Earnings Call Transcript - BKYI Q4 2022

Operator, Operator

Good morning, ladies and gentlemen. Thank you for standing by, and welcome to the BIO-key International Fourth Quarter 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, Friday, March 31, 2023. Now I would like to turn the call over to Bill Jones, Investor Relations. Please proceed.

William Jones, Investor Relations

Thank you, thank you for joining today's call. Participating today are BIO-key's Chairman and CEO, Mike DePasquale; CFO, Cecilia Welch; VP of Channels for North America, Galen Rodgers; and myself. I will remind everyone that today's conference call and webcast as well as answers to questions may include forward-looking statements, which are subject to certain risks and uncertainties that may cause actual results to differ from those projected. Words such as anticipate, believe, estimate, expect, and plan, as well as similar words typically identify and express forward-looking statements. These forward-looking statements are made based on management's beliefs and assumptions today, 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 risk factors that may affect the future performance of BIO-key, please see risk factors in the company's annual report filed on Form 10-K with the Securities and Exchange Commission. Listeners are cautioned not to place undue reliance on such forward-looking statements, which speak only as of today's date. The BIO-key company undertakes no obligation to revise or disclose revisions to such forward-looking statements to reflect future events or circumstances occurring after today. And with that, I will turn the call over to Mike. Mike?

Michael DePasquale, CEO

Thanks, Bill. Good morning, and thank you for joining our call today. After my remarks, I want to let one of our new Senior Sales Executives, Galen Rodgers, introduce himself and review sales and channel initiatives for 2023. Ceci will provide financial highlights, and then we'll open the call to investor questions. From a high level, we had a strong close to the year, achieving full-year revenue of $7 million, which met the low end of our revenue guidance. More importantly, we made tremendous progress in 2022, solidifying our global reach and brand, while continuing to expand our base of high-margin annual recurring revenue. We now serve tens of millions of end users across 600 customers globally, leveraging our PortalGuard platform in North America and Swivel Secure in Europe and the Middle East. We've evolved our business to a software-as-a-service or SaaS-based model, or more precisely what we refer to as ID-as-a-Service or IDaaS. Our 2022 net loss increased due to added expenses from the acquisition of Swivel Secure, our PortalGuard IDaaS sales and marketing build, and the active development of enhanced features for our solutions, including MobileAuth. Additionally, our personnel and other costs reflected general inflation-based increases that were experienced by most companies in 2022. In response, we have been taking steps to reduce costs wherever possible, including streamlining our headcount and overhead. We're also looking to enhance our financial liquidity by working to reduce hardware inventories, which we increased to navigate potential supply chain challenges back in late 2021 and early 2022. We had $4.8 million of inventory at year-end, and we have a goal to reduce that by at least half in the first two quarters of 2023. Importantly, during 2022, BIO-key achieved higher software revenues in North America, Europe, the Middle East, South America, and Asia; given ongoing funding and rollout delays for government-sponsored civil ID programs in Africa, it was the one region that did not achieve growth. However, we are cautiously optimistic that things could begin to turn around in Africa, in particular Nigeria, as we progress through 2023. Innovation remains critical to BIO-key’s growth and competitive position. During 2022, we made significant progress expanding and enhancing our solutions, including our passwordless and mobile solutions, which include our proprietary identity-bound biometrics, or IBD capabilities. We launched enhancements to our Mobile Authenticator app in Q3 2022. We also developed and launched an updated Admin panel that delivers an improved user experience for PortalGuard users. These successful launches received excellent feedback from customers and prospects. Our PortalGuard IDaaS franchise continued to build momentum in 2022, further expanding penetration of customers across higher education, county governments, and business enterprises. Customers prefer PortalGuard for its effective security, ease of use, scalability, and attractive value proposition. In 2023, we will look to increase PortalGuard's penetration of these verticals while also pursuing opportunities in new adjacent markets. To enhance the global reach of our solutions and sales, we have expanded our direct sales team, which is supported by both traditional and digital marketing campaigns. In conjunction with the management transition announced in January 2023, we recruited Galen Rodgers as VP of Channels and Chad Carter as VP of Sales, both in North America. I will turn the call over to Galen in a moment. But let me first say that we are very excited to bring their experience, skill sets, and leadership to our company, as they each have decades of valuable sales experience within larger organizations in our industry. It cannot go unnoticed that cybersecurity challenges continue to grow in both the number of episodes and their severity. To counter this trend, industry forecasters expect another record level of cybersecurity spending in 2023, and we believe BIO-key is well positioned to benefit. To date, nearly a third of all organizations have launched passwordless authentication solutions, which is up from 22% last year, but still leaves a very substantial sales opportunity on the table. We think our multi-factor solutions with identity-bound biometrics offer a unique and cost-effective solution for organizations across most verticals and use cases, especially for those looking to implement passwordless or zero-trust solutions, which are critical in today's environment. I could go on, but let me just say that we believe our substantial direct sales and partner distribution footprint positions us well around the globe. We are working on a solid pipeline of customer opportunities, including several that are very substantial in scale. While we also continue to build this pipeline through our sales and marketing outreach. The true force multiplier for us is our Channel Alliance Program or CAP. That is being spearheaded in EMEA by our Managing Director Alex Rocha and here in North America by Galen. As a result, we feel confident for continued growth in 2023 and beyond. We disclose today that we expect Q1 2023 revenue will be at a record level, getting us off to a strong start to the year. Rather than attempt to project a specific revenue range for 2023, we've instead indicated that we expect 2023 will be a period of substantial top-line and bottom-line improvement. This outlook is supported by our strong start in Q1, along with our growing base of high-margin contracted annual recurring revenues, which we currently estimate to be at approximately $7 million in run rate. Based on these factors, we feel very confident that we will substantially exceed our 2022 top and bottom line performance, reduce our cash burn, and move towards breakeven and profitability. Before I turn the call over, I'll note that a recent report by Houlihan and Lokey showed median valuation multiples for public companies in the cybersecurity software industry range from a low of three to seven or eight times revenue on an enterprise basis, depending upon expected growth. Obviously, BIO-key is trading at much less than that based on 2022 results. We are off to a strong start in 2023, which can lead to solid appreciation for all of our stakeholders. I'll now turn the call over to Galen Rodgers, who joined us in early 2023, to briefly review how he is working to take BIO-key's sales reach to higher levels in 2023. Galen?

Galen Rodgers, VP of Channels for North America

Thank you very much, Mike. First about myself. I have 23 years in this business with 16 years in technology sales, with the majority of my time being in Channel Sales. Most recently, I was Director of Strategic Channel at Ping Identity. From a channel perspective, our mission is to build scalable, dependable, and collaborative avenues that contribute to revenue growth and value while expanding our market presence globally. More specifically, what this means is that we have focused on the core objectives of reaching new markets, building pipeline, generating partnerships, and increasing our deal size, then tackling specific higher value opportunities. Higher value opportunities in cybersecurity would include established cybersecurity systems integrators, large account resellers, and technology partnerships. From there, we manage and analyze what's working and not working, so that we can continue to enhance our process and performance. We currently have a great base of partners in our Channel Alliance Partner Program, with over 500 partners globally. We have key distribution partners such as Intellisis, 3i, and DLT, a TD SYNNEX company, and our SLED partner. We have key value-added reseller relationships with important tech alliances with firms like AWS, BeyondTrust, and ForgeRock. We also have key cyber-managed security service provider relationships, and one of my initiatives in 2023 is to roll out our new enhanced partner program to new and current partners. This will provide structure and incentives to evangelize, sell licenses, and provide services to the market. This program will reward cybersecurity partners differently from the previous program by training partners to implement our solution and in turn provide additional sourced opportunities, which I believe is low-hanging fruit to drive the business. From a numbers perspective, our plan includes $1 million of channel sourced bookings in 2023, in addition to $3.5 million in future opportunities to the sales pipeline, from channel-sourced deals. We have a number of new partners we are targeting, and obviously, I won't discuss those for competitive reasons. However, we have a comprehensive list of prime targets. I'm very excited about the opportunity to be part of the BIO-key team, and I'm looking forward to taking our channel development and productivity to the next level. With that brief overview, I'll provide an update from the VP of Sales, Chad Carter, who has joined the BIO-key team. Chad has been in the industry for 25 years, specifically in network and security sales. He recently finished six years with a European cybersecurity software provider, Wallex, building their US team up to eight people and primarily self-sufficient. He made the move to BIO-key because he really liked our products, biometric differentiation, and market opportunity, and he was ready for a new challenge. Our team is focused on some core goals for 2023, which include increasing average deal size, better prospecting, targeting enterprises with bigger budgets, and most importantly, channel enablement. We believe that the channel needs to be involved in almost every deal early on. This is how channel and field sales work together. We will assign a partner as often as possible when it makes sense because to gain their mind share and focus, you need to be feeding the deals into the channel and get deals in return. It's really a symbiotic relationship when it works best. When talking about increasing deal size, it really involves several factors that start even before you engage with the customer. We are focusing on longer-term opportunities like three-year deals that are paid upfront. This is achieved through better prospecting, targeting companies by revenue, larger prospects, those near current customers, and focusing on key verticals outside of what we internally call SLED, which is state and local counties, municipalities, and education, which has been PortalGuard's sweet spot. Chad's theory with bigger prospects has always been land and expand, meaning let's get our foot in the door and we can grow the relationship over time. In this regard, we have been focusing on $500 million to $5 billion companies, meaning account-based marketing, taking a narrower focus and going deeper – by thinking bigger, we can increase our average selling price quite substantially by as much as 50% in the first year. All these things can lead to larger deal size. In line with our partner strategy, we're doing account mapping to align with our channel partner sales teams to drive new opportunities, and we're implementing a more formal referral selling program. We found that customers are often open to giving a referral versus being a case study. Again, some of this is basic, but as previously mentioned, we see some low-hanging fruit strategies and tactics that need to be communicated and executed, and we're in that process. This is what the team is focused on in North America. And with that, I will turn the time over to our CFO, Ceci Welch.

Cecilia Welch, CFO

Thank you, Galen. Please let me review some of our financial highlights. Q4 2022 revenue rose 88% to $1.8 million from $0.9 million in Q4 2021, reflecting higher software license and service fees, including the benefit of the Swivel Secure acquisition in March of 2022. Likewise, 2022 revenue rose 37% to $7 million versus $5.1 million in 2021. In both current year periods, higher software license and service fees were partially offset by lower hardware revenue. Revenue from software licenses increased 92% in Q4 2022 and 79% to $4.6 million in fiscal year 2022, reflecting the addition of Swivel Secure and new quarterback customers and existing recurring revenue contracts. Service revenue increased 104% in Q4 2022 and increased 41% to $1.8 million for the full year 2022, with the majority representing recurring maintenance and software support. Recurring service revenue increased 13% to $1.2 million in 2022, largely due to increased maintenance related to software licenses. Non-recurring customer services increased 216% to $546,000 in 2022 due to increased new customer installations, Swivel service fees, and the conversion to cloud platform. As our customer base continues to grow, we expect service revenues to continue to increase. Our sales increased 25% in Q4 2022 but decreased 50% to $646,000 for the year. The annual decline was due to sales to an international government agency in Nigeria in 2021 that did not recur in 2022 due to delayed rollout of the government project. Strength in Q4 2022 was attributable to new customer orders in addition to expanding existing installations. Gross profit increased to $1.2 million in Q4 2022 compared to $0.6 million in Q4 2021, due to higher revenue and a better realized gross margin of 67% versus 60% in the prior year period. For the full year, gross profit margins improved to 71% in 2022, from 67% in 2021. Total operating expenses increased to $5.9 million in Q4 2022 from $2.6 million in Q4 2021. The full year 2022 operating expenses increased to $14.7 million from $8.4 million. The 2022 periods reflect the addition of the Swivel Secure operations, non-cash impairment charges to goodwill, and $1.8 million of higher SG&A and research and development and engineering expenses. Higher SG&A costs included marketing expenses, legal and professional fees, and other expenses incurred in connection with the acquisition of Swivel and our ADB capital loan, bad debts, and an allowance for doubtful accounts. Moving forward in 2023, we do not expect bad debt and allowance for doubtful accounts to recur. Higher R&D expenses reflected an increase in personnel costs and product development activity, including the Q3 launch of significant enhancements and updates in our MobileAuth app. We expect lower R&D expenses in 2023 as outside resources for 2022 product development activities are no longer required. As such, BIO-key recorded a Q4 2022 operating loss of $4.8 million versus an operating loss of $2 million in Q4 2021, with the increase primarily due to the Q4 2022 non-cash goodwill impairment charge. BIO-key’s 2022 operating loss increased to $9.7 million from $4.9 million in 2021, due to higher costs and the goodwill impairment. Likewise, BIO-key reported a net loss of $5.1 million, or $0.62 per share in Q4 2022, versus a net loss of $2 million, or $0.26 in Q4 2021. The company reported a 2022 net loss of $10.2 million, or $1.26 per share versus a net loss of $5.1 million or $0.65 per share in 2021. BIO-key ended the year with current assets of $9.7 million, including $2.6 million of cash and cash equivalents, $1.6 million of accounts receivable, and $4.8 million of inventory. BIO-key had a current note payable, with the current portion of the loan due at $2.2 million. That concludes my remarks. Now I'm going to turn the call back over to the operator for Q&A.

Operator, Operator

The first question will be from Jack Vander Aarde from Maxim Group. Please go ahead.

Jack Vander Aarde, Analyst

Okay, great. Good morning, guys. I appreciate the update, and thanks for taking my questions. I think as I did this last time, I'll just start with some fourth quarter questions and move on to your outlook. But Ceci, I will finish with the question on what stock compensation was in the quarter and what the current total shares outstanding are as I wait for the 10-K. So let me start with the question from Michael. First, on the fourth quarter OpEx, you mentioned you expect the OpEx to be reduced sequentially as you head into the first quarter, obviously overhead. But SG&A expense in the fourth quarter was $3.3 million, so that was a pretty substantial increase of $800,000 from the third quarter and well above any other prior quarter. So can you just help me understand, what is normalized SG&A expense on a quarterly basis as you kind of enter 2023?

Michael DePasquale, CEO

Good morning, Jack. That's a great question. At a high level, based on our prepared remarks, we've made significant investments in development in two main areas: IDaaS, specifically enhancing and expanding our SaaS solution, and our MobileAuth technology. As a result, you will start to see our expenses stabilize and decrease since most of the initial development is now complete. Now, I will allow Ceci to address the specific increase in SG&A for Q4, as it's best for her to provide clarity on that matter.

Cecilia Welch, CFO

Okay, thanks, Mike. Yes, Jack, as we indicated, we wrote off some of the things that had been outlying as far as things we had on receivables that we didn't consider collectible. We paid some substantial fees for the loan and for acquiring Swivel. Due to a lot of factors, we wrote off the goodwill we had on the books. So, you know, as you can see, there were just some goodwill loans of $1.8 million, and then we had over another $1 million in other miscellaneous non-cash expenses that we could consider that were not viable assets on the book.

Jack Vander Aarde, Analyst

Okay. I guess, excluding the impairment charge, I'm not referring to that. I'm just talking about your actual SG&A expense, which was $3.3 million roughly. Is that kind of a normal baseline or was that the highest quarter with a book value of $2.5 million in the third quarter?

Cecilia Welch, CFO

No. We've been streamlining it, and we expect that SG&A and R&D will be under $3 million per quarter moving forward. That's our budget target.

Jack Vander Aarde, Analyst

Okay. Excellent. I appreciate the color there. Let me switch gears and quick to your outlook. Michael, it's good to hear you expect sequential revenue growth in first quarter 2023 and then substantial growth for the full year of 2023, even despite what sounds like limited visibility into the African contract contribution. But it may be just for clarity, as far as your first quarter 2023 revenue outlook for sequential growth. Does that assume anything from those two African contracts? Or is this just mostly from the strength of your recurring license business? Thanks.

Michael DePasquale, CEO

Right now, the strength of our core business is evident. Our current recurring revenue stream consists mainly of two components: subscription revenue and annual subscription revenue. The second component is maintenance from our traditional customers who purchased perpetual licenses and now pay for ongoing support. Collectively, these two areas represent our contracted business, which will generate approximately $7 million in revenue. This establishes our base, matching our full revenue picture from 2022. Anything beyond that, which I am currently projecting, will be revealed when we report our Q1 results, and it indicates a very strong and record quarter for us. This projection does not include any contributions from the African business right now. We remain cautiously optimistic that this segment will begin to grow again. There was a recent election in Nigeria, and the National Identity Management Commission had been fundamentally halted in processing payments to the agents managing enrollments for a World Bank initiative. Thankfully, we see signs of progress as the World Bank is considering covering the enrollment costs directly to facilitate the project. Overall, we're projecting results excluding Africa, which I view as an upside opportunity for us. Additionally, our EMEA group, led by Managing Director Alex Rocha, has been actively signing partners in Africa to promote our PortalGuard solutions. We announced a new partnership with Ethnos, a cybersecurity firm that operates across Africa and assists enterprises and government agencies in strengthening their security infrastructure. We believe we will be selling our traditional products globally, including in Africa, but our primary focus remains on our core business: PortalGuard and biometrics.

Jack Vander Aarde, Analyst

Okay, got it. That's very helpful. You mentioned that the $7 million baseline is where you're starting with your recurring revenues, which is high-margin revenue. That's certainly a positive. Regarding your efforts to move towards profitability, considering your comments about expected reductions in overhead costs alongside significant revenue growth and bottom line improvement in 2023, it seems reasonable to reassess. Do you have an idea of what revenue level represents breakeven or profitability for you?

Michael DePasquale, CEO

Well, I think on a high level, right, if we're in the $3.5 million range right now, with current expense at the current expense run rate, we're going to be certainly at breakeven or profitability. So, if you want to look at it on an annualized basis, it's probably around $14 million, give or take. Now, there's some cost savings and advantages that we may see, as we traverse through the course of the year, and we're going to see our revenue grow as well. So perhaps that point will change. But right now, that's probably the best perspective I think to give.

Jack Vander Aarde, Analyst

Okay, that's very helpful. I appreciate that color. And then, as I mentioned at the beginning, Ceci, if I could just reflect what the total stock compensation was in the fourth quarter and what the current total shares outstanding are?

Cecilia Welch, CFO

Yes, so I'm just going from the K, which gives me annual. So the stock compensation was $388,000; outstanding shares are a little over $9.2 million.

Jack Vander Aarde, Analyst

Great. And just for clarity, is the 10-K going to be coming out today? I don't think I've seen it quite yet. But I imagine it'll be filed today?

Michael DePasquale, CEO

Jack, we found out yesterday that it likely will not be filed today. We plan to file next week. Our auditors have faced challenges due to a shortage of resources, making it difficult for them to complete the process with their number of clients. Our audit firm was acquired by Marcum in the middle of last year, and we have been transitioning to the new firm. This transition has taken extra time over the last two quarters. So, while we will file, it will be late.

Jack Vander Aarde, Analyst

Okay, I understand. I have noticed that this issue is common among many emerging growth companies as well. That makes sense. I'm pleased to hear about your positive outlook for substantial growth. That's all from me. Thank you for the questions.

Michael DePasquale, CEO

Thank you, Jack. Thank you everyone for joining today's call. We look forward to updating you on our Q1 call, which will be held in May. So it's not too far away. And as usual, we'll continue to provide regular updates via press releases for newsworthy developments as they happen. Once again, we thank you for taking the time to join us this morning. Have a great weekend everyone.

Operator, Operator

Conference has now concluded. Thank you for attending today's presentation. You may now disconnect.