Good morning, ladies and gentlemen. Thank you for standing by. Welcome to BIO-key International's Fourth Quarter and Full Year 2018 Conference Call. During the presentation, all participants will be in listen-only mode. After the speakers' remarks you will be invited to participate in a question-and-answer session. As a reminder, ladies and gentlemen, this conference is being recorded today, April 2, 2019. I would like to now turn the conference over to today's host, Scott Mahnken, BIO-key's Vice President of Marketing. You may begin, sir.

Thank you, Lisa. Good morning, and thank you for joining us on today's call. With me this morning are Mike DePasquale, BIO-key's Chairman and CEO; Fred Corsentino, BIO-key's Chief Revenue Officer; and Ceci Welch, BIO-key's Chief Financial Officer. I'd like to remind everyone that today's conference call and webcast may contain forward-looking statements that are subject to certain risks and uncertainties that may cause actual results to differ materially from those projected on the basis of these statements. The words estimate, projects, intends, expects, anticipates, believes, and similar expressions are intended to identify forward-looking statements. Such forward-looking statements are made based on management's beliefs, as well as assumptions made by and information currently available to management, pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. For a complete description of these and other risk factors that may affect the future performance of BIO-key International, see Risk Factors in the company's Annual Report on Form 10-K, and its other filings with the SEC. Listeners are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date made. The company also undertakes no obligation to disclose any revision to these forward-looking statements to reflect events or circumstances after the date made. At this time, I'd like to turn the call over to Mike DePasquale.

Thank you, Scott. Good morning, everyone, and thank you for joining us today. Before reviewing opportunities, we see shaping our favorable outlook for 2019 and beyond. I'd like to review a few factors that substantially altered our 2018 reported results but contributed to greater visibility for 2019 and 2020. Our full-year 2018 revenues were impacted by the implementation of the new GAAP revenue recognition standards, which resulted in approximately $4 million reduction in the amount of revenue we were able to record in the fourth quarter and full fiscal year 2018 compared to our expectation and our revenue guidance. As you recall, we closed out 2018 with our largest ever software license ordered to-date, valued at over $10 million from a Chinese-based customer in the technology and financial services sectors. The agreement called for equal monthly installment payments of $555,000 per month to commence in February 2019. From a revenue recognition standpoint, we had structured the engagement, so as to book $5 million in revenue under the contract in Q4 2018 and $5 million in Q4 2019. However, under the new accounting standards codification, ASC 606 revenue recognition guidelines, this treatment was not possible. Instead, we were able to record only the cash payments we have received under the contract, as revenue, and as a result we have recorded $1.1 million from the contract in the fourth quarter of 2018, which reflects receipt of the first two cash payments we received. We will book payments received each quarter or payments received up through the time of reporting each quarter. So, for Q1, we expect to book revenue received in April and May. Going forward, we're able to book future payments received each quarter as revenue. So, assuming a timely payment, that would equate to approximately $1.5 million per quarter; and…

Thanks, Mike. As Mike mentioned, we are working with several hardware and software partners, which cater to customers in various sectors, including healthcare, financial services, government and other target markets. Our overarching sales objective is to sell end-to-end authentication and security solutions to such diverse customers, supporting both their common and unique security and authentication needs. Our approach to meeting this objective is three-fold. First, is to continue to invest in our relationship with Microsoft. Our Microsoft partnership is crucial to reaching large enterprise customers operating Microsoft applications. Recent Enterprise Technology survey found that 83% of enterprises rely on Microsoft Office applications for getting work done. While the classic Microsoft Office has been that the full productivity suite for most enterprises, Microsoft has devoted significant resources to drive adoption of their latest Windows 10 Operating System and new Windows service solutions, including Windows Hello for Business and their Azure Cloud platform. Both our software and hardware solutions are compatible with all of Microsoft's applications, and our goal is to target more enterprises with our ID Director for Windows Solution, which provides enterprise customers the ability to implement and operate a multi-factor authentication solution within their Microsoft Active Directory and Azure Cloud platforms. Second, we continue to leverage existing reseller relationships and channel partners to expand into new agreements to sell more of our solutions to their existing base of clients. Our sales forecast for 2019 reflects these newly created sales channels. Our products are interoperable with all major fingerprint reader and hardware manufacturers enabling application developers and value-added resellers to easily integrate our fingerprint biometrics into their applications, while minimizing maintenance, upgrade and lifecycle costs. This is an attractive selling point and makes our technology more viable than competing technologies. Finally, we have launched a new sales channel targeting small…

Thank you, Fred. Our full year 2018 revenue declined 36% in 2018 to $4 million versus $6.3 million in 2017, due primarily to reflecting the recognition of the $1.1 million in revenue from over the $10 million in software license contracts executed in Q4 2018 versus $2.5 million in Q4 2017. Additionally, hardware, including readers and locks declined to $1.3 million in 2018, compared to $1.9 million in 2017, and represented 33% of the total revenues in 2018 versus 30% in 2017. Gross margin declined to 3%, compared to 49% in 2017, principally due to the lower recorded revenue in 2018 and the increased software license rates amortization expense of $1.1 million. Operating expenses declined to $6.7 million in 2018, compared to $7.3 million in 2017, reflecting decreases of $0.3 million and $0.2 million in selling, general and administrative expenses, and R&D expenses respectively, offset by $0.7 million write-down of an aged receivable in 2018. Full-year 2017 operating expenses included $531,000 of non-recurring fees and costs related to the uplifting of BIO-key shares to the NASDAQ Capital Market. In 2018, net loss was $6.9 million or $0.73 per basic share after preferred dividend, compared with a loss of $4.3 million or $0.76 per basic share after the preferred dividends in 2017. Per share results in 2018 and 2017 are based on weighted average of 11.6 million and 6.6 million basic shares outstanding, respectively. At December 31, 2018, our total cash and cash equivalents plus current receivables was approximately $1.9 million as compared to approximately $3.2 million at December 31, 2017. We ended the year with a total stockholders' equity of 10.4 million and approximately 14 million shares of common stock outstanding. And now, operator, let's start with the question-and-answer session.

Thank you very much. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Josh Goltry of Maxim Group. Please go ahead.

Hi, guys. How are you? So, a few questions. Given the multiple new customer wins cited over the past few months of the low end of the $11 million revenue guidance, how much of that has already been booked?

Good morning, Josh.

Hi. Good morning.

Good, good. We're coming into the year with approximately somewhere between $7 million and $8 million in what I would consider booked backlog. So, not forecast pipeline, but backlog.

Okay. And just to follow-up with that, what specific metrics gives you confidence that you can achieve your 2019 guidance range?

What I just mentioned backlog, that we're coming into the year and the forecasted pipeline that we have. I think Fred alluded to, I'll call it a pretty dramatic shift for us over the last two quarters in refining our sales model and refocusing our marketing efforts to very specifically generation activities. We're seeing – we have a very bold and strong market right now, which we didn't even have a year ago. The move to multi-factor authentication with the biometric option puts us in a very unique position, because there are some very large authentication solution providers act out there. You probably know some of the names like AXA [ph], Cell Point, Ping [ph]. They have authentication solutions that generally speaking utilize soft tokens or phones, mobile phones for multi-factor authentication. They do not have a biometric option. And enterprises who want central control of their identification and authentication practices, really like biometrics because of the ease of deploy, because of the positive identification they get with the biometric, and the fact that they do not have to rely on and add at the end device like a mobile phone to authenticate to their corporate portals. So, we feel very strong right now and very bold about the opportunity and the forecasted pipeline that would build.

Right. Great. And normalizing for the write-down of the age accounts receivable, SG&A is pretty much flat sequentially. So, given the momentum that you're seeing in new contracts, why not ramp that more aggressively?

Well, I'm going to let Freddy answer that. He's got a plan for that and let him answer the sales ramp plan.

So, we will be doing that and we are looking at adding additional resources to the sales team incrementally as the opportunities present itself and as we create them. So, we're not getting too far ahead of ourselves, but really adding additional resources as needed and we're seeing the uptick. So, we're adding resources currently as we speak.

Got it. And how – what does the – gestation period for new sales and marketing investments?

Yes. So, if we hire reasonably, technology-oriented sales people that have some background in networking and security, it's, you know, a three to six-month ramp to be completely on the ramp that a normalized sales rep would be at, so three to six months is the right answer.

Got it. And the 40% – about 41% gross margin that you had this past quarter. Is that a range or a number that we should be expecting going forward? Or, just I would like a little bit more color on that if you can?

Well, we think it'll be much, much higher. Remember, the gross margin is driven by the software license line in our P&L. And so, as you see the software license sales on a steady, consistent basis, across each quarter, be a really big portion of the total revenue mix, the margins are going to be higher.

Okay, good, great. And then last question. So, at the current cash burn rate, are you expecting a large operating cash inflow during the first quarter of 2019 or are you going to think about returning to the capital markets?

We have no intention right now returning to capital markets. So, we have obviously receivables in place with the existing contract, $10 million contract we have, as well as other options that we may consider, including equity line of credit or debt. But right now, we have no plans to go to the equity markets to raise cash.

Okay. That's fair. All right, guys, thank you. I appreciate it.

You're welcome.

[Operator Instructions] Our next question comes from Richard Pew of Richard Pew Investment Counsel. Please go ahead.

Good morning, Michael.

Good morning.

It sounds like good news. In your press release, it mentions specifically this Claro Subsidiary and with regard to that, it says the sale will help – your software will secure access to customer data. Now, of all the data intrusions we've heard about in the past, the most notable I think being Equifax, I guess Target was another, and it wasn't even the federal government invaded at one point, I'm not sure. I've asked you in the past, whether or not your software could be used to block people from getting access to data and the way that – part of your press release reads and makes it sound like it can do that. And I thought that in the past, you've suggested that was not possible. Could you clarify?

Sure. Our software and our technology in general, our finger scanners, software, and so forth combined, what they do is they authenticate or they validate that the individual who is accessing that information is authorized by the company to do that. So, in that context, obviously, we're preventing people who are not authorized to access that information. We're preventing them from accessing that information. There's a whole different set of technologies called intrusion detection technologies, which really work on the network side outside of the authentication for people to access information. And, you know, that's generally speaking what the hackers focus on first, right. First, they have to break into the company's network and then they have to try to act as an authorized agent to access that information. That's the point where we serve those customers. And in particular, as it relates to Claro very specifically, we're helping them secure access to customer information in their call centers. So, there you have a call center representative accessing the customer information because they're helping the customer for whatever reason the call takes place. We're helping secure that access.

Well, from what you've just said, it sounds to me like you must have a huge market for all these people who had data intrusion problems?

Well, the reason that we're seeing a significant uptick in requests for the biometric option for multi-factor authentication from customers at all levels, small, medium, and large, is just that. They recognize that they have to have some form of technology that more positively identifies the individuals in their company or their contractors, whoever they've authorized access to their portals. And that's what we do.

Sounds was very good to me. Now, the first quarter is complete. Do you have any color to add on what you've achieved so far?

I think, as you know, we provide annual guidance. We do not provide quarterly guidance. So, we're not going to provide quarterly guidance for this year. But as we have stated in our press release and in the comments, we made this morning, we feel that our performance is going to be more consistent, because we're coming into the year with that backlog that we just discussed.

That sounds to me like you're avoiding the question. The first quarter is over. You know what you've done in the first quarter? No, I'm not talking about how you can report it in by the financial standards, but you must have some idea of whether it was a really good quarter or a weak quarter or something like that?

Yes, we – I'm going to go back again and say that we do not provide quarterly guidance. And I am also going to make another statement, which I think is very, very true. We just closed the quarter over the weekend and right now we really couldn't in any way shape or form, you know, give any perspective on that.

[Operator Instructions] Our next question comes from Dan Camus, Investor. Please go ahead.

Hi, I know it was indicated that OpEx decreased to $6.7 million. What's your expected number for OpEx in 2019?

We think our expenses are going to be relatively flat. Fred, spoke, made a few comments about adding sales resources, as we ramp the business, but we're doing it selectively. I think what he tried to describe there is, we're not, for example, just hiring, five new people this quarter. We're doing it incrementally as we see the business grow, and so we think our operating expenses in general are going to be flat, but rise, as we incrementally add resource to sell more. So, I think the numbers that you see now are pretty good numbers to carry forward in the – at least in the first half of the year. And then if the business ramps, obviously in the second half, we'll obviously deal with that.

Okay. What do you think, if it ramps, would be the high end for the second half?

Well, you know, again, we provide annual guidance. We said somewhere between $11 million and $14 million, that was our...

No, no, not the revenue, I mean OpEx.

OpEx? I mean, let me – it cost us full-in to bring a rep on, right, give or take fully loaded $100,000 a year. So, it's a $25,000 per quarter, expense give or take right. So, if you add in two or three resources you'd be talking about, about adding under $100,000 in quarterly expense?

Okay. Can you give us more color on the write-down? How much has been written down so far? How much is left to write-down and is the chances collection essentially down to zero?

Yes. So here we are with that. We've been collecting money in dribs and drabs, and the project is – continues to be viable. In fact, we think there's a reasonable probability that we'll get all that back in 2019 or early 2020. So, we just made a decision not to carry that receivable anymore and to clear the debts. So, even though again, we're collecting money, it's just not been substantial enough given the situation in Africa right now.

Okay. Do you have a number on the probability that you'll get it or?

Well, it's a...

What's the chance that you won't get it or...

It's not – we provided a guidance of $11 million to $14 million. We talked through the backlog. It's not in our backlog. You know, it's really not in our short-term forecast. It's hard to say. I have been embarrassed before by the tenure of that project. And I'd rather not say what the probability is. I believe it's going to happen because it's ongoing and they're relying on our technology for a very specific application. But we'll see.

Okay. Looks like you're developing an interesting niche in the foreign law enforcement market. Is there a reason police forces are so interested in your ID Director? And I guess, are US police forces a tougher market? Or is that coming?

Okay, so there are a couple of threads to your question. Yes, we've had a couple of nice wins in not only the law enforcement space, but in the federal defense space as well, international. So, we're doing business now, and we have a number of prospects with some very large national federal defense agencies. We have one of them. That's one of the most prominent in the world that uses our technology. They test and evaluate all kinds of software and hardware. Why did they wind up with BIO-key? Because web key is a very mature, very, very highly capable platform for biometrics, in particular our finger biometrics. It's very secure. So, it's been built through the years to withstand all kinds of intrusion attacks. It has various levels of encryption. It has an administrative facility and flexibility that allows it to be tailored for virtually any venue. And with all that complexity and all that configurability, it's also very easy to deploy. And with our ID Director for Windows on top of that, allows those customers to integrate to their Microsoft environment, their active directory environment, where they control generally, all of the identities and the authentication for applications that they serve. So, you know, that's the primary reason, and we do continue to see growth there. And we think that that market in general will be good for us, not just domestically, but internationally. The second part of your question or the third part, I should say, said what about domestic opportunities in the police department? Generally speaking, the police departments in the United States, use a platform for dispatch and communications. We used to be in that business. You remember we owned, when we bought the Aether Mobile Government Group back in 2004, 2005, we were the largest provider of mobile data solutions for that venue. So, as that kind of market is evolved, all of the access and access control comes through – fundamentally comes through their dispatch system and their CAT. So, you know, we've had some opportunities and we've done some integrations because of our previous experience. But the market doesn't seem as robust domestically, as it does internationally for us. At least right now.

Got it. I heard there was some – there was a hardware decline from $1.9 million to $1.3 million. What does that tell us about the hardware growth, business hardware growth going forward?

Just timing. Our hardware is selling alongside our software in a very robust way. You probably will see a change they are in the first quarter. It's just...

Great. Okay. Thank you. The last question, Samsung released glass fingerprint reader in the Galaxy S10. Are we working anything that will help monetize the password user authentication patent?

Not yet. We love the idea that the ultrasound, ultrasonic fingerprint sensor has been embedded under the glass in that device. I think that's a confirmation that fingerprint biometrics are the preferred choice for authentication for consumers and that's a consumer device, keep that in mind. It's a closed device, meaning that just like with touch ID on the iPhone, it's only to access the device itself. And if it's connected to any application, it's just releasing the token that says, yes, this is, my device. It's not providing any positive identification or authentication for users and for – in particular for enterprises. We do have a few patents that could be interesting over time as that technology itself continues to proliferate. I think we're going to see under the glass sensors in most devices over the next 12 to 18 months. And so, we'll see.

Does that include Apple?

I believe Apple will put a fingerprint. This is one man's opinion. But I do believe that Apple will put a fingerprint sensor back in their premium devices in the next generation.

Okay. Well, looking forward to a very good 2019. Thanks guys.

Thank you.

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

Thank you, everyone. We look forward to updating you on our business progress and outlook on our next call, which will be heard and take place early May. Please also be sure to follow us on social media and our website blog where we can provide ongoing updates on our products and activities. Our social media information is at the end of today's press release. Again, thank you for your interest in BIO-key and for your participation on today's call.

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