Earnings Call Transcript - IDN Q3 2021

Operator, Operator

Good day, everyone, and welcome to the Intellicheck Third Quarter 2021 Earnings Conference Call. Now, I am pleased to hand it over to your host, Mr. Gar Jackson. The floor is yours, sir.

Gar Jackson, Host

Before we get started, I will take a few minutes to read the forward-looking statement. Certain statements in this conference call constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 as amended. When used in this conference call, words such as will, believe, expect, anticipate, encourage, and similar expressions as they relate to the company or its management, as well as assumptions made by and information currently available to the company's management, identify forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on management's current expectations and beliefs about future events. As with any projection or forecast, they are inherently susceptible to uncertainty and changes in circumstances, and the company undertakes no obligation to and expressly disclaims any obligation to update or alter its forward-looking statements, whether resulting from such changes, new information, subsequent events, or otherwise. Additional information concerning forward-looking statements is contained under the headings of Safe Harbor statements and risk factors listed from time to time in the company's filings with the Securities and Exchange Commission. Statements made on today's call are as of today, November 10, 2021. Management will use the financial term adjusted EBITDA in today's call. Please refer to the company's press release issued this afternoon for further definition, reconciliation, and context for the use of this term. We will begin today's call with Bryan Lewis, Intellicheck's Chief Executive Officer, and then Bill White, Intellicheck's Chief Financial Officer, who will discuss the Q3 financial results. Following their prepared remarks, we will take questions from our analysts and institutional investors. Today's call will be limited to one hour, and I will now turn the call over to Bryan.

Bryan Lewis, CEO

Thank you, Gar, and thank you all for joining us today for our 2021 third quarter Intellicheck earnings call. We have started to see things open up, although there are still lingering COVID impacts to one component of our business. Year-over-year, we believe that more people will be shopping brick-and-mortar, which, of course, is positive. We recognized that due to savings rates and stimulus received during the pandemic, currently, shoppers are not necessarily buying on credit or, more importantly, opening new credit card accounts. While we believe this will continue to impact us in the short term, we believe that as things start to return to pre-pandemic levels and consumers begin to spend in a normalized way, this will drive credit card applications and additional card-not-present transactions. I would also like to point out the distinction I made just a moment ago when I noted COVID-19's lingering impact to one component of our business. I have talked to many people who seem to think we are just a brick-and-mortar credit card business. Three years ago, that may have been the case, but we have been on a transformational path since I arrived. We have expanded our client base far beyond just credit cards into banking, call centers, gambling, cannabis, stadiums as well as the digital world, which continues to become an increasing portion of our business. This transformation continues with new technology and partnerships, which I will be discussing shortly. Returning to customer shopping habits, we know that shoppers will continue to make in-store purchases, online pickup in-store purchases. They will make purchases online with delivery, and they will engage in Buy Now Pay Later purchases. Yes, the holiday shopping season will likely see an increase in credit purchases. And what each of these behaviors have in common is the risk of fraud and identity theft; neither is going away. The data shows identity theft and fraud rates continue their upward trend at a record-setting pace. The breaches we continue to see, along with the enormous amount of personal information already available on the dark web, suggest that fraud is only going to get worse. Criminals continue to impersonate individuals with fake IDs created using identities that they have purchased on the dark web, and we don't see this trend diminishing. Looking at the quarter, our Q3 SaaS revenue was up 32% over Q3 2020, and it was flat to Q2 2021, driven largely, we believe, by the factors I discussed at the start of the call. We saw an interesting mix in transaction volumes among our clients. Department stores, particularly those predominantly selling apparel, were down 7% to 10% in transaction volumes during the quarter, while those retailers selling electronics, appliances, and our banking clients were up almost the same amount. Interestingly, those same retailers that were down in the quarter had October volumes that were up 15% over September. Again this quarter, much of what we have been investing in and working on this year has been transforming the company to be more of a digital identity company rather than purely an ID validation company. As I said earlier, this transformation will allow us to move into many more markets and provide more services to our clients and prospects than purely ID validation. Any time you need to validate an identity, whether in a physical or digital setting, we believe our efficacy makes us the best and most vital first step, and therefore, the logical partner to acquire other risk signals from. We stop the bad guys from getting in. But even if you are exactly who you say you are, there is additional information we can provide through partnerships to help clients and prospects with their KYC or Know Your Customer obligations. We believe that this opens up opportunities for new verticals that require a much more in-depth identity check that goes beyond simply verifying if an ID is authentic. Moving forward, there are developments on a few fronts that I want to share with you and bring you all up to speed. As usual, we are going to first look at some highlights with our existing clients and some new wins. We are also going to look at the changes we made to our pricing model and our new efforts on channel partner sales. I will also tell you about the reseller agreements we have entered into to expand the product set we can offer our clients and the launch of our new Platform 2.0 that makes this all possible. First, let's look at our financial services clients. Financial services company #2 completed its project to provide applications and account lookups through a tablet instead of having to go through the point-of-sale system. This allows them to get their clients up and running and using our services much quicker. In addition, we are working with two new retailers with approximately 600 locations each, and they expect to be live in early Q2 for credit applications and account lookups. They are very excited about their new business pipeline and they tell us it should be a very good year for new clients using our services. Financial services company #3 has rolled out their pilot of their teller workstations. So far, all is going well, and they expect full deployment to their 720 branches in Q1. They continue to work with their home improvement clients to expand to their multiple point-of-sale systems. However, that requires some changes to the bank's internal systems, and that timing remains out of our control. Given the speed at which company #3 moves, I would expect that to be a second-half of 2022 event. The good news is that they continue to be an excellent reference for us, both with industry analysts and prospects. It never hurts to have the Senior Vice President of Fraud tell prospects that he thinks we are one of the top five fraud-fighting tools of all time. Financial services company #4 is pushing to integrate our services into all of their retailers' digital channels. A big benefit of online is that it does not impact their point-of-sale system, so we can be working during the normal holiday code freeze. In addition, as they look to increase the use of our products in Canada, we are bringing live the ability to authenticate Canadian health cards. These are valid forms of ID for some provinces and have barcodes similar to Canadian driver's licenses. Additionally, they are in the process of rolling out their mobile banking project that allows their clients to validate themselves on the bank's mobile app. This effectively adds a layer of security for both the bank and their client as the banks add more digital use cases. They estimate that 40% to 45% of their clients have the mobile app installed on their phones. In addition, you may remember from the last call that they prepaid for what they believed would be a year's worth of transactions. But at the current rate of consumption, it looks like they will draw that current allocation down by May. We anticipate that if the additional clients and use cases they plan on rolling out happen on time, more likely they will run out by Q2. I am also pleased to share with you the latest development with the bank's consortium-owned company we signed late in Q4 last year that helps financial firms detect and prevent fraud. They have agreed to be a beta client for our new Platform 2.0, which I will be discussing shortly. This will allow them to use our products more frequently in their call center, and their intention is to then roll out our services to their digital payments network. In addition, we now have a new financial services client. We signed a master services agreement with a California-based provider of, among other things, mobile banking, personal loans, credit cards, and student loan refinancing. They are going to start with our no-integration product while they integrate our API into their systems. We expect rollout in Q1. As we look at expanding into other markets, one of the markets we have been targeting is college stadiums. With more colleges and universities selling alcohol in their stadiums on game days, there is an increased focus on preventing underage access. We are talking about more than football games; this trend is spreading across a variety of sports and has brought greater focus on the continuing and growing use of sophisticated ID checks by minors. Recognizing this opportunity, we have been targeting an increasing number of college stadiums selling alcohol, with good effect. We recently signed two major SEC schools who are pre-purchasing 20,000 transaction buckets that automatically refill when the balance gets low. Proposals are out to several other schools as we continue to grow our footprint in what we see as a very promising market. You noticed that I have been saying transaction buckets. As we discussed on the last call, we are having customers prepay for a specific number of transactions they can use in a month or year. This has been very successful. Most new clients are being signed this way. All renewals are now under this model. Looking at renewals, I am pleased to report that we have continued to have a very sticky client base. As our clients' contracts come up for renewal, it's important to note that we are raising prices for each of those contracts. Our client's acceptance of these double-digit price increases underscores the value our technology solutions continue to provide. Earlier in the year, I alluded to our plan to refocus our efforts involving channel partners to resell our products, and we are making strides in that area. First, we signed an agreement with one of the largest providers of inventory and point-of-sale systems for the cannabis industry. Integration is complete, and we have begun joint marketing efforts targeting their customers. We have also signed agreements with two major point-of-sale system providers in the hospitality industry to incorporate ID validation into their systems. Collectively, these two point-of-sale system providers represent over 2,400 bars and restaurants, and integration with both is now underway. In addition, we have signed an agreement with a company that sells an omnichannel, multi-biometric platform to banks, marketplaces, and healthcare systems to use our ID validation tools as part of their onboarding process. They have pre-purchased 250,000 transactions. We continue to work on other channel partners and resellers as part of our Intellicheck inside strategy that features integrating our technology solutions and then selling them through our partners. In a similar way, we signed deals where we are the reseller of additional validation tools, similar to what we have done with biometrics. As part of the KYC process, many clients need to know about criminal backgrounds, so we have signed a deal with a company to sell access to criminal background data. Another significant development that opens up global opportunities revolves around the expansion of our validation capabilities beyond North America. We signed a deal with a company that will give us the capability to validate identity documents from over 200 countries. We will be sharing more details with you shortly, but what it comes down to is this: we believe our superior accuracy compared to what some view as our competition in North America, coupled with being on par with over 200 additional countries with less sophisticated forms of identification, gives us a distinctive competitive edge for clients that need international coverage, while at the same time potentially expanding our footprint globally. Integration for both the background checks and international validation is underway, and we intend to update you with press releases when we are ready to launch in Q1. As I said earlier, this has been a very transformational year, and achieving this advancement has required additional investments in the business. We started by retooling the sales force, and based on the prospects I see in our CRM, this is paying off. Looking ahead, we believe we should show notable growth in 2022. As you know, we also invested in creating a marketing department, and that also has paid off. We signed twice as many clients in Q3 from inbound leads as we did in Q2. While so far, most of these new agreements signed have been for smaller clients, given the number of these deals, the ACV or Annual Contract Value adds up. I can also say that lately, we have had inbound leads from key individuals at major financial institutions, so our brand and market awareness continues to grow. The stage for this major phase of transformation is what we are calling Platform 2.0. Historically, we did only one thing, and we believe we did it far better than anyone else, which is validating North American IDs, driver's licenses, and military IDs. Unfortunately, our back-end was lacking the level of flexibility needed to become more of a powerhouse within identity validation and digital identity. For example, what we formally called Age ID was a separate platform from what we call Retail ID. This level of complexity didn't make much sense, as they both did the same thing: validate the ID. The only difference was what we return to the client and how they wanted to consume the services, whether through a handheld device or a direct integration. This also made it difficult to quickly incorporate new features that clients want to utilize as part of their KYC process. Remember, to open an account, I may be who I say I am, but there are other things you might want to know about me to evaluate the risk of doing business with me. Depending on the nature of your business, other essential questions you may need to answer include: Am I a politically exposed person? Am I a special interest person? Am I a relative or close associate of any of those people? Are there any sanctions against me, or have I committed a crime? These are important data points that we need to offer to fully support many of the markets we are targeting. With 2.0, we can easily integrate new risk signals into the platform, and while doing so, we are able to make it very easy for our clients to pick and choose off of a menu based on their needs, enabling them to select additional risk and identity services they would like us to provide them. I am excited by where all of these developments are taking us. We truly believe we have effectively moved the company forward to become a future-ready, on-demand, global platform by allowing our clients a more flexible, refined solution for validating any ID in both physical and digital use cases with the additional risk signals of their choice. All of that while continuing to distinguish ourselves in the industry by providing what no one else can with near-perfect certainty. We believe we continue to be a leader in authenticating a government-issued ID as the first critical step in combating identity fraud, keeping age-controlled products out of the hands of minors, and increasing police officer effectiveness and safety. In closing, early in my tenure, I told you that I was excited by the prospects that I believe the future held. My feelings have not changed. I remain excited and energized by the opportunities I believe lie ahead and what I believe is a bright future for this innovative company. I will now turn the call over to Bill to go over our financial results for the quarter.

Bill White, CFO

Thank you, Bryan, and a good day to our shareholders, guests, and listeners. I would like to discuss some of the financial information that was contained in our press release for the third quarter ended September 30, 2021. I will begin with the third quarter results. Quarter-over-quarter SaaS revenue grew 32% to $3,245,000 versus $2,451,000 in the prior year. Total revenue for the third quarter ended September 2021 increased 79% to $4,831,000 compared to $2,699,000 in the prior year comparable period. Gross profit as a percentage of revenue was 68.7% for the quarter ended September 30, 2021, compared to 89.1% for the quarter ended September 30, 2020. During the quarter, the company sold scanning equipment to a bank that is continuing to roll out our software to their bank branches, which are normally sold at lower margins. Excluding the sale of hardware in both periods, on a pro forma basis, gross profit as a percentage of revenue was 93% for the quarter ended September 30, 2021, compared to 92.6% for the quarter ended September 30, 2020. Operating expenses that consist of selling, general and administrative and research and development expenses increased by 79.5% or $1,892,000 to $4,272,000 for the quarter ended September 30, 2021, versus $2,380,000 for the quarter ended September 30, 2020. The increase is primarily due to higher stock-based compensation costs, increased headcount, related accrued incentives, and expanded marketing costs. The company posted a net loss of $952,000 for the three months ended September 30, 2021, compared to a net income of $32,000 for the quarter ended September 30, 2020. The net loss per diluted share was $0.05 versus a net income per diluted share of 0 in the prior period. Adjusted EBITDA for the quarter ended September 30, 2021, was a negative $271,000 compared to a positive adjusted EBITDA of $169,000 in the September 30, 2020 quarter. Interest and other income expenses were negligible for the quarters ended both September 30, 2021, and 2020. Now I would like to focus on the company's liquidity and capital resources. As of September 30, 2021, the company had cash of $13.3 million, working capital defined as current assets minus current liabilities of $12.9 million, total assets of $25.9 million, and stockholders' equity of $21.8 million. During the nine months ended September 30, 2021, the company gained net cash of $145,000 compared to a net cash provided of $9.5 million during the nine months ended September 30, 2020. Net cash provided by operating activities was $407,000 for the nine-month period ended September 30, 2021, compared to a net cash used of $311,000 for the same period in 2020. Net cash used in investing activities was a negative $339,000 for the first nine months of 2021 compared to a net cash used of negative $408,000 for the nine-month period ended September 30, 2020, and we generated $76,000 from financing activities for the nine months ending September 30, 2021, compared to $10.2 million for the same period in 2020. The company has a $2 million revolving credit facility with Citibank that is secured by collateral accounts. There are no amounts outstanding under this facility. We currently anticipate that our available cash, as well as expected cash from operations, will be sufficient to meet our anticipated working capital and capital expenditure requirements for at least the next 12 months. As of December 31, 2020, the company had a net operating loss carry forward of approximately $17 million. I will now turn the call back over to the operator to take your questions.

Operator, Operator

Our first question is from Mike Grondahl with Northland Securities.

Michael Grondahl, Analyst

Yes, interesting developments kind of expanding up the platform a little bit. And maybe, Bryan, can you give a little bit more color on the prepay? Were you saying all new customers are prepaying? I guess I would just like a little bit more color there. And then maybe, Bill, if you could kind of mention what's the outlook for hardware sales? Is there anything to call out the next couple of quarters that you may be expecting?

Bryan Lewis, CEO

Mike, so it's Bryan. I will start. Yes, the model that people are adopting is buying buckets of transactions. It just makes it easier for us to manage expectations. Instead of what we used to do, where clients would pay a small minimum and then be billed monthly based on their actual use, now we have found that clients have a pretty good idea of their expected usage. So we enter into a contract where they commit to this amount, and if they go over that, we will charge them accordingly. For the most part, clients are buying a bucket that they expect will cover a period of time. If they use that bucket up, they simply renew their contract. It’s a much simpler way for us to track what our clients are doing with more certainty.

Michael Grondahl, Analyst

Do you have a rough guess of the percent of revenue that's under that model?

Bryan Lewis, CEO

Right now, I would say certainly client #4 went to that model. We will move client #3 to that when they come up for their renewal. Client #2, I think, is also up for renewal later in the year. But right now, it’s primarily with our smaller clients. We haven't implemented this model with major banks yet, but it's a model that all clients seem comfortable with. We had really no issues when we were renegotiating with client #4.

Bill White, CFO

As far as the hardware sales, we don't have any forecast for hardware sales at this point.

Bryan Lewis, CEO

Yes, and Mike, remember, we do hardware only as an accommodation. It's not our core business. It's not like the salespeople make significant commissions off of it. If it helps us close a deal, we might provide the hardware, but we are not actively out promoting hardware sales.

Michael Grondahl, Analyst

I understand. I just wanted to confirm that you had a couple of quarters with hardware sales, and I wanted to ensure most of it was completed and if we should factor it into our modeling moving forward. So I understand.

Operator, Operator

I will move next to Scott Buck with H.C. Wainwright.

Scott Buck, Analyst

Bryan, can you provide a little bit of color on the competitive environment? Once you get out of your kind of legacy credit card vertical and get into some of these, whether it’s cannabis or gambling or any of these others that you listed, is the environment meaningfully different from a competitive standpoint?

Bryan Lewis, CEO

I think one of the things I would say is that depending on how they are doing it, it really comes down to whether they genuinely want to catch the people committing fraud. In certain markets, the loss might be a fine if I'm selling product to someone who is not of age. But we have found that clients want the best solutions because not doing so could lead to significant losses for their businesses. For instance, in casinos, the consequences for failing to verify age can be severe if they lose their liquor license. They want to do the right thing, and they want the most accurate systems, so I believe we maintain a competitive advantage here.

Scott Buck, Analyst

That is very helpful. And second one Bryan, can you help us understand how you think internally about the balance between investing in growth and maybe generating positive EBITDA or showing some operating leverage in the model to appease some investors?

Bryan Lewis, CEO

The way that I look at it is we have been frugal in how we have spent. We certainly added headcount this year, which I think was necessary, primarily in sales, marketing, and also some development to launch Platform 2.0. I don't see us needing much more beyond our current team. I will always be on the lookout for strong salespeople because they tend to pay for themselves. We have many opportunities to explore, especially with the enhancements our new platform offers, but I believe we have ample leverage in our model. We don't need to spend significantly more on advertising or other personnel beyond sales.

Scott Buck, Analyst

All right. That's great. And then last one for me. I imagine you have even better visibility under the new pricing structure. Are we approaching a point where you might feel comfortable providing some guidance?

Bryan Lewis, CEO

Yes, it's a question we get often, and it is something that is discussed at the Board level. So I would say that remains to be seen.

Operator, Operator

We will go next to Jeff Van Rhee at Craig-Hallum.

Jeff Van Rhee, Analyst

On the implementation, I guess two questions. How many implementations are in the quarter? I think you coming into the quarter had $40 million in the backlog. I guess, just one, how many implementations? And then any other quantification of the increase in the value pipeline?

Bryan Lewis, CEO

I think we experienced a slowdown in implementations during the quarter, achieving around $6 million. Some client projects were delayed, not canceled, but pushed to a later date. While we remain ready, sometimes the other parties are not. I prefer not to assign dollar values to our pipeline as it can distort expectations, but I can say that the quality of our prospects and the discussions we are having are all positive. Our sales team is strong, and we are making significant progress in new markets.

Jeff Van Rhee, Analyst

Was there a commonality in terms of the customers as to why they slowed or pushed out on the implementation?

Bryan Lewis, CEO

No, I wouldn't say there was a commonality. It was really two major clients encountering some internal development issues. We remain in close communication with business sponsors who are pushing hard for progress. It's unfortunate; I wasn't pleased about the delays, but at least the issues are not related to point-of-sale development and we are still ready.

Jeff Van Rhee, Analyst

I think the commentary following Q2 was that headcounts were down roughly 10% from pre-COVID. How does it look for Q3?

Bryan Lewis, CEO

I didn't run the numbers recently, but I have been looking at how we are tracking quarter-to-quarter. There's a distinct difference between our major clients. Apparel transactions appear down, while electronics and appliances are experiencing growth, alongside banking transactions. We also saw digital transactions up by 34% over Q1. It appears our shift towards digital services is working, and as we continue to move closer to a normal world, I anticipate we will return to pre-pandemic levels.

Jeff Van Rhee, Analyst

Lastly, regarding the store representatives, I believe you mentioned that you’ve been increasing capacity. Last quarter, you noted that their time to productivity was generally meeting or exceeding expectations. What are you observing this quarter with the latest group and their speed in reaching productivity compared to the others?

Bryan Lewis, CEO

By and large, they are performing quite well. I believe we've added another one since our last discussion. We've gone from having 10% capacity to now 11%. We are seeing interesting candidates, and I look at our target-rich environment and realize that the team can benefit from more specialization in key markets instead of jumping around industry languages. We will expand further when we feel that our training bandwidth allows for it. Overall, I feel it's working well, and we continue to explore new talent.

Operator, Operator

I will take our next question from Rudy Kessinger, D.A. Davidson.

Rudy Kessinger, Analyst

I want to go back to the commentary on the different types of retailers. I guess, Q3 SaaS revenue being essentially flat with Q2 and the apparel companies being down about 7% to 10% sequentially. Just what percentage of either total scan loans or revenue or the number of retailers that you have out there are apparel versus the rest?

Bryan Lewis, CEO

They represent a larger portion of our business. I will speculate, Bill can correct me, but overall, in terms of transaction volumes, they are likely the majority.

Rudy Kessinger, Analyst

Okay, got it. That's helpful. With customer #3, when did that price increase take effect? Did it occur within the quarter or after? Also, did the change to the new kind of purchase volumes ahead of time reduce its potential impact in the quarter? Any additional details on that would be appreciated.

Bryan Lewis, CEO

No, because it took effect during the quarter. The impact was limited because they essentially pre-purchased transaction buckets. We bill as they go under the new model. They previously had some minimum on hardware pricing, but now it’s purely transactional in nature. Since this new model has a volume commitment, we expect it to yield better long-term revenues.

Rudy Kessinger, Analyst

And that was going to be my next question. I mean with them and both some of the stadium customers, some of your other new customers that you have signed, are people typically buying what they estimate will be about a year's worth of transactions, or shorter or longer?

Bryan Lewis, CEO

It varies. Some customers prefer to guarantee a larger volume for a longer duration, which we incentivize with better pricing structures. There's a benefit for them in prepaying for a longer period of time.

Rudy Kessinger, Analyst

Lastly, as I think about Platform 2.0 and some of these new capabilities, doing the global ID stuff, where is all that in terms of being generally available?

Bryan Lewis, CEO

We anticipate that most of these capabilities will be launched in full production by Q1. We currently have about ten beta clients eager to test the platform with us, demonstrating significant interest.

Operator, Operator

We have no other questions holding. I would like to turn the conference back to Mr. Lewis for any additional or closing comments.

Bryan Lewis, CEO

I just want to thank everybody for dialing in. As you can see, we are quite a different company than we were at the start of the year. I believe that our transformation and new platform open up new markets to us and plenty of opportunities for the company as a whole. I look forward to working with our team to achieve great outcomes. Thank you very much, and enjoy the rest of your evening.

Operator, Operator

Ladies and gentlemen, that will conclude today's call. We thank you for your participation. You may disconnect at this time, and have a great day.