Good morning ladies and gentlemen. Thank you for standing by and welcome to BIO-key International’s Second Quarter 2018 Conference Call. All participants will be in listen-only mode. After the speakers’ remarks, you’ll be invited to participate in a question-and-answer session.

As a reminder ladies and gentlemen, this conference is being recorded today, Tuesday, August 14, 2018. 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. Good morning and thank you for joining us on today’s call. With us this morning are Mike DePasquale, BIO-key’s Chairman and CEO; Barbara Rivera, Chief Operating 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, intends, 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 events or circumstances after the date made. At this time, I’d like to turn the call over to Mike DePasquale.

Mike?.

Yeah, thank you Scott and good morning everyone and thank you for joining us today. I want to take some time to review highlights from our second quarter performance, as well as our outlook for the remainder of fiscal 2018, to better understand where we are and potentially where we’re headed.

While we would of course liked to have delivered stronger revenue in the Q2 period, for reasons we have often mentioned, principally around the timing of closing larger customer opportunities, our Q2 results did not match those in the year ago period.

Further as our exposure to consumer product based revenues grows, the more we expect to have exposure to retail sales patterns, which are heavily weighted to the second half and generally the holiday season towards again the end of the year.

While we understand it makes it more challenging for shareholders to have such limited visibility into our revenue patterns, we expect to have similar challenges over the next year and we’ve discussed this many times. Making full year performance and long term revenue trends a more effective means to assess our progress.

Fortunately what is becoming abundantly clear is that the need to securely identify, authenticate and report on the individual accessing a network or database, has become an issue of critical importance at most leading organizations.

One significant contract that occurred in the second quarter includes providing software and hardware to Claro, a unit of América Móvil, a global telecommunications provider. This project involved enabling fingerprint based log-in as a method of creating a thorough audit trail of employees accessing sensitive customer records.

The use case for our technology is in the authentication and reporting on access to customer data, and it’s the second recent deal for BIO-key with a major telecom call center.

We believe this use case is an exciting and potentially very large opportunity for us, as organizations are focused to reevaluate their existing security platforms and practices for securing customer and enterprise data.

High profile media coverage of various customer data breaches has been very helpful in escalating the importance of taking preventative measures against the internal threats where a large percentage of security breaches occur.

Any company that collects consumer information, especially financial data is a target for hackers, as well as internal breaches that may expose that information. Another international customer deployment was in Hungary, where our ID Director for Windows was selected to provide multi-factor authentication.

This customer already had several types of fingerprint scanners in place, but wanted to deploy finger biometric authentication across their organization. BIO-key’s interoperable support allowed them to leverage existing fingerprint scanner hardware and help offset the cost for their deployment.

It’s a great validation of all that we have been building this past decade and when we get to see our brand recognized globally, it’s very satisfying. Expanding our footprint also proves helpful in building new sales and distribution opportunities. In particular, that opportunity was very closely tied to IBM.

They own the security infrastructure at that customer site. To support this growing global demand, we are working to increase our presence across Asia, with offices in India and Singapore and our primary subsidiary office in Hong Kong.

Additionally, we have new sales partnerships with leading technology providers across Europe and North Africa, supporting our international expansion strategy. Turning to our hardware solutions, we’ve been working to build awareness and retail distribution reach for our innovative biometric and Bluetooth enabled locks across Asia and North America.

Placing our TouchLock line in major brick-and-mortar retailers has been a key objective for us; one that we have determined is often best achieved through partners that have existing reach and infrastructure.

For this reason we have worked to expand our base of distributors that have been successful in placing our product with prominent retailers such as Best Buy, where our products are available in store and online.

Our objective the past few quarters has been to put in place an expanded national and international reach for our hardware products in order to position BIO-key for meaningful participation in the coming holiday selling season.

As you’ve seen in the past few quarters, BIO-key continues to demonstrate the strength of our innovation and technology leadership in the biometrics security space with the receipt of new patents.

We believe our patent portfolio represents a significant future opportunity for the company as enterprises increasingly move toward adoption of biometric solutions. BIO-key recently secured a patent for our Adaptive Indexing method that accelerates biometric searches.

While the current use of biometrics is principally focused on device based authentication for mobile devices, our patent for rapid one-to-many biometric authentication in the Cloud enables a far more secure and value aided solution, that could prevent duplicate enrollments, fraud and identity errors.

Such protections are not just possible in the device-only authentication world. This technology that is associated with our patent is already in use in our enterprise biometric solutions and the new patent issuance may present additional revenue opportunities for us in the future.

As much as we feel that we are on track to deliver on our outlook, we continue to focus investors on full year results, as we believe this longer term measure presents a more relevant performance metric for our business. That said, we feel confident in a fiscal 2018 revenue guidance range of $8 million to $12 million.

I would however like to reiterate that BIO-key’s quarterly performance will continue to fluctuate based on the timing of larger software and hardware agreements, which in the past two years have been heavily weighted to the second half of the year.

With that, I’d like to now turn the call over to Barbara Rivera to review Q2, 2018 operational highlights. Barbara..

Thank you, Mike. Good morning! A major area of operational focus in Q2 has been around better aligning our marketing and sales efforts to meet our objectives of increasing sales. As such, our BIO-key website is being redesigned and will include an enhanced Sales Engine Optimization SEO capability.

This strategy will ensure that our website will obtain high ranking placement in search results online around key words that pertain to our solutions. We expect to launch the new site next week and encourage all of you to visit and share your feedback.

We have also added a couple of new marketing automation tools that will allow us to seamlessly shift our marketing effort to a one-to-many approach. Automating lead generation functions allows us to scale our pipeline with more targeted and qualified opportunities.

These marketing and prospecting tools help us to better understand who our customers are, where to find them and what their pain points are. In the area of global sales expansion, we have executed a strategic partnership with QB Advisory, QBA, a global IT services provider to support the growing demand for biometric authentication throughout India.

This strategic partnership provides QB Advisory with the ability to introduce a suite of world class biometric authentication solutions to a marketplace with significant potential for our capability. This partnership also allows BIO-key to respond to customer inquiries within India with knowledgeable sales and technical support in their native land.

The sales office is located in Mumbai and the technical team is located in Calcutta. And with those updates, I’d like to ask Ceci to provide a quick overview of our Q2 financial performance and our current financial position.

Ceci?.

Thank you, Barbara. Our total Q2 ‘18 revenue decreased to $748,000 from $887,000 Q2 ‘17, with lower hardware which includes fingerprint reader, Biometric and Bluetooth-enabled locks versus the year ago period. This is partially offset by sales from our software services and licensees.

In Q2 ‘18 gross margin was negative 38%, principally due to an increase in non-cash amortization of software license rights to $659,000 in Q2 ‘18 from $389,000 in Q2 ‘17, as well as the higher cost associated with providing engineering support for maintenance services.

Excluding non-cash amortization of license rights, gross margin would have been positive 51% in the quarter. Q2 ‘18 operating expenses decreased to 27% versus Q2 ‘17, primarily due to higher expenses occurred in the prior year related to factoring expenses and our NASDAQ up-listing.

R&D costs also decreased 34% in Q2 ‘18 as compared to Q2 ‘17, due to a decline in temporary outside services and a decrease in personnel and related costs. Our Q2 ‘18 net loss was $1.7 million or $0.15 per basic share after preferred dividend, as compared to a net loss of $1.8 million or $0.32 per basic share after preferred dividend in Q2 ‘17.

During the quarter we announced that all remaining outstanding shares of the company’s Series A-1and Series B-1 convertible preferred stock and all accrued and unpaid dividends were converted into common stock at a conversion price of $3.60 per share.

BIO-key had cash and cash equivalents of $304,000 as of June 30, 2018, a slight increase from $289,000 at December 31, 2017. Net cash was generated from operations for the first six months of 2018 for approximately $0.1 million as compared to negative $0.9 million in the first six months of 2017. With that summary, we can move to questions.

Operator, could you please start with the question-and-answer session?.

[Operator Instructions]. The first question comes from Brian Kinstlinger with Alliance Global Partners. Please go ahead..

Hi, good morning guys..

Good morning Brian..

So, I wanted to start with distribution of the Locks, both the TouchLocks, as well as the bicycle locks.

Can you first of all talk about how some of your brick-and-mortar partners, how initial adoption has gone and then talk about the build out of distribution and how that’s gone?.

Sure, I think we have promoted – there was a press release out maybe a few weeks ago or two or so weeks ago that we are now selling our Locks through an OEM partner Aluratek into Best Buy. They are also reaching out to other, not only brick-and-mortar, but e-tail distribution points to expand the availability of those products.

But we were highlighted two weeks ago, Sunday, as a product/deal of the day at Best Buy and we did very, very well; the sell through was strong. So we are continuing to promote the products, they are continuing to promote the products, both online and again in their stores.

We are in 200 – initially we were placed in 200 brick-and-mortar stores at Best Buy and the way they set things up around the country is they are no more than a day away from their other stores.

So if you walk in a store and the locks not in that particular store, it’s in one that’s pretty close by and you can either go there and get it or they will ship it to that particular store for you. Of course you can buy it online and pick it up in any store around the country. So we’re expecting to expand that.

Also we – believe it or not we’re in Brookstone. We haven’t – I don’t think formally made that announcement yet, but of course they also announced two weeks ago that they were going – filing bankruptcy, but that’s for their mall-stores. They’re still absolutely planning to keep their airports stores and of course their e-tail business moving as well.

So we’re continuing to expand. We are working on many, many other large retail brick-and-mortar and e-tail type scenarios as well. Our goal and objective is to over the next few months – to create awareness and demand for the products, so that they’ll get pulled through that distribution in e-tail network for the holiday seasons.

We also have other marketing plans that are in the formulation stages today, that will again relate back to creating a greater level of awareness and demand.

Also as Barbara mentioned, we are going to be launching an entirely new website and we’re actually separating our consumer products, when I say consumer products the locks here at this point, because the finger scanners, although they are consumer, they also sell in enterprise.

But we are creating a standalone website that will highlight TouchLock, so that for example if you’re the CIO of a very large you know, let’s say General Motors for example and you come looking for an enterprise solution you don’t want to see a lock on the homepage or anything that we are leading it in the context with locks, because you’re looking for an enterprise solution.

Conversely consumers who are looking for a lock, don’t want to come to a website where they see all kinds of enterprise type of software or hardware. So we’re separating that out and we think that will also have a positive benefit on our visibility and reach..

Can you talk about – I mean it’s early, but can you share with us your numbers in terms of how many locks maybe have been shipped to Best Buy or how many have been sold or any kind of – and how big can those numbers get in the holiday season as you ramp-up for production and get ready for manufacturing..

Well, I can’t share any specific numbers yet, because believe it or not we’re just starting to get the feedback from the larger e-tailers and retailors, so I can’t really share any numbers. I could share this though, we are now – we’ve gone through the last six to eight months really refining our product.

You know we put it out in the market, we got some really, really good feedback, we made some enhancements, some changes, we really fed that back in through engineering, to our group in China and now we’re pretty much – we are very stable and more importantly we are now capable of significant volume manufacturing.

So we can build tens of thousands of product between now and the holiday season. So we’re set to ramp significantly, if that demand is there. So we’re really expecting that that’s going to grow especially again as we continue or as we begin to more aggressively market these products.

So you know one thing I will say, I can’t sit here today and say exactly how much product we’ll sell before the end of the year. Our goal and objective is to be able to satisfy the order demand, so that we can ship as much as is possible. The products as you know range at retail price anywhere from you know $40, all the way up to $120.

Our bicycle lock which we launched in Asia has done very, very well they. In fact in Japan, Asahi bicycles is selling the lock with their bikes and as an add-on. We are going to launch that product here in the U.S.

this month and depending upon which model, that product has an MSRP of the combination version which can open Bluetooth or can open up with a fingerprint that has a MSRP of $119. So they carry quite a good, a sizeable revenue possibility and the margins on those products are good as well.

You know we keep saying that the margins on our hardware finger scanners and the consumer products are north of 50% and volume can make that a little bit better. So we are not in a position to be exactly precise on how much product we’re going to be able to sell or moved through the end of the year.

I think we are just kind of getting our self in line to support that demand..

And then just based on your annual guidance, should we think about it kind of like last year? There could be one or two very large orders, but the timing is uncertain and so that will be the driving factor to reaching those numbers..

That will certainly be the case, but I want to also say that we really expanded our footprint.

Barbara spoke about the opportunity in India and I don’t want that one to sold short, because we’ve always had many enquiries from companies in India, large and small and we’ve competed and we’ve won some, but nothing significant and really we found that culturally we weren’t really able to support that business.

The acceptance of biometrics across India is incredible, because of a project they call Aadhaar, which fundamentally has every single citizen in the country is enrolled in a biometric system, whether it’s fingerprint, Iris, you know they have a very broad range biometrics, so it’s widely accepted.

And in that context it’s also now being very widely accepted in the enterprise and business community.

So having feet on the ground, having an office there with a number of opportunities by the way in our pipeline and backlog right now with some very sizeable companies, we think not only will we look at a couple of large opportunities like last year, but I think our network is building and there are going to be many more small and medium sized opportunities that not only fall into our pipeline, but come out of our pipeline to closure between now and the end of the year as well.

And a couple of examples in Q2, even though our numbers weren’t where we wanted them to be, I was very, very pleased with the variability of our revenue and the fact that our international business is really starting to ramp and you know that’s big for us.

Also I don’t have to tell you that América Móvil is the fourth largest telecommunications company in the world outside of China. You know we closed a very large telecommunications contract in the fourth quarter of last year. So we’ve also closed business in India with Vodafone, we’ve done business with NTT in Japan.

So we have a really nice footprint in that space and our solutions fit very nicely in that space and call centers with shared workstations, we have the perfect, perfect solution. So that’s going to build as well and continue to expand. So it’s going to come with a couple of large contracts, but our business is also filling out..

Great. Thanks for answering my questions..

You’re welcome..

The next question comes from Josh Goltry with Maxim Group. Please go ahead..

Hi guys, how are you? I just have a question about this amortization expense that’s within cost of sales.

Is that going to continue to occur in the preceding quarters, because it seems like that’s the case now?.

Yeah, let me address that and then Ceci can back me up on that. So that amortization expenses is associated with a license arrangement that we put in place approximately two years ago, a little more than two years ago.

We are in the process, almost complete and are actually marketing now a solution set in Asia that will take advantage of that technology. We’ve built that into our WEB-key platform for multi-factor authentication. And so that amortization will change as we begin to market and sell that solution more broadly across, again across the market.

But right now we are writing that down on a quarterly basis and the amortization accelerated into this year, but again that could go down or in many ways go away as we begin to sell that technology on a broader basis..

Right. And you know, why do have such little insight on as to when you know you’ll be receiving revenue from certain customers, because you know you’re saying that you expect to maintain your guidance, but you don’t have visibility on when you’re going to recognize revenue from customers.

So I just want to understand why you have such a lack of visibility there..

Well, I want to you know separate two things. We had a conversation just a minute or two ago with Brian Kinstlinger from AGP about the visibility into our consumer business, and you know what could our potential consumer product lock sales be and I was – you know again, I’ve said it before, we just don’t have that level of visibility.

We’re just now new into the market. Really, this is our first holiday season where we’re in volume manufacturing, so I don’t have great visibility into that business and frankly quantity counts. So that’s clear, that’s what we talked about.

On the enterprise site, our business has always been lumpy and it’s always been a quarter-to-quarter, a differential based on as we’ve written in our press release and as we’ve described for many quarters based on again, when some of these contracts fall.

Do they fall in the second quarter, do they fall in the third quarter, do they fall in the fourth quarter as they did last year. So it’s not lack of visibility, it’s the cycles associated with these contracts.

And generally speaking, the larger they are, you know more tenuous in the context of closed timeframe they are and things have been that way and as I also described, they will likely continue to be that way, you know until we can get our base big enough.

As we’re expanding our international operations, as we have more irons in the fire, as we’re selling to a broader base of customers in not only various industries, but in various geographies, I think we’ll get more visibility into our business, but that may not happen for another year..

And I had a question about a balance sheet item that was introduced last quarter.

It’s called capitalized contract costs and I just want to understand what that is?.

For that one I’m going to turn it over to – yeah, no go ahead Ceci..

Great. That’s actually a new pronouncement by the accounting standards board.

What they are talking about is when you get contracts from certain companies, that relationship you know carries on and you usually get follow-on things or follow-on support and they see a lot of those activities that are related to getting that contracts specifically for us commissioned, should be amortized over a longer period than just expensing it at the current time because of that relationship, and so that’s where that number come from.

From those contracts that we’ve gotten, the commission earned then gets capitalized on and then expensed over a longer period of time, not specifically related to the revenue that’s recognized at that point in time..

Okay, I understand. Alright, I mean so you’re saying if you’re going to maintain your guidance of $8 million to $12 million for this year, you’re at least going to make $3.2 million in the next two quarters each, right.

So $3.2 million in Q3 and $3.2 million in Q4, that’s essentially what you’re saying?.

Yeah, we’re holding on our guidance. I think through the first half we’ll do, yeah, $6 million-plus in business in the next two quarters..

Okay guys, thank you. I appreciate it..

You’re welcome..

The next question comes from Adam Baker a Private Investor. Please go ahead..

Good morning, thanks for taking my call.

My question is, as you ramp up production, do you guys have the cash available to continue to grow with the revenue?.

We are always looking at that. It certainly takes more cash for us to build inventory, you know buy parts and pieces and components, to be ready to ship on a short term basis. Right now our turnaround is about 30 days on our consumer products and a little bit less than our finger scanners.

So we’re always looking at that and looking at options to ensure that we can support our business. So we have factoring arrangements in place. We have a credit line that we put in place.

A number of years ago, actually two years ago we’ve not drawn down on our utilized, but that’s certainly something that we’re always looking at on a on a daily basis, if not weekly basis..

So that being said, do you have enough to manufacture the $6 million that you are expected to sell in the next two months..

That’s variable. It depends on the timing, it depends on the size of orders, it depends on the term, so we really – I really can’t answer that question. It really depends..

Okay. That’s it from me..

Thank you..

Our next question comes from Matthew Chambers a Private Investor. Please go ahead..

Hi Mike.

Question, about the $6 million here coming up in the next half, what percentage of that is going to be the locks or what part did you break in – how much did you bake in for that?.

I can give you some, maybe some historical data and then we’ll see obviously how we extrapolate that given the discussion we had around the locks, right, and not really understanding the magnitude of what that can be. Last year we generated about $6.3 million or so in revenue.

About 70% of our product sales right, forget services and maintenance and so forth, 70% of our product sales was software and about 30% were hardware. We believe that as we came into the year that that mix would change.

That software could – as our target is bigger right, $8 million to $12 million, that hardware could grow and be a greater portion of our overall revenue. So we might see – you know it might be in the 60%, 40% range this year and again, depending upon the locks right, remember our finger scanner sales are also quite significant.

But depending upon the locks, that component might be higher, but that’s yet to be seen and we’ll see how we do during the holiday season..

Great. [Audio Gap] locks compared to the finger scanners..

Again, that really depends on the uptake that we get during the holiday season, which is you know what we’ve been discussing. Our fingerprint scanner business is not only stable, its growing and we’re seeing more and more that customers that buy our software are buying significant quantities of finger scanners from us as well.

So for example, the deals that I mentioned to you, that we announced in Q2, the international deals, they both included not only software but also hardware and finger scanners..

Alright, thank you..

You’re welcome..

That’s it from me..

You’re welcome..

[Operator Instructions] Showing no further questions, this concludes our question-and-answer session. I would like to turn the conference back over to Mike DePasquale for any closing remarks..

Thank you, and thank you all again for participating in today’s call. We hope you will join us again for a third quarter conference call in the fall. Thank you everyone..

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