executed agreements with a New York Regional Bank and a Maryland Credit Union to utilize our ID Director Software solution along with our fingerprint readers to provide a secure and frictionless single sign-on solution. Of course, as we have said in the past, high profile media coverage of various customer data breaches like the recent Capital One breach proved very helpful in triggering customer prospects to reevaluate existing security platforms and to take preventative measures against internal threats where a large percentage of security breaches occur and where biometrics can greatly reduce those risks. During the quarter, we also announced a significant follow-on order from a leading foreign defense ministry for a major expansion of their bio-key deployment using our WEB-key along again with our PIV Pro fingerprint scanners. We view this project which now approaches $1 million in total as a great validation of our advanced technology from a globally recognized security and technology team. For driving greater visibility and sales growth for our products, including ID director for Windows and SAML, we are focusing our sales strategy on developing actionable SAML partnerships with Identity and Access Management or IAM leaders. Leaders in the IAM space provide customer access and infrastructure that substantially extends the visibility and reach of our solutions to new and prospective customers.
Turning to our Hardware solutions including fingerprint readers and biometric locks. We were successful in increasing sales in this category in the second quarter compared to the period a year ago. We've also made notable progress engaging additional candidates for some of our flagship hardware solutions, including EcoID, SideTouch, and SideSwipe.
Finally, and as much as we feel that we were on the right track to deliver our strategic goals, we continue to work on providing greater visibility on what's working or not working in our business, and how that shapes our annual performance. I previously touched on the revenue impact of going from selling one-time software licenses to recurring subscription and subscription revenue models. While this transition does decrease the upfront revenue opportunity from a new software engagement, the positive dynamic is that it creates the potential for more steady, predictable recurring revenue streams that can reduce volatility and provide more consistency to our performance in the future.
Unfortunately, we also continued to experience a delay in the receipt of anticipated software license payments related to a large-scale contract we executed in the fourth quarter of 2018 with a Chinese customer. As we've mentioned, we believe that the current and escalating trade tensions between the US and China have made it challenging for Chinese companies to remit cash payments to the US. Following receipt of the first payments earlier this year which were reflected in our Q4 fiscal 2018 results, we've not received any further monthly payments which we had expected to total approximately $1.7 million in Q2, 2019, and about nearly to $2 million to $3 million for the first half of full fiscal year
In order to support our financial needs, as we await the resumption of these payments, BIO-key completed a convertible note financing in July, raising $2.55 million in gross proceeds. The note is convertible into BIO-key common stock at $1.50 a share at the option of the investor. And BIO-key retains the right to redeem the note at any time for $3 million. Reflecting on our performance to date and the current uncertainty regarding the timely of monthly software license payments, we revised our 2019 revenue guidance to a range of between $6 million and $12 million. The upper end of the range now assumes the receipt of all the software license payments contractually due and which can be recognized this year totaling approximately $6 million, whereas the bottom end of the range excludes the receipt of any such payments. Within this guidance range, BIO-key expects to deliver significant top and bottom-line improvements for the full fiscal year, and we would expect to achieve positive cash flow and net income on a full-year revenue of $8 million or above. We’ll obviously revise our guidance as warranted as we continue to proceed through the rest of this year.
Finally, in addition to building our pipeline of revenue opportunities, we also to continue to explore small tuck-in acquisitions that could expand our technology or product portfolio and customer base, enabling BIO-key to deliver a broader, more flexible array of security and authentication solutions. We continue to identify and evaluate these potential opportunities. However, this process is difficult to predict given all the variables, but we do want you to understand we are absolutely looking at various strategic scenarios.
With that, I'd now like to turn over the call to Fred Corsentino to review our revenue pipeline for the remainder of 2019. Fred?
Thanks Mike. Major area of focus in Q2 was expanding our sales pipeline for future revenue opportunities with clients and sectors, where we see the most activity and potential. Currently, the sector with the greatest sales prospects is financial services; the companies must adhere to compliance and security requirements to protect their customers and network. We are also seeing strength across electoral jurisdictions, where we've done quite a bit of work providing our multi-factor authentication biometric solutions for voter security in the US and abroad.
We completed successful deployments in Brevard, in Collier counties in Florida last year. And we are working to build upon those successful cases both in Florida and across the country as we approach the election season. Law enforcement and government is a core area of strength for our business. And we've recently signed a few foreign government institution customers seeking to secure internal access to their internal network and databases.
Turning to sales and marketing, we have successfully implemented several new marketing initiatives designed to expand their online reach to better support direct and indirect sales. These efforts include enhancements to our search engine optimization or SEO strategies in order to enhance BIO-key's placement in targeted search results. We have also ramped our PR visibility and reach by securing interviews and other media placements and leading technology and security publications. We also continue to refine our use of the latest marketing automation tools including a central demand sensor to seamlessly track the effectiveness of our marketing efforts and lead generation functions with qualified opportunities.
Overall, these marketing and prospect tools help us to better understand who our customers are, where to find them, how to reach them on a cost-effective basis and then to intelligently address their needs. Finally, we are excited to introduce our Channel Partner Program this quarter that will formalize and expand our relationships with integrators, VARs and MSPs who offer security solutions to their customer base. Many commercial and enterprise accounts prefer to do business with partners who they have existing relationships and contracts with.
We will be formally announcing the program in September. As Mike mentioned in his remarks, our goal is to transition the majority of our revenue base from one-time license sales to recurring revenue opportunities. The benefits of a recurring revenue model make it easier for our customers to initiate and to budget the use of our solutions. This model should also help us better navigate variability in the business and economic environment and provide us with better clarity on our future revenue pipeline. With those updates like to add Ceci to provide a quick overview of our Q2 financial performance and our current financial position. Ceci?
Thank you, Fred. Our Q2, 2019 revenue declined slightly to $728,000 approximately 2.7% versus $748,000 in Q2, 2018, principally due to lower software license fees and service revenues and the delay in software license payments previously reviewed by Mike. Somewhat offset by higher hardware revenue. Service revenues decreased 7% to $232,000 in Q2, 2019 compared to $249,000 in Q2, 2018 principally due to the decline in non-recurring service revenues for custom projects. Software license revenue decreased 61% to $60,000 in Q2, 2019 from $154,000 in Q2, 2018 principally due to the customer -- the countries -- the company's transition to software as a service SaaS model from its historical license sale model.
The net effect of this transition to decrease the upfront revenue opportunity from a new software engagement and replace it with the recurring revenue stream with the potential to be significantly larger over time. Hardware sales increased 26% to $436,000 from $345,000 in Q2, 2018 as a result of a large fingerprint reader order from an existing customer in addition to several new customer deployment. Gross margin in Q2, 2019 was 7% compared to negative 38% in Q2, 2018 due to the impact of a much higher level of non-cash software license amortization expense in Q2, 2018.
Excluding the impact of the software license amortization expense gross margin would have moderated to 45% in Q2, 2019 versus 51% in Q2, 2018 principally due to lower levels of software license fees and increased hardware revenue, which carries a lower gross margin. In Q2, 2019, operating expenses decreased 1% to $1.36 million from $1.37 million in Q2, 2018 due primarily to lower SG&A expenses related to reduction in payroll and non-cash compensation offset by increased factoring fees. BIO-key's Q2, 2019 net loss improved to $1.4 million or minus $0.10 per basic share as compared to $1.7 million or minus $0.15 per basic share after dividends, preferred dividends in Q2, 2018.
Per share results are based on $14.1 million and $11.4 million weighted average basic shares outstanding in Q2, 2019 and Q2, 2018 respectively. At June 30th, 2019, BIO-key had a net working capital of $1.1 million compared to $3 million at December 31st, 2018. Net working capital included $687,000 of cash and cash equivalents at June 30th, 2019 versus $324,000 at December 31st, 2018. These figures do not reflect the benefit of the $2.55 million in gross proceeds from BIO-key convertible note financing, which was completed in early July.
With that summary, we can move forward to questions. Operators, could you please start the question-and- answer period.
The first question comes from Nehal Chokshi with Maxim group. Please go ahead.
Yes. Thanks for taking my question. So, I think Ceci you mentioned that the recurring service revenue decrease 5% year-over-year as some current renewals are pending. I guess if those renewals were not pending, what would have been the year-over-year trend then?
It would have been up, trending up a little bit. We continued to get more orders and they continued to renew. So, it would have trended up. We just cannot recognize the revenue unless the cash is received. So that's our reason for doing that.
Yes. Understood. I think for 1Q 2019, you had commented that the recurring maintenance revenue was up 19% year-over-year. So, making those adjustments for those renewals had been made, can you give a finite number as far as how much it would have been up year-over-year then?
I can't at this time, no. I don't have that information.
Okay. And then can you provide some color on why these renewals are pending?
That's just the timing of billing and collecting the cash. That's all.
Okay. To your knowledge, there's no issue as far as customer satisfaction or anything along those lines?
No, it’s quite the reverse. Sometimes, they don't renew because everything's working so well.
Got it, understood. And then so, usually like to focus on net new ARR, but because you do have these pending renewals, maybe you can talk about what was the gross new ARR in the quarter.
I don't have that figure in front of me either, I'm sorry.
That's okay. I guess one, Fred, when you're thinking about sales productivity, what are your targets for your salesforce in terms of net new ARR per quarter or per rep?
Yes. We don't have specific target. We are working on quarter -based plans for our sales reps. So, there's no specific ARR target, if that's your question.
Yes, okay. And then last quarter you did comment that the pipeline was up 150% Q-over-Q for the March quarter. Do you have any color for this quarter?
Yes. I don't have a specific number, it is up though. And clearly in some of the sectors like financial services, it's up significantly. So, we feel pretty good about where we're at in building those opportunities. That was a dramatic increase in last quarter that's starting to reflect some of the efforts and we're continuing to build on that. A lot of those opportunities are leading [ph] forecast pipeline opportunities and going through the process in cycle right now.
Okay, and then I think you guys have mentioned multiple times throughout the script that license revenue is being impacted by a transition towards the software-as-a-service, basically the monthly recurring fee. Can you give a sense as to what percent of bookings was indeed of a recurring, monthly recurring arrangement as opposed to a perpetual license?
This is Mike. I don't think I have -- we don't have that data in front of us right now. I could say this, we are other than with existing installed base accounts, we're moving everything to a subscription-based contract, everything. We really no longer are selling licenses short of again an installed base account, where we have a history of doing that right, and the expansion is contingent on them being able to license additional users. So, we will likely begin reporting recurring revenue, i.e. subscription revenue as we approach the end of the year. And we certainly won't be doing that in 2020. But we're really just kind of making that shift, and as you were discussing with Ceci before, there's an interesting dynamic between maintenance revenue, service revenue which means custom kind of professional services revenue that we do based on a customer specific requirement of the likes.
And then, of course the feed off to subscription. And so, all that is just kind of transitioning right now, and I think we'll have better clarity on that as we approach the end of the year.
Okay. That will certainly be appreciated break out if you're indeed able to provide that. All right, my last question is that I think it certainly reasonable given the elevated trade tensions to provide that $6 million if the payments don't come in, $12 million if they do. Within that $6 million base there how should we think about the distribution between hardware license and recurring maintenance?
Hardware and recurring maintenance or recurring subscription and software sales, they all kind of fit together right.
So, yes --
I think maybe you are asking, let me just -- are you asking what's the breakdown between hardware and software?
Yes, okay. That's a different story. So difficult to predict but I'd like to believe it's going to be somewhere in the 60/40 range. And again, that really depends on is it installed based accounts, is it mostly new accounts that make up our revenue stream going to the end of the year. We also have a number of existing accounts, installed based accounts very large ones that could deploy very large hardware unit counts as we approach the end of the year as well. So, I'm going to go with the 50:50 to 60:40 split between hardware and software.
Just to be clear on the case where it might be up to 60%, that 60% is hardware correct?
Correct. And these are a number of, I'll call them very, very large companies that are considering very, very large deployments for their users. And as you know, our hardware margins, especially for the products that we manufacture are EcoID, SideTouch, SideSwipe are robust.
Yes. That they are. And that was a good hardware gross margin by the way this quarter. That's it for my questions. Thank you.
This concludes our question-and-answer session. I would like to turn the conference back over to Mike DePasquale for any closing remarks. Please go ahead, sir.
Great, thank you. Thank you again everyone for participating in today's call. We hope that you'll join us again for our third quarter call that will take place in the fall. Thank you very much.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.