Bio Key International Inc: Form 10-Q for the period ended Sep 30, 2023

This Management’s Discussion and Analysis of Financial Condition and Results of Operations is provided as a supplement to and should be read in conjunction with our unaudited condensed consolidated financial statements and related information contained herein and our audited financial statements as of December 31, 2022.

Overview

BIO-key International, Inc. (the “Company,” “BIO-key,” “we,” or “us”) is a leading identity and access management, or IAM, platform provider enabling secure work-from-anywhere for enterprise, education, and government customers. Our vision is to enable any organization to secure streamlined and passwordless workforce, employee, customer, student and citizen access to any online service, workstation, or mobile application, without a requirement to use tokens or phones. Our products include PortalGuard® and PortalGuard Identity-as-a-Service (IDaaS) enterprise IAM, AuthControl Sentry, AuthControl Enterprise, AuthControl MSP, WEB-key® biometric civil and large-scale ID infrastructure, and accessory hardware to provide a complete solution for our customers.

Millions of people use BIO-key multi-factor-authentication, or MFA, solutions every day to securely access a variety of cloud, mobile and web applications, on-premise and cloud-based servers from all of their devices. We go beyond passwordless to offer phone-less and token-less authentication methods. This critical differentiator is particularly effective for retail, call center, manufacturing, shop-floor, and healthcare environments which utilize roving workers and shared workstations. Unlike most digital identity solutions, BIO-key also plays a role in securing in-person identity. For example, a banking customer has enrolled over 22 million of its customers’ biometrics with BIO-key as part of their know your customer, or KYC process, and then uses BIO-key fingerprint technology each time their customers access bank services to ensure positive identification before transacting with them.

BIO-key PortalGuard and hosted PortalGuard IDaaS authentication platforms enable our customers to assure that only the right people can access the right systems by utilizing our world-class biometric capabilities, among 17 other available authentication methods. PortalGuard goes beyond traditional MFA solutions by allowing roving users to biometrically authenticate at any workstation without using their phones or tokens which addresses sizeable security gaps, including eliminating unauthorized account delegation, detecting duplicate users, and accommodating in-person identification.

Our customers use PortalGuard to manage and secure digital systems access by their employees, contractors and partners, which we call workforce identity. PortalGuard is also used to manage and secure the identities of an organization’s customers through integration of APIs we have developed and industry-standard federation standards, which we call customer identity. By using PortalGuard, our customers can securely collaborate with their supply chain and partners, and provide their customers with flexible, resilient user experiences online or in-person.

In 2022, we expanded our product offerings and customer base when we acquired Swivel Secure Europe, a Madrid, Spain based provider of IAM solutions. Swivel Secure Europe is the exclusive distributer of the AuthControl Sentry, AuthControl Enterprise, and AuthControl MSP product line in Europe, Africa and the Middle East, or EMEA, excluding the United Kingdom and Ireland. These solutions include PINsafe, a patented one-time-code extraction technology, helping enterprises manage the increasing data security risks posed by cloud services and “bring your own device” policies.

Large-scale customer and civil ID customers use our scalable biometric management platform and FBI-certified scanner hardware to manage enrollment, de-duplication and authentication for millions of users.

We sell our branded USB fingerprint and FIDO authentication hardware as accessories to our IAM platforms, so that customers can have a single vendor providing all components of their IAM solution. Our fingerprint biometric platform is certified by NIST and unique among fingerprint platforms in that it supports mixing and matching of different manufactures’ fingerprint scanners in a deployment. This provides our customers with the flexibility to select the right scanner for their specific use case, without mandating the use of a particular scanner.

We operate a SaaS business model with customers subscribing to term use of our software for annual recurring revenue. We sell our products directly through our field and inside sales teams, as well as indirectly through our network of channel partners including resellers, system integrators, master agents and other distribution partners. Our subscription fees include a term license of hosted or on-premise product and technical support and maintenance of our platform. We base subscription fees primarily on the products used and the number of users enrolled in our platform. We generate subscription fees pursuant to noncancelable contracts with a weighted average duration of approximately one year.

Strategic Outlook

Historically, our largest market has been authentication within highly regulated industries such as government, financial services, and healthcare. With the adoption of MFA as a cybersecurity requirement, nearly all enterprises are beginning to adopt MFA for their user bases. Our ability to add value to or replace the first-generation MFA solutions deployed by these enterprises with our phone-less and token-less biometrics sets us apart from a crowded field of phone- and token-based MFA solutions. We believe that as enterprises experience the lifecycle costs associated with managing tokens and passwords, they will have an economic incentivize to consider adding BIO-key PortalGuard to their IAM solution. PortalGuard will allow them to continue to use their existing FIDO devices, while selectively augmenting their authentication options with tokenless and phoneless biometric choices.

We expect to grow our business within government services and highly-regulated industries in which we have historically had a strong presence including financial services, higher education, and healthcare. We believe that continued heightened security and privacy requirements in these industries, and as colleges and universities continue operating in remote environments, we will generate increased demand for security solutions, including biometrics. In addition, we expect that the compatible, yet superior portable biometric user experience offered by our technology for Windows 10 users will accelerate the demand for our computer network log-on solutions and fingerprint readers. Through value add-offerings via direct sales, resellers, and strategic partnerships with leading higher education platform providers, we will continue to grow our installed base.Through Swivel Secure Europe, we also expect to grow our business in EMEA.

Our primary sales strategies are focused on (i) increased marketing efforts into the IAM market, (ii) dedicated pursuit of large-scale identification projects across the globe and (iii) growing our channel alliance program which we have grown to more than one hundred and fifty participants and continues to generate incremental revenues.

A second component of our growth strategy is to pursue strategic acquisitions of select businesses and assets in the IAM space. In furtherance of this strategy, we are active in the industry and regularly evaluate businesses that we believe will either provide an entry into new market verticals or be synergistic with our existing operations and in either case, be accretive to earnings. We cannot provide any assurance as to whether we will be able to complete any acquisition and if completed, successfully integrate any business we acquire into our operations.

Critical Accounting Policies and Estimates

For detailed information regarding our critical accounting policies and estimates, see our financial statements and notes thereto included in this Report and in our Annual Report on Form 10-K for the year ended December 31, 2022. There have been no material changes to our critical accounting policies and estimates from those disclosed in our most recent Annual Report on Form 10-K.

Recent Accounting Pronouncements

For detailed information regarding recent account pronouncements, see Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 of this report.

RESULTS OF OPERATIONS

THREE MONTHS ENDED September 30, 2023 AS COMPARED TO September 30, 2022

Consolidated Results of Operations - Percent Trend

19

Revenues and cost of goods sold

Revenues

For the three months ended September 30, 2023, and 2022, service revenues included approximately $297,000 and $304,000, respectively, of recurring maintenance and support revenue, and approximately $291,000 and $68,000 respectively, of non-recurring custom services revenue. Recurring service revenue decreased $7,000 or 2% in 2023 which was due to the timing of certain quarter end renewals. Non-recurring custom services increased 326% due to additional new customer customizations and upgrades. As our customer base continues to grow, we expect the service revenue to increase in future periods.

For the three months ended September 30, 2023, license revenue increased $31,755 or 3% to $950,015 from $918,260 in the corresponding period in 2022. We increased both the variation and number of customers, including additional revenue from Swivel Secure customers and customers in the higher education market.

For the three months ended September 30, 2023, hardware sales increased 235% to $279,200 from $83,333 in the corresponding period in 2022. The increase was due largely to add-on orders from an existing customer in 2023, compared to reduced new hardware deployments in 2022

Costs of goods sold

For the three months ended September 30, 2023, cost of service decreased approximately $38,000 or 23% to $125,039 from $162,632 in the three months ended September 30, 2022, due to reduced costs to support the PortalGuard and new Swivel Secure deployments. For the three months ended September 30, 2023, license fees increased to $203,891 from $173,310 in the three months ended September 30, 2022, due largely to an increase in license fees for third-party software included in our Swivel Secure offerings. For the three months ended September 30, 2023, hardware costs increased to $147,674 from $57,841 in the three months ended September 30, 2022, related to costs associated with increased hardware revenue.

Selling, general and administrative

Selling, general and administrative expenses for the three months ended September 30, 2023, decreased 38% from the corresponding period in 2022. The decreases included reductions in administration, sales and marketing personnel costs and marketing shows and expenses.

Research, development and engineering

For the three months ended September 30, 2023, research, development, and engineering costs decreased 33% to $558,686 as compared to $829,506 in the corresponding period in 2022. The decrease consisted primarily of reductions in personnel costs and reductions in outside services related to the development of our MobileAuth application which we completed in 2022.

Other income (expense)

Other income (expense) for the three months ended September 30, 2023 consisted of interest income of $5,917, interest expense of $45,655 on the secured note payable and the government loan through the BBVA bank net of interest and change in fair value of $167,283 on the convertible note payable. Other income(expense) for the three months ended September 30, 2022 consisted of interest income of $8, a reserve on the investment-debt security as adjustment for collections in the amount of $40,000, and interest expense of $2,071 on the government loan through the BBVA bank.

The provision for income taxes for the three months ended September 30, 2023 consisted of current income taxes of $6,811 for our Swivel Secure subsidiary, and deferred tax benefit of $7,000 relating to intangible assets from the acquisition of Swivel Secure.

nine months ended September 30, 2023 AS COMPARED TO September 30, 2022

Consolidated Results of Operations -Percent Trend

21

Revenues and cost of goods sold

Revenues

For the nine months ended September 30, 2023, and 2022, service revenues included approximately $899,000 and $944,000, respectively, of recurring maintenance and support revenue, and approximately $842,000 and $259,000, respectively, of non-recurring custom services revenue. Recurring service revenue decreased 5% in the first nine months of 2023 due to the timing of certain quarter end renewals. Non-recurring custom services revenue increased 225% in the first nine months of 2023 due largely to the additional service revenue from Swivel Secure customers during the entire period in 2023. As our customer base continues to grow, we expect the service revenue to increase in future periods.

For the nine months ended September 30, 2023, license revenue increased 32% to $4,664,341 from $3,540,592 in the corresponding period in 2022. We increased both the variation and number of customers, including additional revenue from the Swivel Secure customers, and customers in the higher education market.

Hardware sales decreased $93,794 during the nine months ended September 30, 2023, to $424,583 from $518,377 in the nine months ended September 30, 2022. The decrease was attributable largely to the absence of any new large deployments in 2023, as compared a large order for our Pocket 10 product from a new customer in 2022.

Costs of goods sold

For the nine months ended September 30, 2023, cost of service increased $85,774 or 46% from $554,222 in the nine months ended September 30, 2022, due to the increased costs to support the new Swivel Secure deployments. For the nine months ended September 30, 2023, license fees increased to $1,022,919 from $604,677 in the nine months ended September 30, 2022, due largely to an increase in revenue and third-party software for the Swivel Secure licenses. For the nine months ended September 30, 2023, hardware costs decreased to $240,074 from $296,278 during the nine months ended September 30, 2022, corresponding to decreased hardware revenue.

Selling, general and administrative

Selling, general and administrative expenses for the nine months ended September 30, 2023, decreased 14% from the corresponding period in 2022. The decreases included reductions in administration, sales and marketing personnel costs and marketing shows and expenses.

Research, development and engineering

For the nine months ended September 30, 2023, research, development and engineering costs decreased 25% from $2,418,855 to $1,807,026. The decrease consisted primarily of reductions in personnel costs and in outside services related to the development of our MobileAuth application which was completed in 2022.

Other income (expense)

Other income (expense) for the nine month period ended September 30, 2023 consisted of interest income of $5,944, a loss on foreign currency of $15,000, a change in fair value of $264,706 on the convertible note payable, and interest expense of $159,379 on the secured note payable and the government loan through the BBVA bank. Other income (expense) for the nine months ended September 30, 2022 consisted of interest income of $216, a reserve on the investment-debt security as adjustment for collections of such security of $190,000, and interest expense of $3,611 on the government loan through the BBVA bank.

Provision for income tax

The provision for income taxes for the six months ended September 30, 2023 consisted of current income taxes of $162,811 for our Swivel Secure subsidiary, and deferred tax benefit of $20,000 relating to intangible assets from the acquisition of Swivel Secure.

LIQUIDITY AND CAPITAL RESOURCES

Cash Flows

Operating activities overview

Net cash used by operations during the nine months ended September 30, 2023 was $2,326,417. Items of note included:

• Net positive cash flows related to adjustments for non-cash expenses of approximately $622,000.
• Net positive cash flows related to inventory, accounts payable, accrued liabilities, income tax payable and deferred revenue of approximately $1,080,000.
• Negative cash flows related to changes in accounts receivable, due from factor and prepaid expenses of approximately $1,730,000, due to working capital management.

Financing activities overview

Net cash used for financing during the nine months ended September 30, 2023 was $125,386 for repayment of the government loan through the BBVA bank and $25,434 for deferred offering costs. Net cash received from financing during the nine months ended September 30, 2023 was $13,934 of proceeds from sales of common stock under the employee stock purchase plan.

Investing activities overview

There were no investing activities during the nine months ended September 30, 2023.

Liquidity and Capital Resources

Since our inception, our capital needs have been met through proceeds from the sale of equity and debt securities, and revenue. We expect capital expenditures to be less than $100,000 during the next twelve months.

The following sets forth our investment sources of capital during the previous two years:

On October 30, 2023, we completed a public offering of units consisting of shares of common stock, pre-funded warrants to purchase shares of common stock, and warrants to purchase share of common stock. Each Unit was sold at a public offering price of $0.175. resulting in net proceeds of $3.3 million, after deducting the placement agent fees and offering expenses.

In December 2022, we entered into and closed a securities purchase agreement (the “Purchase Agreement”) with AJB Capital Investments, LLC under which we issued a $2,200,000 principal amount senior secured promissory note (the “Note”). The principal amount of the Note was due six months following the date of issuance, subject to one six-month extension. We elected to extend the maturity date of the note to December 22, 2023. Interest under the Note accrued at a rate of 10% per annum, payable monthly through month six and currently accrues at the rate of 12% per annum in months seven through twelve, payable monthly. The Note is secured by a lien on substantially all of our assets and properties and can be prepaid in whole or in part without penalty at any time. We recently prepaid $1,400,000 of the principal amount due under the Note from the proceeds of the public offering.

In March 2022, in connection with the acquisition of Swivel Secure, we assumed a €500,000 government loan that was issued through BBVA Bank during the COVID-19 pandemic. The loan bears interest at the rate of 1.75% per annum and is payable in monthly installments of approximately $11,900 inclusive of interest from May 2022 through maturity in April 2026. Upon closing of the acquisition, Swivel Secure had cash equal to the outstanding balance.

We entered into an accounts receivable factoring arrangement with a financial institution (the “Factor”) which has been extended to October 31, 2023 and may be discontinued at that time. Pursuant to the terms of the arrangement, from time to time, we sell to the Factor a minimum of $150,000 per quarter of certain of our accounts receivable balances on a non-recourse basis for credit approved accounts. The Factor remits 35% of the foreign and 75% of the domestic accounts receivable balance to us (the “Advance Amount”), with the remaining balance, less fees, forwarded to us once the Factor collects the full accounts receivable balance from the customer. In addition, from time to time, we receive over advances from the Factor. Factoring fees range from 2.75% to 15% of the face value of the invoice factored and are determined by the number of days required for collection of the invoice. We expect to continue to use this factoring arrangement periodically to assist with our general working capital requirements due to contractual requirements.

Liquidity outlook

At September 30, 2023, our total cash and cash equivalents were $307,086, as compared to $2,635,522 at December 31, 2022. At September 30, 2023, we had working capital of approximately $1,792,000.

As discussed above, we have historically financed our operations through access to the capital markets by issuing secured and convertible debt securities, convertible preferred stock, common stock, and through factoring receivables. We currently require approximately $710,000 per month to conduct our operations, a monthly amount that we have been unable to consistently achieve through revenue generation. During for the first nine months of 2023, we generated $6,829,804 of revenue, which did not generate enough cash to fully fund our average monthly requirements. We expect that Swivel Secure will generate positive cash flow in 2023. We also have approximately $3.8 million of inventory purchased for projects in Nigeria. We are exploring other markets and opportunities to sell or return the product to generate additional cash.

If we are unable to generate sufficient revenue to fund current operations and execute our business plan, we may need to obtain additional third-party financing. The approximate $800,000 outstanding balance of the Note is due on December 22, 2023. Unless we generate sufficient positive cash flow from operations or liquidation of existing inventory, we expect that we will need to obtain additional financing during the next twelve months to repay our outstanding secured note and support operations.

Our long-term viability and growth will depend upon the successful commercialization of our technologies and our ability to obtain adequate financing. To the extent that we require such additional financing, no assurance can be given that any form of additional financing will be available on terms acceptable to us, that adequate financing will be obtained to meet our needs, or that such financing would not be dilutive to existing stockholders. If available financing is insufficient or unavailable or we fail to continue to generate sufficient revenue, we may be required to further reduce operating expenses, delay the expansion of operations, be unable to pursue merger or acquisition candidates, or in the extreme case, not continue as a going concern.

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2023. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate, to allow timely decisions regarding required disclosure. Based on the evaluation of our disclosure controls and procedures as of September 30, 2023, our CEO and CFO concluded that, as of such date, our disclosure controls and procedures were not effective to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act was recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. As reported in our 10-K for the year ended December 31, 2022, in connection with the audit of our financial statements as of and for the year ended December 31, 2022, our management identified a material weakness relating to the effectiveness of management’s review and controls over the income tax provision in our financial footnotes, such that management’s review procedures were not operating at a level of precision to prevent or detect a potential material misstatement in our consolidated financial statements. We have also identified a lack of control over our foreign subsidiaries with respect to the filing of required tax returns on a timely basis. We are continuing to assess the actions that need to be taken to remedy each of these material weaknesses. Each of the material weaknesses noted will only be deemed to have been remediated after the new controls and procedures have been in place for a sufficient period and management has concluded through appropriate testing that the controls are operating effectively. We are in the process of implementing new controls designed to remediate the aforementioned material weaknesses. These efforts have included engaging a consultant to review income tax transactions for appropriate accounting treatment and assist with the preparation of financial statements.

Changes in Internal Control Over Financial Reporting

Other than the forgoing described above, there have been no changes in our internal control over financial reporting during the fiscal quarter ended September 30, 2023, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.