BIO-key International, Inc. (NASDAQ:BKYI) Q3 2019 Earnings Conference Call November 15, 2019 10:00 AM ET
Scott Mahnken - Vice President, Marketing
Michael DePasquale - Chairman and Chief Executive Officer
Frederick Corsentino - Chief Revenue Officer
Cecilia Welch - Chief Financial Officer
Conference Call Participants
Nehal Chokshi - Maxim Group
Good morning, ladies and gentlemen. Thank you for standing by. And welcome to BIO-key International's Third 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, Friday, November 15, 2019.
I would now like to turn the conference over to Scott Mahnken, BIO-key's Vice President of Marketing. Please begin, sir.
Thank you for joining us on today's call. 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 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 any 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. Thank you for joining today’s call. As we outlined in our press release, though our sales performance in the third quarter and year-to-date is not where we had anticipated, we have many reasons for optimism regarding the outlook for the business for the balance of the year and 2020 and beyond.
The long expected, enterprise by metric revolution has been very slow to come, but there are more and more signs of its awakening. With each passing month, we see more and more signs of growing appreciation of the value that biometric technologies can provide in delivering improved security and improve user experience, far better tracking and reporting on secured data access and a compelling reduction in total cost of ownership for businesses and governments worldwide.
Supporting those clear value propositions, our efforts by a wide range of companies, including many managed service providers to support the growing integration of biometric software and hardware technologies, such as we've discussed with Microsoft Windows platform, as well as in mobile devices and IoT. Validating this, the FBI Cyber Task Force, just last month, issued a private industry notice, recommending the addition of biometrics and behavioral information checks to multi-factor authentication approaches, citing the vulnerabilities of token and phone based MFA methods.
We continue to actively pursue several customer opportunities, each of which could be substantial contributors to our results this year and next. Beyond the shortfall in revenue, we've experienced the past few months, our third quarter and year-to-date results have also been negatively impacted by our transition from a software license sales model to an annual subscription model, which has gained broad acceptance across the software industry.
Historically, we were able to book the full multi-year value of a perpetual license at one time, yielding much higher revenue than a comparable agreements on an annual subscription basis. Despite this short term impact, the subscription model is far more favorable for BIO-key in the long term. It creates a more predictable recurring revenue stream, which has the potential to be substantially larger over several years than a comparable software license sale. Of course, this model needs to also work for customers and they have come to appreciate the lower initial cash outweighs, predictable annual software expense and ongoing upgrades and enhancements. We are now fully standardized on subscription model pricings for all new customers.
Our Q3 and nine months results were also impacted by the ongoing U.S. and China trade uncertainty, which tension has led the effect of stalling monthly cash payments due under a large contract we close with the Chinese customer in the last quarter of 2018. Fundamentally, this tension has caused the Chinese government to restrict international payments. And in particularly in the areas of technology and software, that has been a challenge.
Overall, our business outlook for the balance of 2019 and next year is far more favorable. We're currently engaged in several large active customer procurement discussions with a strong likelihood of closing some event before the year-end.
In recent years, Q4, our fourth quarter that we're in right now has been particularly strong quarter, and we believe that will likely reoccur this year. But given the episodal nature of our business, we are revising our 2019 revenue guidance to $5 million to a range of between $5 million to $11 million based on the receipt of cash pursuant to the Chinese software license payments. Payments do under the agreement were expected to be about $1.6 million in Q3, and about $4.3 million in the first nine months of 2019. So that kind of gives you a window as to what we were looking to collect, and what we perhaps have the opportunity in collect. If we do, obviously we'll hit the high end of our guidance. On the other hand, the low end of our guidance we revise from $6 million to $5 million.
Within our revenue guidance range, we expect to deliver top and bottom line improvements for the full fiscal year 2019. And we would expect to achieve positive cash flow and net income on any revenue above $7 million.
On another note, we believe Africa will become a major market for BIO-key. And as a result, we plan to open an African subsidiary to better position BIO-key to participate in opportunities on this fast continent. To that end, we have partnered with the Technology Transfer Institute of Africa to pursue business opportunities across the African continent were demand for biometric security solutions for large scale ID, authentication needs, in areas like mobile communications, payments, immigration, and border security and welfare programs are being well funded. As mentioned in our press release, the World Bank recently approved nearly $0.5 billion of funding for a Nigerian Biometric National ID Registration program. You'll hear more on these strategic initiatives in the coming weeks.
With that overview, I'd now like to turn the call over to Fred Corsentino, to review some specific accomplishments and developments in our business. Fred?
Thank you, Mike. One of the big developments in Q3 was the launch of our Channel Alliance Program. This program is designed to expand our sales and marketing reach by partnering with Managed Service Providers, Security Integrators and Value-Added Resellers specializing in security solutions. We are engaged with companies through our existing distributors who have proven expertise in enterprise and network security applications. Alliance partners are trained and authorized to represent BIO-key’s complete line of biometric solutions for single sign on or multi-factor authentication across an organization. This program is already expanding the reach of our products to new markets globally. We've already partnered with 12 companies, including CyberPeak Solutions based in Florida, who closed the mid-sized law firm that needed a strong MFA biometric solution to connect the critical client systems.
We're also seeing growing interest in our solutions for election security and government related engagements. In October, two additional county election boards in Florida chose to deploy BIO-key solutions for their identification and authentication process for granting staff members and volunteers with access to voting data. We have since added another large county in Florida joining Brevard and Collier counties who were first on board with BIO-key in October last year. We are working to expand awareness and interest in our solutions into other state jurisdictions. And we are beginning to receive election security inquiries, not only from Florida, but from other states across the nation.
We currently are planning to showcase our biometric authentication solutions at statewide election conferences in Maryland and Georgia. We look to capitalize on expected going interest in our election security solutions as we progress towards the 2020 presidential election.
We've also gained a small foothold in the U.S. Congress where group of government administrative employees are now using BIO-key EcoID fingerprint reader to access their Microsoft Windows devices. They simply plug the reader into their device, enroll their fingerprints and have immediate biometric sign on capabilities, allowing them to utilize one touch biometric authentication in place of passwords or pins.
Additionally, the FBI has issued private industry notification to business IT leaders, alerting them to FBI research, which has found certain widely used multifactor authentication methods of vulnerable and recommended very biometric or behavioral authentication methods, they added a strong cyber security. This notification is resonating with prospective clients and underscores our marketing methods. Along with highly regulated industries such as financial industry law and force enforcement is an emerging area of strength of BIO-key.
Recently, a South American police force became a third national police force to adopt BIO-key solutions. In this case, ID Director for Windows for multifactor identity access management for network access.
The last thing I'll touch on is, early this month, we showcased our line of Microsoft and Windows Hello qualified fingerprint readers, a full spectrum of biometric authentication solutions, as well as our ID Director for SAML Solution at the Microsoft Ignite event in Orlando. This is one of the premier tech and cyber security events for IT leaders globally. And as a Microsoft partner, we generated over 400 new leases for partners and customers.
I'll leave it there and pass the call to Ceci for the financial review. Ceci?
Thank you, Fred. Our Q3 '19 revenue declined to $463,000 versus $740,000 in Q3 '18. Hardware sales decreased by $186,000, due to smaller new customer deployments and lower volume of lock orders.
Hardware sales declined by 186,000 with smaller new customer deployments, and a lower volume of lock orders.
Software license revenue decreased by $112,000 from Q3 '18, due to smaller orders and more diverse customers. Software license revenue has been negatively impacted by the company's transition to the subscription model from historical license sale model. This net effect of the transition is to decrease the upfront revenue realized from new software engagement and replace it with a recurring revenue stream with the potential to be significantly larger over time.
Service revenue increased by $12,000 to $237,000 in Q3 '19 from the prior period. Service revenue is made up 52% of revenues in Q3 '19, up from 31% in Q3 '18 with approximately 95% of service revenue classifies as recurring revenue.
Gross Margin in Q3 '19 was negative 12% compared to negative 27% in Q3 '18, due primarily to the impact of the non-cash offer license amortization expense. Excluding the non-cash amortization expense, gross margin would have been 50% in Q3 '19, verses 62% in Q3 '18, with a decline due to lower levels of software license fees and product mix.
Q3 '19 operating expenses decreased 226,000 to $1.2 million from $1.4 million in Q3, due to primarily lower SG&A expenses related to reduction in marketing and administrative payroll and non-cash compensations, partially offset by increased sales, payroll and legal fees.
BIO-key's Q3 '19 net loss improved to $1.9 million, or loss of $0.13 per basic and diluted share as compared to $3.1 million or loss of $0.23 per basic share after preferred dividends in Q3 '18. The prior year period included deems dividend relating to the repricing of outstanding warrants of $1.4 million or a $0.11 per share.
Per share results are based on 14. 4 and 13.1 million weighted average basic and diluted shares outstanding in Q3 '19 and Q3 '18 respectively.
On September, 30 2019, BIO-key had networking capital worth of approximately 0.5 million versus approximately 3 million at December, 31 2019, which does not reflect the benefit of the financing that was mentioned in our press release earlier today.
The equity financing is a private placement with limited number of investors and is expected to price at a premium to the current market price of the company's stock. This funding is intended to support our near term working capital needs, as well as the required repayments pursuant to the interim convertible debt financing obtained earlier this year. We are limited in what more we can say about this funding, except that we are in the process of closing and therefore expect to announce that in short order.
With that overview, we can move to questions. Operator, could you please start the question-and-answer session.
We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Nehal Chokshi with Maxim Group. Please go ahead.
Yeah, thank you, guys. Of the services revenue for the quarter, how much of that is the recurring – annual recurring revenue type excluding the maintenance from the prior perpetual licenses?
We have – go ahead Mike.
No, no, Ceci, go ahead, you have the numbers.
Alright. So the actual license revenue was about 50-50 or perpetual versus the SaaS model would have doubled our revenue in that. Service revenue is just inching up slowly on the SaaS section. So probably 15% most.
Okay, great. That's helpful. And we're able to track down what is the new ARR within the – that was booked within the quarter, that doesn't necessarily, you know, hit the revenue line, but booked new ARR within the quarter?
Right, but like I said, it's inching up to close to 15% on the recurring revenue.
Okay. All right. And then at the low end of the 5 million full year guidance, the balance implies 3.2 million for the December quarter. What's the composition that you expect between services, license and hardware then?
I would expect that it would be – that there'll be a strong component of license which could again be recurring or from existing customers, it could be traditional will certainly have hardware in that line, as you know, our hardware complements our software, our software complements our hardware. So we sell both together, it's almost every new customer. And then from a services perspective, as you know, in a subscription venue, there is no service, the service is the subscription. So, I would expect, you know, our maintenance right now is running approximately, 800,000 to a 1 million a year. So, give or take our traditional maintenance should be in a couple of hundred to $250,000 range.
Okay. That's very helpful. Thank you. And then, Fred, past three quarters, you've talked about how pipeline has increased Q-over-Q, I think in the second quarter, you said 150% Q-over-Q – I'm sorry, no, first quarter, you said 150% Q-over-Q. Second quarter, you said was continues to track up Q-over-Q, though you didn't give natural percentage. I was wondering if maybe you could give us an actual percentage for the 2Q and then also for 3Q in terms of pipeline?
You know, in terms of overall summary, I mean, the pipeline is definitely increasing still as we focus in on our key market. So I don't have a specific number, but in terms of growth of a pipeline from those quarters, but it is growing. We continue to see a lot of progress in the key segments, financial services in particular, healthcare, and government, as I outlined is a new market for us. So we're really focused on those key markets. And the pipeline in those key markets is growing very nicely.
Okay. And then when you talk about pipeline, or usually when companies talk about pipeline, they have phases of how deals move through a pipeline. Have you defined those phases for BIO-key?
Have I defined, is was the question?
Can you share what those phases are?
But we go through a normal qualification process. And, you know, as I've mentioned in prior calls, we have also mentioned, so things are not, opportunities are not qualified as forecast until they're fully qualified. You know, and then we go through our discovery process, typically a demo process and a value proposition process, which may include a proof of concept. And then we enter into negotiations and you know, final closing the deal.
Okay. And when you look at how, while the pipeline has been increasing Q-over-Q-over-Q, right for past four quarters not more or less. The one that investors probably care about the most is the last one. How has the pipeline within that phase progressed?
Yeah, again, I don't have that specific number in front of me. But you know, as moving towards Q4, very nicely, Q4 as Mike noted is typically a very good quarter. It is a good closing quarter end of year budgets. And we are seeing a lot of that. So, you know, I would expect some improvement with that part of the pipeline right now for sure. And those are the opportunities that we're working on and the ones that are, you know, beyond that 50%.
Okay. And I am coming back to you, Mike. You talked about South Africa police closing third major national organization that's adopting the BIO-key solutions that all three are on a subscription basis, is that correct?
That is correct.
Okay. And presumably, the ARR that you're collecting from these three, is a small piece of each of those three overall opportunities at this point time, is that correct as well?
No, actually, you know, some of it is significant. I believe the Dubai police, the total contract value was about $200,000. So perhaps $50,000 or $60,000 of that maybe a little bit more was subscription software and then the balance hardware. So some of these deals are significant. Again, it depends on the size and how they start. But the one that we closed just last quarter that we are talking about here was probably about a $50,000 or $60,000 deal and maybe $20,000 or $30,000 in software, and then the balance in hardware. So there's a mix.
Okay. All right. Thank you very much.
[Operator Instructions] At this time, there are no further questions. I would like to turn the conference back over to Mike DePasquale for any closing remarks.
Thank you. I want to thank everyone again for participating in today's call. We certainly hope that you'll join us for our year-end conference call in the spring, also we will be attending the Imperial Capital Security Conference towards the end – towards the middle of December. And you'll see a notice from us on that event, and perhaps some of you will be there. We look forward to seeing you. In any event, have a great day and a wonderful weekend.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.