BIO-key International, Inc. (NASDAQ:BKYI) Q1 2024 Earnings Conference Call June 18, 2024 10:00 AM ET

Corporate Participants

Bill Jones - Investor Relations
Mike DePasquale - Chairman and Chief Executive Officer
Ceci Welch - Chief Financial Officer
Jim Sullivan - Chief Legal Officer

Conference Call Participants

Operator

Good morning, everyone. Thank you for standing by, and welcome to BIO-key International's First Quarter 2024 Conference Call. During management's prepared remarks, all participants will be in a listen-only mode. Afterwards, listeners will be invited to participate in a question-and-answer session. As a reminder, this conference is being recorded today, Tuesday, June 18, 2024.

I would now like to turn the call over to Bill Jones, Investor Relations. Please proceed.

Bill Jones

Thank you, Betsy, and thank you all for joining this call.

Our hosts today are BIO-key's Chairman and CEO, Mike DePasquale, and CFO, Ceci Welsh, as well as Jim Sullivan, Senior VP of Strategy and CLO, who will provide some insights on BIO-Key's new product launch.

As a reminder, today's conference call and webcast, as well as answers to investor questions, include forward-looking statements, which are subject to certain risks and uncertainties that can cause actual realized results to differ from those currently expected.

Words such as anticipate, believe, estimate, expect, plan, project, or similar words typically express and identify these forward-looking statements. Such statements are made based on management's beliefs and assumptions as of today and using information currently available pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. For a complete description of these and other risks that may affect future performance of the company, please see risk factors in the company's annual report as filed on Form 10-K with the SEC.

Listeners are cautioned not to place undue reliance on such forward-looking statements, which speak as of today's date only, BIO-key undertakes no obligation to revise or disclose revisions to forward-looking statements to reflect circumstances or events that occur after today.

Now, let me pass the call to Mike to begin. Mike?

Mike DePasquale

Thanks, Bill, and good morning, and thank you all for joining us today. After my remarks, Jim will provide more details around our formal launch of BIO-key's Passkey:YOU authentication solution. Then, Ceci will provide a brief overview of our financial performance, and afterwards, we'll open the call to your questions.

First, the audit of our 2023 financial statements was recently completed by our independent public accounting firm, and we filed our 10-K on June 5th, and we recently filed our Q1 10-Q this past Friday. BIO-key is now up-to-date and compliant with all of our regulatory filings. Again, Ceci will review the numbers, but from a high level, we continued our progress in 2023 with revenue up 10% from 2022 to $7.8 million.

In Q1, we generated positive operating cash flow as we benefited from the expansion of a biometric client identification system by a long-term financial services customer who continues to expand their use of our biometric solutions. In fact, they're currently looking to potentially upgrade their license from a simple to a more complex client ID-featured solution, which we may have more to say about later this year. They certainly have been a good customer of BIO-key's and have generated significant revenue for us over the past years, as has our Foreign Defense Force customer that had provided several add-on orders to BIO-key in late 2023, and there certainly will be more and the possibility of an expanded use of our solution into other areas within that organization.

In Q1, we also reduced our expenses 17% year-over-year, and therefore reduced our operating loss by more than 70% to approximately $500,000 in Q1 '24. We have more work to do, but we believe we are heading in the right direction with our Q1 performance. We look to continue this progress as we move forward through 2024 with a focus on larger opportunities that could have a meaningful impact on our results, as well as further efforts to reduce cost.

We believe our growing global distribution network and customer base has us in a good position to drive revenue and move to positive profitability over the next several quarters. The majority of our sales today are through partnerships that we've developed through the years with over 150 partners, including value-added resellers, system integrators, MSPs, or managed service providers as well. All of our European sales are through channel partners, and the majority of our overall company sales now originate or are brought to us through a partner.

Leveraging partners and their customer networks allows us to reach a broader, addressable market, and also frees up our direct sales team to pursue the larger revenue deals, of which I've mentioned a couple examples that are currently in our pipeline.

Another point of focus in 2023 is that we began strategically partnering with some of the larger identity in access management providers in the industry, like SailPoint, Ping, and ForgeRock, who have large customer bases with installed IAM solutions who can upgrade their MFA to include BIO-key's unique identity-bound biometric offering. The overall IAM market continues to grow for many reasons.

Enterprises are migrating to the cloud, their workforces are working remotely or hybrid, and third-party contractors require access to systems. There are increasing cybersecurity regulations and cyber insurance requirements, and BIO-key solutions help our customers meet all of these regulatory and insurance requirements around stronger, more secure authentication, while providing superior user experience and better value than alternative mainstream authentication options. The current climate of broad enterprise adoption of multi-factor authentication and advanced IAM approaches provide plenty of opportunities for BIO-key to differentiate itself on a more flexible, lower total cost of ownership, and more user experience-centric authentication approach through biometrics.

Multi-factor authentication, zero trust, and password-less environments are essential for enterprises who want or need cyber insurance, as well as to meet the SEC's new cybersecurity risk management and reporting rules and CISA regulations that require covered companies to promptly report cyber disruptions and ransomware payments. We expect all of these emerging requirements, as well as constant cybersecurity incidents and high-profile breaches, to keep cybersecurity a top-priority item in boardroom and management discussions throughout 2024 and 2025. Again, BIO-key solutions allow companies to meet these challenges with more flexibility, lower costs, and so the current environment represents a very favorable backdrop for sales of our solutions.

We also expect the use of Passkey authentication to expand its market penetration in 2024. As such, we just launched Passkey:YOU, a unique password-less authentication solution that does not require the use of phones or hardware tokens. This solution is very useful for a variety of business use cases, and in a moment I'll pass the call to Jim Sullivan to discuss this exciting opportunity in greater detail.

I've discussed many of the reasons for a positive market outlook for identity and access management providers, and I've touched on some factors specific to BIO-key and our very unique solutions. We are an industry leader in biometric identity, such as fingerprint and palm and facial ID, which are among the 17 different authentication factors that we currently offer our customers, which is the most flexible and option available in the industry, and that really does separate BIO-key from the competition. Today we have over 600 customers and a solid base that provides recurring high-margin license fee revenues or ARR.

We continue to pursue large revenue opportunities through our direct sales team while leveraging our channel partners to reach a larger addressable market. We will continue to pursue cost reduction initiatives to accelerate our path to profitability and continued positive cash flow. Also in Q2, we are exploring opportunities to convert some slow-moving hardware inventory into cash.

In 2023, we wrote down approximately 4 million of inventories, including about $3.1 million which was purchased for our African initiatives. We expect to monetize some of that inventory in the current and continuing quarters. For all of these reasons, we believe BIO-key is well positioned to continue meaningful top and bottom-line performance improvement as we progress through this year.

Now let me turn the call over to Jim to discuss our new Passkey:YOU solution. Jim?

Jim Sullivan

Thank you, Mike.

Everyone may have seen the press release from last week where we announced the formal launch of BIO-key's Passkey:YOU authentication solution, which is targeting underserved workplace scenarios that involve roving users who share workstations, preventing phishing by eliminating passwords, and implementing multi-factor authentication, or MFA, as a goal of nearly every enterprise. But mainstream identity platforms are only offering limited authentication options based on one of two priority approaches, either phone apps, which now would include things like phone-based Passkeys, or per-user FIDO hardware tokens like YubiKeys, which sell for a cost of $30 to $80 each.

Both phone apps and FIDO tokens are implementations of what we call something-you-have authentication, as opposed to something you know, like passwords, or something you are, like biometrics. Operational challenges arise because something-you-have authentication options don't fit well and aren't well suited for many workplace scenarios, such as manufacturing shop floor, retail, call centers, healthcare, or hospitality, where users are typically roaming among a variety of shared workstations, kiosks, or point-of-sale terminals, or they use handheld devices. These workplaces often prohibit the use of personal phones for safety or distraction reasons and leave an enterprise identity team only a single apparent option for strongly authenticating those large roving workforces. That's to buy them FIDO hardware tokens.

But one token per user risks user lockout if they lose their token, so the FIDO alliance is recommending that each user be provisioned with two or three FIDO tokens each. Now, outfitting 5,000 workers with a pair of tokens would mean buying and maintaining 10,000 to 15,000 of these $25 to $70 tokens, so that if we're looking at a manufacturer who has 5,000 workers, they're spending millions of dollars every couple of years in order to be able to provide those tokens to workers.

Manufacturers of tokens themselves are projecting that 25% loss per user is a typical loss rate, so this becomes a consumable spend that really swamps the economics of adding a multi-factor for those roving workforces.

Now, our Passkey:YOU changes all of that by marrying BIO-key's renowned biometric authentication with just a touch of a finger to a hosted passkey that is based in software and hosted on servers, so that each user can unlock a personal passkey at any of those workstations with just a touch of their finger instead of having to carry a phone or a token, and that means users carry nothing, and BIO-key Passkey:YOU does the work to provide a phoneless, tokenless, and passwordless authentication experience at any workstation in the enterprise.

So Passkey:YOU is leveraging the existing FIDO2 WebAuthN authentication workflows that are already in every identity and most application platforms, and therefore, it supports a drop-in functional replacement where you might have previously used hardware tokens to instead allow the user experience of a touch of a finger or also support tapping their door access badge that they already have, in many cases, on a shared device at the workstation. This changes the hardware economics from buying hardware for every user to putting hardware at the access point itself and radically reduces the cost of rolling out multi-factor strong authentication to a workforce.

Now, the fact that we are FIDO compliant is important because we're passing all of the superior user experience and lower cost through the existing standard FIDO authentication workflows that usually are thought of as accepting only FIDO hardware tokens or phone-based passkeys, so the economics of putting this in place is going to be simple in terms of both cost to deploy as well as the fact that you're not buying hardware for every one of your users, and our customers have been asking us to make the biometric experience that they love more accessible without having to necessarily do integrations and maybe even bring in our product like PortalGuard. So this allows us to enter existing solutions where there are IDPs like Okta or Ping already present, and those identity providers are able to then adopt our biometric experience.

Now, we built this in order to deliver this solution with our partner, IDmelon, who has the ability to essentially turn our authentication experience into a passkey, and that makes it so that it's essentially effortless for an enterprise to add passkeys where they're already potentially looking at hardware tokens instead. And we think this product will be a valuable tool for the hundreds or even thousands of enterprises that are currently struggling to deliver strong passwordless authentication to all their users within an existing IAM workflow.

Now, in its biometric mode, Passkey:YOU is already powered by our existing platform, which allows an unlimited number of users to essentially be their own phish-proof credential, and this is a phish-proof solution because the entire authentication process is cryptographically secured so that no credential could be obtained by fooling the user with a phishing attack into providing their authentication credential like a password. So, this is entirely secured against phishing, and yet it's also easier for the users.

So, that combination of lower cost, easier user experience is going to make it so that this is we think is going to be a very popular solution to bring into these shared workstation workflows. Biometric platform is built with privacy capabilities and privacy law compliance built in so that our customers don't have to worry about being compliant because we take care of ensuring that things like consent for all the users as part of enrollment is integrated into the workflows. We also provide user-controlled privacy dashboards so that users can be compliant with understanding how their biometrics is being used, have control over whether they want to revoke it or remove it. Those are the capabilities that we've built into the product so our customers don't have to worry about it. This ensures that BIO-key Passkey:YOU will integrate into any existing framework without having to have either a compliance concern or an integration effort. And again, we want to make it as easy as possible for people to adopt and benefit from the biometric experience that we've got so many customers using already.

I'd be happy to answer any questions that you may have regarding Passkey:YOU in the Q&A, but for now I want to turn the call over to Ceci Welch so she can review the financials.

Ceci Welch

Thank you, Jim.

As Mike referenced, the audit of our 2023 financial statement was recently completed by our independent registered public accounting firm and therefore we filed both the 2023 10-K and our 10-Q for Q1 '24. I'll review the Q1 '24 results which were also in our press release issued yesterday as compared to the restated Q1 2023 results.

Q1 '24 revenues were up 19% sequentially to $2.2 million, which was in line with the comparison in Q1 '23. The current year period benefited from the expanded use of our BIO-key biometric client identification system by a long-time financial services customer in South Africa. A large order from them drove 23.6% increase in license fee revenues offset by a decline in recurring and custom services and hardware revenue.

Services declined due to the loss of a large service agreement and a large customer order for Sewell Secure Q1 '23 that did not recur. Our gross profit and gross profit margin benefited from the greater proportion of license fee revenues which command a higher margin than services and equipment. As such, our gross profit grew to $1.9 million from $0.9 million in Q1 '23, with our blended gross margin improved to 86% from 40% in Q1 '23, which included a hardware reserve expense.

If you exclude the hardware reserve expense in Q1'23, it would have been 62% versus 86% in Q1 '24, with the current year period also benefiting from the revenue mix that included a higher margin license fee revenue.

Turning to expenses, we reduced our total operating expense by $231,000, or 17% in Q1 '24 versus Q1 '23. This included SG&A reductions of $149,000 and $83,000 less in research and development and engineering expenses. Expense reductions included sales personnel and marketing show expenses and lower lease expense for our New Jersey headquarters, as discussed in prior calls. We were able to downsize the corporate headquarters, reducing our lease expense and related occupancy costs, as most of the team is now working remotely. These cost-cutting initiatives were slightly offset by higher audit and professional fees related to public reporting and regulatory filing.

Given higher revenues and gross profit, we trimmed the operating loss by $1.2 million to an operating loss of $509,000 in Q1 '24, from an operating loss of $1.8 million in Q1 '23. In terms of bottom line, BIO-key significantly trimmed its net loss by 70% to $ 510,000, or $0.32 per share in Q1 '24 versus $1.9 million, or $3.51 per share in Q1 '23. We will continue focusing on increasing revenue and cost-saving initiatives in 2024 to support our cash to cash flow break-even and profitability.

In terms of the bound key items, as of March 31, 2024, BIO-key had current assets of approximately $2.3 million, including $690,000 of cash and cash equivalents, $710,000 of accounts receivable and due-to-factor, and $440,000 of inventory, net of the $4 million of reserves. As mentioned, in Q1'24, BIO-key received $1.5 million in cash related to an extended two-year extension of a license agreement with a long-term financial services customer that utilizes our biometric technology for customer authentication.

In 2023, we wrote down $3.1 million of inventories that were slated for projects in Africa down to zero. We are working to convert that portion of the hardware inventory to cash upon shipment to support our growth initiatives and operations. We also have several larger projects with new and existing customers that are in a request for proposal or proof of concept stages with healthcare and financial customers and a foreign defense force that's an existing customer, which could potentially benefit our results in upcoming quarters. That concludes our prepared remarks.

Now I'll ask the operator to begin the Q&A.

Question-and-Answer Session

Operator

We will now begin the question-and-answer session. [Operator Instructions]

Unidentified Analyst

Bill Jones

Operator

At this time, we are showing no questions and the Q&A session has ended. I'll ask Mike DePasquale for closing remarks.

Mike DePasquale

Thank you, everyone, for joining our call today. We look forward to updating you on future investor calls. Please reach out to our IR team, whose contact information is listed in our press release with any follow-up questions. We look forward to updating you on our Q2 call, and as always, we'll provide news and updates in the interim by press release. Again, thank you for your time today.

Operator

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