Bio Key International Inc: Form 10-Q for the period ended Jun 30, 2024

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, 2023.

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, 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 21.7 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

We plan to have a more significant role in the IAM market which continues to expand. With the adoption of MFA as a cybersecurity requirement, nearly all enterprises are beginning to adopt MFA for their user bases. We plan to continue to offer customers a suite of authentication options that complement our biometric solutions. 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.

Recent Developments

The current trend of continued remote work environments increases the risk of unauthorized users, phishing attacks, and hackers who are eager to take advantage of the challenges of securing remote workers. A growing trend of security incidents that highlight potential cybersecurity vulnerabilities, additional regulatory requirements, and increasingly stringent Cyber Insurance underwriting standards that mandate enhanced security solutions has resulted in many businesses requiring MFA for their employees, partners and customers to access their business systems and data. We believe that biometrics should continue to play a key role in remote user authentication.

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, 2023. 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 June 30, 2024 AS COMPARED TO June 30, 2023

Consolidated Results of Operations - Percent Trend

Revenues and cost of goods sold

18

Revenues

For the three months ended June 30, 2024, and 2023, service revenues included approximately $274,000 and $310,000, respectively, of recurring maintenance and support revenue, and approximately $10,000 and $310,000 respectively, of non-recurring custom services revenue. Recurring service revenue decreased $36,000 or 12% in 2024 which was due to the loss of one large customer service agreement. Non-recurring custom services decreased 97% due to loss of one large customer for Swivel Secure customizations and upgrades. We expect the service revenue to remain at the current lower rate in future periods.

For the three months ended June 30, 2024, license revenue decreased $461,546 or 37% to $774,2254 from $1,235,771 in the corresponding period in 2023 , as several anticipated orders slipped into the third quarter.

For the three months ended June 30, 2024, hardware sales increased 15% to $83,492 from $72,693 in the corresponding period in 2023. The increase was due largely to a change in the mixture of hardware sales.

Costs of goods sold

For the three months ended June 30, 2024, cost of service decreased approximately $287,000 or 80% to $73,385 from $360,156 in the three months ended June 30, 2023, due to reduced costs to support the PortalGuard and Swivel Secure deployments. For the three months ended June 30, 2024, license fees decreased to $148,432 from $198,147 in the three months ended June 30, 2023, due largely to a decrease in license fees for third-party software included in our Swivel Secure offerings. For the three months ended June 30, 2024, hardware costs decreased to $40,455 from $47,808 in the three months ended June 30, 2023, related to costs associated with mixture of hardware revenue.

Selling, general and administrative

Selling, general and administrative expenses for the three months ended June 30, 2024, decreased 9% from $2,143,164 in the corresponding period in 2023 to $1,941,866 in the current quarter. The decreases included reductions in administration, sales personnel costs and marketing show expenses, offset by an increase in professional services.

Research, development and engineering

For the three months ended June 30, 2024, research, development, and engineering costs increased 6% to $591,234 compared to $558,181 in the corresponding period in 2023. The increase consisted primarily in an increase in personnel costs.

Other income (expense)

19

Other income (expense) for the three months ended June 30, 2024 consisted of interest income of $46 and interest expense of $8,910 comprised of approximately $1,400 on the government loan through the BBVA bank and the balance on the 2024 Note, and a loan fee amortization amount of $4,000. Other income (expense) for the three months ended June 30, 2023 consisted of interest income of $23, interest expense of $56,806 on the secured note payable and the government loan through the BBVA, bank net of interest and change in fair value of $44,568 on the convertible note payable.

Six MONTHS ENDED June 30, 2024 AS COMPARED TO June 30, 2023

Consolidated Results of Operations - Percent Trend

Revenues and cost of goods sold

20

Revenues

For the six months ended June 30, 2024, and 2023, service revenues included approximately $467,000 and $602,000, respectively, of recurring maintenance and support revenue, and approximately $30,000 and $551,000 respectively, of non-recurring custom services revenue. Recurring service revenue decreased $135,000 or 22% in 2024 which was due to the loss of one large customer service agreement. Non-recurring custom services decreased 95% due to loss of one large customer for Swivel Secure customizations and upgrades. We expect the service revenue to remain at the current lower rate in future periods.

For the six months ended June 30, 2024, license revenue decreased 89,668 or 3% to $2,724,659 from $2,814,327 in the corresponding period in 2023. Several anticipated orders sliding from the second quarter to the third quarter, contributed to the decrease.

For the six months ended June 30, 2024, hardware sales decreased 30% to $101,140 from $145,382 in the corresponding period in 2023. The decrease was due largely to reduced add-on orders from an existing customer in 2024, compared to increased new hardware deployments in 2023.

Costs of goods sold

For the six months ended June 30, 2024, cost of service decreased approximately $303,000 or 59% to $212,234 from $514.957 in the six months ended June 30, 2023, due to reduced costs to support the PortalGuard and Swivel Secure deployments. For the six months ended June 30, 2024, license fees decreased to $296,652 from $819,028 in the six months ended June 30, 2023, due largely to a decrease in license fees for third-party software included in our Swivel Secure offerings. For the six months ended June 30, 2024, hardware costs decreased to $12,573 from $44,592 in the six months ended June 30, 2023, related to costs associated with decreased hardware revenue.

Selling, general and administrative

Selling, general and administrative expenses for the six months ended June 30, 2024, decreased 9% from $4,074,896 in the corresponding period in 2023 to $3,724,839. The decreases included reductions in administration, sales personnel costs and marketing show expenses, offset by professional fees.

Research, development and engineering

For the six months ended June 30, 2024, research, development, and engineering costs decreased 4% to $1,198,755 compared to $1,248,340 in the corresponding period in 2023. The decrease consisted primarily of changes in personnel costs and reductions in outside services.

Other income (expense)

Other income (expense) for the six months ended June 30, 2024 consisted of interest income of $51 and interest expense of $10,267 for approximately $,2,700 on the government loan through the BBVA bank and the balance accrued on the 2024 Note, and a loan fee amortization amount of $4,000. Other income (expense) for the six months ended June 30, 2023 consisted of interest income of $27, a change on foreign currency in the amount of $15,000, interest expense of approximately $2,000 on the government loan through the BBVA bank and approximately $112,000 on the secured note payable, which amounts were offset by a change in fair value of $97,423 on our secured convertible note payable.

LIQUIDITY AND CAPITAL RESOURCES

Cash Flows

Operating activities overview

Net cash used in operations during the six months ended June 30, 2024 was $1,123,533. Items of note included:

• Net positive cash flows related to adjustments for non-cash expenses of approximately $415,000.
• Net positive cash flows related to inventory, accounts receivable, amount due from factor, accounts payable and deferred revenue of approximately $1,054,000.
• Negative cash flows related to changes in prepaid expenses, and accrued liabilities of approximately $416,000, due to working capital management.

Financing activities overview

Net cash provided by financing activities during the six months ended June 30, 2024 was $1,912,408 which included $2,000,000 of proceeds from the 2024 Note, $1,400 from the exercise of prefunded warrants, and $1,939 from the purchase of shares in the Employee Stock Purchase Plan, which amounts were offset by repayment of the government loan through the BBVA bank and $13,470 for offering costs. Net cash received from financing activities during the six months ended June 30, 2024 was $1,400 of proceeds from the exercise of prefunded warrants.

Investing activities overview

Net cash used in investing activities during the six months ended June 30, 2024 was $1,869 for capital expenditures.

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 June 24, 2024, we entered into and closed a note purchase agreement which provided for the issuance of a $2,360,000 principal amount senior secured promissory note (the "2024 Note"). This resulted in gross proceeds of approximately $1,826,000 after deducting placement agent fees, estimated offering expenses, and the original issue discount. The 2024 Note is due eighteen months (18) following the date of issuance, accrues interest at a rate of nine percent (9%) per annum, and commencing six months after the date of issuance of, the lender shall have the right to redeem up to $270,000 of principal amount each month. For a more complete description of the 2024 Note, please see Note 9 to Our Condensed Consolidated Financial Statements included in Part I Item 1 of this report.

On November 20, 2023, we completed a private placement of shares of common stock and warrants resulting in net proceeds of approximately $435,000, after deducting placement agent fees and estimated offering expenses.

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 with AJB Capital Investments, LLC under which we issued a $2,2 million 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. Interest under the Note accrued at a rate of 10% per annum, payable monthly through month six and at 12% per annum in months seven through twelve, payable monthly. The Note was secured by a lien on substantially all of our assets and properties. The Note was repaid in December 2023.

We entered into an accounts receivable factoring arrangement with a financial institution (the “Factor”) which has been extended to October 31, 2024 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 June 30, 2024, our total cash and cash equivalents were $1,260,351, as compared to $511,400 at December 31, 2023. At June 30, 2024, we had negative working capital of approximately $2,560,000.

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 $732,000 per month to conduct our operations, a monthly amount that we have been unable to consistently achieve through revenue generation. We also have approximately $3.6 million of inventory (currently reserved) purchased for projects in Nigeria. We continue to explore other markets and opportunities to sell the product to generate additional cash. If we are unable to generate sufficient revenue to fund current operations and execute our business plan, we will need to obtain additional third-party financing. 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 support operations.

In addition, as reported in our Current Report on Form 8-K filed June 14, 2024, we are no longer in compliance with Nasdaq Capital Market continued listing rules which require us to maintain stockholders' equity of at least $2,500,000. Our plan to regain compliance will require us to raise additional equity capital in the near term. There can be no assurance that we will be able to raise such capital or regain compliance with the continued listing requirements.

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 June 30, 2024. 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 June 30, 2024, our CEO and CFO concluded that, as of such date, our disclosure controls and procedures were not effective.

As previously reported in our Annual Report on Form 10-K for the fiscal year ended December 31, 2023, in connection with the audit of our financial statements as of and for the year ended December 31, 2023, our management identified a lack of control over properly assessing revenue, allowances for accounts receivable and certain reserves for inventory. This resulted in certain errors in the manner in which we recognized revenue generated by our European subsidiary, Swivel Secure Europe, SA, in the first quarter of 2023. In addition, certain allowances for accounts receivable and certain reserves for inventory were understated. We are currently working to implement appropriate corrective actions to remediate the material weakness to strengthen our internal controls over the recording of revenues. This has included thoroughly accessing all accounts for potential adjustments required for proper presentation of the value of the accounts, changing management of our Swivel Secure operation, and implementing additional revenue recognition controls.

Changes in Internal Control Over Financial Reporting

Other than as described above, there have been no changes in our internal control over financial reporting during the fiscal quarter ended June 30, 2024, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.