BIO-Key International Inc (BKYI) 2016 Q2 法說會逐字稿

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the BIO-key International second-quarter 2016 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 August 16, 2016.

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

Thank you and good morning, everyone. Thank you for joining today's call. With me this morning are Mike DePasquale, BIO-key's Chairman and Chief Executive Officer; Ceci Welch, BIO-key's Chief Financial Officer; and Jim Sullivan, our Senior Vice President of Sales.

I would 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, 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. 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 revisions to these forward-looking statements to reflect events or circumstances after the date made.

At this time I would turn the call over to Mike DePasquale.

Thank you, Scott, and thank you all for joining us today. I will start by reviewing recent developments in the business and our strategic outlook for the remainder of the year.

Despite a number of very favorable trends in market actions that we believe will support the accelerating use of biometric technology to address key authentication and ID challenges, our Q2 performance was disappointing because several different larger scale software opportunities did not close during the quarter.

These are prospective deals that remain very much in active discussion but for a variety of reasons outside of BIO-key's control, we have not yet been able to execute final contracts. Prospective deals include a very large deployment for a global telecom provider and a broad deployment for a global bank, in both instances providing software and hardware to enable biometric user authentication across their global employee base.

We also had expected an additional deployment with a mobile payments company here in the US but a design change on their end pushed this into the second half of the year. The deal builds upon our initial international deployment with this customer that we booked in Q4 of 2015. We continue to believe these opportunities have very real potential to close during the balance of 2016 but at this point we recognize the difficulty of predicting their timing.

We are also hard at work on the rollout of our fingerprint reader hardware to support both enterprise and retail customers in utilizing the innate biometric authentication capability in Microsoft Windows 10 operating platform.

Our highly accurate but modestly priced and small form factor readers are an ideal solution for adding the biometric capability needed to utilize the Windows 10 biometric framework. Importantly, Microsoft has doubled down on the commitment to further strengthening its security capabilities and its recently launched Windows 10 anniversary edition. It will continue to significantly expand the integration and functionality of its biometric security providing users with the ability to securely not only sign on to their devices as well as into a growing base of applications and web services such as iHeartRadio.

We view our growth opportunities in deploying hardware as being equally significant and have put in place a growing base of distribution channels reaching both retail and enterprise customers. We have also developed training materials for Microsoft personnel to help them in understanding and recommending our solutions to their customers who want to take the exciting step before going the vulnerability and cumbersome requirements of passwords and adopt the strength and ease and use of biometric technology from BIO-key.

Given this lack of visibility on the timing of larger software oriented deals and the somewhat later than expected rollout of our fingerprint readers into broad distribution, we have lowered our full-year revenue guidance to a range of $6 million to $8.5 million which compares to $5.3 million in 2015 and our prior guidance of $7 million to $9.5 million.

As we have often mentioned given our current size, the variable nature of deal size and timing makes our business both difficult to predict but also highly variable on a quarter-to-quarter and year-over-year basis.

Our Q2 performance reflects this dynamic as our Q2 2016 revenues declined to $415,000 versus $2.3 million last year in Q2 of 2015 and that particular quarter included a single $2 million software license order from an international customer. However despite the delays in closing these larger deals, we do see a range of encouraging developments across the broader authentication market that underscores our optimism for BIO-key's opportunity to monetize our technology and solutions.

Our marketing partnership with Microsoft to provide hardware readers that enable the biometric features of their Windows 10 operating system remains one of the significant drivers in our ongoing enthusiasm for our sales outlook.

Windows 10 has been downloaded on over 350 million devices and it continues to expand its global reach. As a result of their shift from passwords to more secure and convenient biometric authentication options, Microsoft will also be marketing and selling our fingerprint scanners in the Microsoft stores and online beginning early September.

Also we are expanding our reach with the Microsoft enterprise sales and support force and are introducing our integrated biometric solutions for active directory which is used by most small, medium and large corporations around the world. If you have not had the opportunity, please go to our website and view the video we produced called the Power of a Touch which highlights our offerings for the Windows 10 platform.

While the Microsoft partnership continues to offer a solid avenue for potential growth for our offerings, we are continuously engaging other distribution partners to expand our visibility. Most notably we recently partnered with Access Sales Group, a national distributor with extensive networks to mass-market retailers, consumer electronics stores, warehouse clubs, retail, TV, electronics, distribution and the federal government. Building strong distribution channels remain a key component of our hardware and software sales strategy particularly as our hardware dialogues continue to prove very fruitful in initiating complementary sales discussions around our software algorithms and web key cloud services for securely transporting biometrics into the cloud for authentication.

As you may be aware in 2014, we forged a partnership with Norwegian technology company, IDEX, to collaborate on delivery of sensor to server infrastructure solutions for mass-market consumer devices and as a result of our partnership, we officially expanded the production and sale of our new fingerprint reader, SideTouch. SideTouch combines IDEX's advanced off chip sensor technology with BIO-key's universal Windows biometric framework fingerprint engine.

We also launched our fingerprint readers on Amazon in a three pack format targeted for enterprise sampling. Amazon represents an increasingly powerful distribution channel for IT security and our position on Amazon has expanded our product visibility while also simplifying order fulfillment.

These partnerships are an important step in building our sales and marketing channels. We are focused on supporting their success and at the same time we work to develop other supportive channels.

Another segment of our business where we anticipate exponential growth is our WEB-key cloud user authentication solutions. As more enterprises migrate their corporate networks and databases to the cloud to streamline their overhead and processes, we expect that they will come to appreciate the enhanced security, internal controls and tracking benefits and ease of use of biometric authentication in the cloud.

We are actively positioning our sales, marketing and distribution channels to take advantage of this natural progression for taking advantages of the full benefits of biometric authentication that is centrally managed versus authentication that only takes place on the device. We plan to leverage our relationship with Microsoft and extend their natural biometric integration for device and application support to enterprises that require a more robust universal solution that takes advantage of their active directory system.

We have the perfect solution which includes biometrics as well as other forms of authentication including prox cards, LTP, challenge response and other mobile friendly factors. While there are plenty of prospects within our primary domestic markets, we also continue to expand our long-term growth prospects to international markets such as Asia-Pacific and the Middle East and Northern Africa where we are building our presence and pipeline of customer opportunities.

As I mentioned earlier, we are also working to build upon an initial order in Q4 2015 with a leading international payments company where we are providing the biometric software and hardware components of their solution. We had anticipated a meaningful US deployment with the customer by now but due to some design enhancements on their end, the contract was delayed into what we believe will be Q3 2016. This customer operates in over 40 countries and our solution has been deployed into just two so far. Therefore, the potential for additional license sales, ongoing maintenance revenue and hardware is substantial over the next few years.

In the Middle East and North Africa, our distribution partner and Moroccan technology provider, Arthur & Company closed an initial sale to a bank that will begin deploying this quarter and we will see a range of other opportunities forming as that market expands.

In Q2, we also moved to strengthen the international reach of our Board with the appointment of UK-based and former Vodafone and Microsoft executive, Pieter Knook. Pieter brings great insight to the technology sphere particularly in Europe and of course his high-priority, high-level management role with Microsoft will prove very helpful for us going forward.

With that I would like to ask Ceci to provide a quick overview of our Q2 financials before we move to your questions. Ceci?

Thank you, Mike. As previously noted, our second-quarter revenue declined versus the year ago period principally due to the $2 million single license order from an international customer in 2015 without a comparable order in 2016.

Service revenues comprised of recurring maintenance and custom service decreased 13% to $220,926 compared to $255,269 in Q2 of 2015 reflecting an increase in maintenance revenue offset by no special software requirements for current or new customers. Underlying strength in this category was masked by a year-ago shipment of $110,000 in nonrecurring custom services revenue. Excluding this nonrecurring item, normalized revenue for service increased approximately 30% in Q2 of 2016 over Q2 of 2015. For six months ended June 30, 2016, we realized a 95% decrease in our core software license revenue as a result of the aforementioned large licensing order that did not reoccur in 2016.

Second-quarter 2016 gross margin declined to 67% as compared to 94% in Q2 of 2015 principally due to the change in mix particularly the significant higher margin software license revenue recorded in the year-ago period. Q2 2016 operating expenses increased 14% to approximately $1.6 million as compared to $1.3 million in Q2 of 2015 reflecting an increase in SG&A and R&D expenses including the addition of our operations in Asia. Our Q2 2016 net loss available to stockholders was $1,576,114 compared to net income of $753,146 in Q2 of 2015.

For the six months ended in June 30, 2016, our net loss was $2,939,953 versus a net loss of $170,967 for the six months ended in June 30, 2015. As Mike referenced earlier, we have lowered our 2016 revenue guidance to reflect the fact that the larger revenue opportunities have developed slower than we had expected. So our revised guidance (inaudible), we do expect revenues to build significantly in the second half of the year.

From a profitability standpoint, our gross margin targets are in a range of 65% to 80% depending on the mix of services, software and hardware sales. Based on our current operating plan, the expected business mix we estimate that annual revenue, breakeven run rate to be approximately $7.5 million. This estimate is predicated on the assumed mix of business with roughly 60% software and services and 40% hardware.

Finally with respect to our financial position, BIO-key remains well-positioned with $4.3 million in cash, cash equivalents and net receivables along with what we believe is strong financial and strategic support from our Asian investor group.

Now, operator, let's start with the question-and-answer session.

(Operator Instructions). Benjamin [Waldman], a private investor.

Nice to talk to you. I know you are a little disappointed by the quarter but I know from talking to you in the past that there is a lot of optimism at the Company. In talking down your numbers, you are not confident that maybe some of the business is going to close and I certainly respect that. But if you wouldn't mind talking to what would happen in terms of earnings and also revenues if say 50% to 75% of your projected business did close, what type of topline number might you be able to bring forth? And with margins in the 55% to 75% range, what would that mean at the bottom line? Thank you very much.

Thank you for your question. So let me start by just reiterating what Cici just mentioned and I mentioned earlier in the call. We revised our guidance down about $1 million from $7 million on the low end to $6 million and to $7.5 million on the high-end versus I think we had -- or $8.5 million on the high-end versus $9.5 million. So we have adjusted $1 million and that really centers around our disappointment with this second quarter in particular.

We had always projected that the second half would be significantly larger than the first just because the way number one, our pipeline was lining up. And number two, we were expecting to get our hardware distribution business churning in the second half.

Just to frame it, we are looking at basically $1 million shift. I think Ceci mentioned that with the gross margins that we expect, we become profitable on the existing expense base somewhere in the $7 million to $7.5 million range in revenues. So again you can look at what the impact would be but that is something that we have been articulating since the beginning of the year and we revised just today. So we still have very high expectations about the opportunity going forward.

Our pipeline continues to grow and that is happening as a result of again our new line of business in the context of hardware and also because we are getting more and more enterprise opportunities that are being fed to us from Microsoft. So we expect that is going to continue to grow as well.

Debra Fiakas, Crystal Equity Research.

Thank you. Good morning, gentlemen. I was wondering if you could perhaps expand a bit on your discussion of the hardware business that you are trying to develop. How do you anticipate those revenue streams to flow in the future? Will that also have some quarterly variance or do you expect those sales to be smoother in nature?

That is a great question. I think a little bit of both. We expect that the enterprise business, the pull through that we get for our hardware from sales of our software and vice versa in the enterprise business could still be somewhat episodal. However, we believe that the sale of our hardware through the distribution network and out through retail to consumers will likely have a smoother trajectory.

So we are just getting into that right now, we are just beginning to and have executed a number of contracts with some large distribution partners that will begin stocking the product and begin pushing it through their network. So their network will include VARs and VADs, it will include retail outlets and so again we think that business will likely be a bit smoother than our traditional enterprise business.

Okay, wonderful. Then if I could also ask a follow-up question just about those hardware distribution agreements that you are crafting now, will you have any, I assume that they will be ordering for their inventory, they will be anticipating some sales in the future. Will you have any way to look into the sales channel and be able to monitor the sellthrough of those hardware pieces?

Absolutely. In fact, two of the -- I will call them master distributors that we are engaged with have a full and complete system in place to be able to help with that and we will have very good insight into their network. So the answer to that question is yes. We expect that to be something again that will become more predictable for us over time.

Okay, excellent. Thank you for answering my questions.

Richard Pew, Richard Pew Investment Counsel.

Good morning, Michael. I have a personal question for a starter. I use a desktop computer, not a laptop. I know the movement in the industry is towards laptops but the pictures I have seen of your fingerprint readers all seem to be attached to laptops and I assume they are being attached by USB connection.

My question is are you making any of these readers available for a person who has a desktop and wants to wire the fingerprint reader to his computer?

Richard, absolutely. In fact, if you go to our website and look at our product we call ecoID, it is a unit that is designed specifically to be wired and plugged into a desktop unit or a docking station because even people who use laptop notebook computers sometimes when they work at their desk especially enterprise users, they will plug into a docking station that then provides print and wireless and other types of capability for them.

So go to our website, look at the ecoID and that is a unit that is specifically designed for desktop users. That is a very high-quality significantly sizable sensor on there that works very, very well for enterprise users, for consumers that want to plug into a desktop. In fact, my wife uses that unit on a personal note on her Windows 10 computer that she just recently upgraded.

My next question is when I am using the fingerprint reader theoretically to avoid a password connecting to some enterprise, that must mean that the enterprise has a contract with BIO-key as well, is that not true?

That depends. Remember that if you utilize that finger sensor, finger reader to access your device using the Windows 10 8.1 or Windows 10 platform, a product that Microsoft has built into the operating system called Hello, that is working just on the device itself. So a consumer can basically plug that in and replace their password to access their device or their PIN without any other connection to the outside world.

Where we specialize, where our software is really best in class really sits on the fact that we can then extend that to the enterprise so that they can confirm a user as part and parcel part of their database and authorized to access any information that they may be accessing.

So Microsoft has done a really good job at incorporating that device-based authentication option that I described before with Hello and we are working with them to extend that beyond in the enterprise to allow for more significant integration into active directory and all the standard I will call it business type software that companies are using. So we go both ways and that is a very important significant differentiator for BIO-key.

Great. Now my next question I think I have asked before but I'm wondering if I didn't ask it right because the current flavor you were giving suggests to me that I didn't get the right answer or I didn't ask the question correctly. If BIO-key can be secure to -- individual to enterprisewide, why can't an enterprise have software installed that attacks anybody who didn't use a fingerprint to try to get into the database and thus make their database secure?

That is also a really good question and that depends on the company's policy. So for example when the company sets up a policy to allow certain types of authentication and certain individuals to authenticate to certain databases or information, they can decide what that policy is. So if they require a fingerprint, then a fingerprint will be the only way to authenticate. If they require a password and a fingerprint, you will have to provide two. If they provide for just the fingerprint or some kind of a mobile authentication option, then that is the way it is.

So companies can provide whatever policy they would like and the beauty about our WEB-key platform, that is our enterprise solution, our WEB-key platform, is they can pick and choose and set different policies but they can also utilize different forms of authentication including PINs and passwords and tokens and challenge response questions and other mobile form factors. So we can provide it all but that really depends. The bottom line answer to your question is it really depends on the enterprise and what they allow.

Okay, but I just want to make sure I understand. We know that hackers are trying to get around anything that you set up to try to protect your database. Why is it not possible or is it not possible that if a hacker actually does obtain access through going around whatever protections the corporation might have that there be a final protection that tells anybody getting into the database -- stop, give us your fingerprint and then we will allow you further access. Isn't that possible?

It certainly is possible and again that it really depends on the way the company, the corporation itself sets up their security policies and practices. But what I think you bring up even a more salient point, we are seeing hacking at all levels. We are seeing it at the government, we just saw recently the FBI, we are seeing at all levels of the government. We are seeing at all levels in the commercial markets and the commercial venues. It is coming from international locations like Russia and some from China, it is coming domestically, it is in coming internally for companies, former employees are hacking databases and actually getting access to information that they are no longer authorized to access. So it is all around us.

The strong authentication capabilities that we provide are one element that can strengthen the fortress. We can strengthen and make it more difficult for hackers but the one thing that is critically important is hackers continue to morph the way they do things and we need to continue to morph along with it.

And so multifactor authentication, what you just described having multiple factors or if something fails moving to another is critically important and we recognize that again in our platform in providing those multiple factors of authentication. That is the way we are going to cut down on this. It is not the only way because there is all kinds of ways to hack a system but we can definitely make it more difficult for these folks to access that information if we deploy and implement these policies, these stronger policies.

And most corporations are looking at this in a significant way which is why our pipeline of opportunities is growing but there is big infrastructure change in some cases required for them to deploy this technology and that is what is taking some time right now.

Let me ask it one more time and I don't want to beat a dead horse here, why is it not possible for BIO-key to provide an end-to-end solution that makes it sure that if anybody going into any corporate database no matter how they are getting into it even if they are a hacker, once the database is being accessed that immediately a fingerprint is required for further access? Can't you do that?

It can be done today. There is no reason why it can't be done. Again, it all depends on the company's priorities and their authentication policies. It is not a technical issue, Richard, it is a policy issue.

Okay. One last question.

Edward Schwartz, Schwartz Investments.

Good morning. Michael, not only are you CEO of the Company but you are also Chairman of the Board, is that correct?

That is correct.

Okay, I would like to ask this question of you wearing the Chairman of the Board hat. For about three years I have listened to conference call after conference call where you have talked about -- where your CEO has talked about a great pipeline of potential opportunities and also an inability to close these opportunities with excuse after excuse after excuse. At what point do you tell your CEO, get this company profitable or we are going to replace you?

Good. So Edward, let me answer that question. First of all, over the last let's say 2 years, 2.5 years or even three we certainly have grown our business. We have provided last year and the year before quarterly guidance. I believe we achieved every one but one quarter of our quarterly guidance. That is number two.

Number three, we have an episodal business, I think we have declared that and we have articulated that through every quarter over the last five years and you can see it was evident in our performance this quarter in relationship to last year's business where we had one big software order that made up the majority of the revenue in that quarter.

We also started the year with a very clear position and perspective that the business would inflect in the second half for all of the things that I've said before and won't repeat right now.

I think we have a very strong management team, I think we have a very strong Board, we have a very strong and directed and positioned strategy to grow and develop this business. We have a market now that is accepting of biometrics which we did not have three years ago. Again, our business has grown through the years.

So it is a very, very difficult scenario for anyone in this space in this industry to deal with because the infrastructure changes as I just described before require to implement this technology in a big way, take large corporations significant amounts of time and they have to make a significant investment in order to move forward. But the good news is we are seeing that happen.

We are seeing formal requests, RFPs, formal processes being put in place by large corporations who want to adopt this technology. And I believe that the Board and I'm answering this question as the Chairman of the Board, I believe the Board sees our strategy and our direction, our bifurcated approach using our software and our hardware sales and combination of both to grow and develop this business in this market sees that we are heading in the right direction.

We also attracted a significant investment last year from our new partners in Asia. They invested a significant sum of money, one of them personally invested nearly $10 million of his own money in the Company because he believes that right now we have the right strategy and the right team in place to be able to execute.

Now we will see what happens over the next two quarters but that is my answer to that question.

Benjamin Waldman, a private investor.

Hi, Michael. I would like you to please answer my question this time because I feel you did not answer it the first time. Very succinct I'm asking two questions. The first with a follow-up is based on Company revenue modeling, what is the projected topline for the full-year 2016?

I think we answered that twice and I will answer it again.

I would like a number. $2 million, $10 million, $15 million, what is the Company modeling going forward?

Our guidance as stated publicly in our press release and as we just articulated on this call is between $6 million and $8.5 million this year.

Thank you. You did, I'm sorry about that.

Richard Pew, Richard Pew Investment Counsel.

Mike, this question comes from past experience with a company that wasn't properly financed and I hope that you have anticipated this. But this is my question, if you got many more orders for your fingerprint readers than you could possibly have expected, are you in a position to be able to finance the production of these readers so that you can get them out to be public and don't run short because you can't give the supplier the funds he needs to produce them in the first place?

That is a great question and one that we dream to be able to obviously have to deal with over the next six to 12 months. The answer to that question is yes, we believe that not only do we have the financing in line to be able to support that growth but we have a very strong partner and partnership as you know in Asia that is building and manufacturing that hardware for us. So we believe that we have everything in the supply chain including logistics and financing in place to be able to grow and develop that business.

In fact, we have got manufacturing capability right now today in place to be able to manufacture up to 300,000 units a month if necessary.

Great, good answer. Thank you. Finally, on a scale of 1 to 10, what do you think the chances are that you could possibly need to raise additional funds in the year 2016 and/or 2017?

It is really difficult to answer that. It solely depends on our ability to execute on our business plan. We had a slow first half, we anticipated a slow first half but we have got to kick in right now. So we've got to start generating revenue in the third and fourth quarter and if we do that I think we will be in good shape but that is clearly dependent on our ability to execute on our business plan.

What is your level of confidence that that is going to happen?

We are very confident. We wouldn't have reiterated our guidance at the $6 million to $8.5 million range if we didn't believe that was possible so I think we are very confident we can certainly grow our business and support the Company.

And you conceivably could exceed that guidance, correct?

We would love to.

All right, thank you very much.

(Operator Instructions). I am currently seeing no further questions so at this will conclude our question-and-answer session. I would now like to turn the conference back over to Mike DePasquale for any closing remarks.

Thank you for joining us and for your interest in BIO-key and your participation on today's call. We look forward to updating you on our progress and outlook during our Q3 call or at one of the upcoming conferences that we will be presenting at. We will be at the Rodman & Renshaw conference in New York in September and we will be at a micro-cap conference in Philadelphia in October where we will be presenting. Thank you everyone and have a good day.

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