BIO KEY INTERNATIONAL INC 10-K

ITEM 5. MARKET FOR REGISTRANT ’ S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES Our common stock currently trades on the Nasdaq Capital Market under the symbol “BKYI”. Holders As of March 26, 2021, the number of stockholders of record of our common stock was 112. Dividends We have not paid any cash dividends on our common stock to-date and have no intention of paying any cash dividends on our common stock in the foreseeable future. The declaration and payment of dividends on our common stock is also subject to the discretion of our Board of Directors and certain limitations imposed under the Delaware General Corporation Law. The timing, amount, and form of dividends, if any, will depend on, among other things, our results of operations, financial condition, cash requirements and other factors deemed relevant by our Board of Directors. Securities Authorized for Issuance under Equity Compensation Plans For information on securities authorized for issuance under the Company’s equity compensation plans, see “Item 12 - Security Ownership of Certain Beneficial Owners and Related Stockholder Matters.” Unregistered Sales of Equity Securities There were no unregistered sales of the Company’s equity securities during 2020 that were not previously disclosed in a Quarterly Report on Form 10-Q or in a Current Report on Form 8-K. Rule 10b-18 Transactions None. ITEM 6. SELECTED FINANCIAL DATA Not Applicable. ITEM 7. MANAGEMENT ’ S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This Management’s Discussion and Analysis of Financial Condition and Results of Operations, and other parts of this Report contain forward-looking statements that involve risks and uncertainties. All forward-looking statements included in this Report are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including those set forth in the section captioned “ RISK FACTORS ” in Item 1A and elsewhere in this Report. The following Management’s Discussion and Analysis of Financial Condition and Results of Operations is intended to help you understand our Company. This discussion is provided as a supplement to and should be read in conjunction with our consolidated financial statements for the years ended December 31, 2020 and 2019 and the accompanying notes included elsewhere in this Report. Effective November 20, 2020, we implemented a reverse stock split of our outstanding common stock at a ratio of 1-for-8. All share figures are reflected on a post-split basis. Overview We are a leading identity access management (IAM) platform provider for the enterprise and large-scale customer and civil ID solutions. Built to leverage BIO-key’s world-class biometric core platform among 14 other strong authentication factors, BIO-key PortalGuard and hosted PortalGuard IDaaS are platforms that enable our customers to securely and easily assure that only the right people can access the right systems. PortalGuard goes beyond traditional multifactor authentication (MFA) solutions by addressing sizeable gaps, such as allowing roving users to biometrically authenticate at any workstation without using their phones or tokens, eliminating unauthorized account delegation, detecting duplicate users, and accommodating in-person identification. 18 Millions use BIO-key every day to securely access a variety of cloud, mobile and web applications, on-premise and cloud-based hypervisor servers from all of their devices. Employees, contractors, students and faculty sign in through PortalGuard to seamlessly and securely access the applications they need to do their important work, without relying on personal phone use or per-user tokens. Organizations use our platform to securely collaborate with their supply chain and partners, and to provide their customers with flexible, resilient user experiences online or in-person. 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. One large bank has enrolled and identifies over 10 million of their customers in branches on a daily basis. We sell our branded biometric 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. We do not mandate BIO-key hardware and our NIST-certified biometric platform is unique in that it supports interoperable mixing and matching combinations of fingerprint scanners regardless of manufacturer, so that the right scanner can be deployed for the right use case, without mandating the user of a particular scanner. Security-conscious developers leverage our platform APIs and federation interfaces to securely and efficiently embed biometric and MFA identity capabilities into their software. Our approach to IDaaS allows our customers to efficiently scale their security and identity infrastructures to protect both internal cloud workforce- and external customer-facing applications. 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. PortalGuard is used by our customers to manage and secure IT 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. We invoice customers in advance in annual and multi-year prepaid installments for subscriptions to our platforms. Strategic Outlook Historically, our largest market has been access control within highly regulated industries such as government, financial services, and healthcare. In 2019 we became the go-to biometric authentication provider for board of election offices as eight offices deployed our hardware and software to secure internal access to the voter registration database. We will seek to extend this footprint in 2021 and beyond. In 2020, we announced that we had secured two of the largest contracts in our history, with our partner Technology Transfer Institute. The contracts, valued at a combined $75,000,000, are for large-scale identification projects in Africa and Nigeria. Under the first contract, we will provide biometric authentication to support the infrastructure of a new e-commerce project developed with the expectation to generate more than one million jobs in Nigeria. The second contract provides for BIO-key hardware and software to be used by a leading African telecommunications company to secure internal access to customer data. Currently Africa and the surrounding regions are receiving government funding to expand the use of biometric authentication solutions to help establish trustworthy government programs and reduce fraud. We received our first purchase order under these contracts in the fourth quarter of 2020 which we expect to ship in the first half of 2021 upon receipt of prepayment for the order. The COVID-19 pandemic has and may continue to delay the rollout of these programs. We plan to have a more significant role in the IAM market which continues to expand. We plan to offer customers a suite of authentication options that complement our biometric solutions. The more well-rounded offerings of authentication options will allow customers to customize their approach to authentication all under one umbrella. 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. 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 forty participants and is starting to generate incremental revenues. 19 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 As discussed under “Item 1A. Risk Factors” above, an outbreak of a novel strain of the coronavirus, COVID-19, has been recognized as a pandemic by the World Health Organization. This outbreak has severely restricted the level of economic activity around the world. In response to this coronavirus outbreak the governments of many countries, states, cities and other geographic regions have taken preventative or protective actions, including imposing restrictions on travel and business operations and requiring individuals to limit time outside of their homes. Given the uncertainty regarding the spread of this coronavirus, the related financial impact cannot be reasonably estimated at this time. The complications caused by COVID-19 has forced organizations to quickly adapt to a work from home remote business model. This increases the risk of unauthorized users, phishing attacks, and hackers who are eager to take advantage of the challenges of securing remote workers. We believe that biometrics should play a key role in remote user authentication. RESULTS OF OPERATIONS Consolidated Results of Operations Two Year % trend Years ended December 31, 2020 2019 Revenues Services 50 % 40 % License fees 34 % 20 % Hardware 16 % 40 % 100 % 100 % Costs and other expenses Cost of services 18 % 12 % Cost of license fees 2 % 41 % Cost of hardware 9 % 56 % 29 % 109 % Gross Profit (Loss) 71 % -9 % Operating expenses Selling, general and administrative 206 % 222 % Research, development and engineering 49 % 58 % Total operating expenses before impairment 255 % 280 % Impairment of resalable software license rights 0 % 307 % Operating loss -184 % -596 % Other income (expense) Total other income (expense) -158 % -47 % Net loss -342 % -643 % 20 Revenues and Costs and other expenses 2020 - 2019 2020 2019 $ Chg % Chg Revenues Services $ 1,432,228 $ 925,245 $ 506,983 55 % License fees 962,038 442,649 519,389 117 % Hardware 442,516 899,634 (457,118 ) -51 % Total Revenue $ 2,836,782 $ 2,267,528 $ 569,254 25 % Costs and other expenses Services $ 502,214 $ 272,318 $ 229,896 84 % License fees 49,891 916,112 (866,221 ) -95 % Hardware 242,721 1,272,815 (1,030,094 ) -81 % Total Costs and other expenses $ 794,826 $ 2,461,245 $ (1,666,419 ) -68 % Revenues Revenue increased $569,254 or 25% to $2,836,782 in 2020 as compared to $2,267,528 in 2019 due to the factors stated below. For the years ended December 31, 2020 and 2019, service revenues included approximately $1,383,000 and $904,000, respectively, of recurring maintenance and support revenue, and approximately $49,000 and $21,000, respectively, of non-recurring custom services revenue. Recurring service revenue increased 53% from 2019 to 2020 which is due largely to the additional service revenue from PistolStar customers in the last six months of 2020. Non-recurring custom services increased 134% due to increased new customer installations. As our customer base continues to grow, we expect the service revenue to increase in future periods. For the years ended December 31, 2020 and 2019, license revenue increased approximately $519,000 or 117% to $962,038. We increased both the variation and number of customers, including additional revenue from the PistolStar acquisition in the last six months of 2020. Hardware sales decreased by approximately $457,000, or 51%, to $442,516 in 2020 as a result of fewer large customer deployments, and reduced lock sales. Fingerprint reader sales decreased approximately $412,000, or 48%, while the biometric locks decreased approximately $45,000, or 98% from 2019. Costs of goods sold For the year ended December 31, 2020, cost of service increased approximately 84% to $502,214, due to the increased revenue and the direct support for the PortalGuard installations. License costs for the year ended December 31, 2020 decreased approximately 95% to $49,891. The decrease was attributable primarily to the amortization and actual deployments of the software rights of approximately $15,000 in 2020 compared to $884,000 in 2019. Hardware costs for the year ended December 31, 2020 decreased approximately 81% to $242,721. The decrease was attributable primarily to the write down of lock inventory and parts as a result of the discontinuance of lock sales in the US in 2019 and reduction of hardware sales. Selling, general and administrative 2020 - 2019 2020 2019 $ Chg % Chg $ 5,848,687 $ 5,036,820 $ 811,867 16 % Selling, general and administrative costs for year ended December 31, 2020 were $5,848,687 representing a 16% increase over 2019. The increase included expenses associated with new marketing personnel and web-site integration of PistolStar, additional costs associated with the PistolStar office staff and expenses, one-time integration costs incurred in connection the acquisition of PistolStar, increased accounting and legal fees incurred in connection with financing transactions, and costs associated with establishing our African subsidiary. These amounts were offset in part by a decrease in travel, bad debt expense, factor fees, and non-cash compensation. 21 Research, development and engineering 2020 - 2019 2020 2019 $ Chg % Chg $ 1,396,436 $ 1,331,667 $ 64,769 5 % For the year ended December 31, 2020, research, development and engineering costs were $1,396,436 representing a 5% increase over 2019, as a result of an increase in recruiting expenses and the addition of PistolStar expenses. These amounts were offset by a decrease in contracting services and non-cash compensation. Impairment 2020 - 2019 2020 2019 $ Chg % Chg Impairment of resalable software license rights $ - 6,957,516 $ (6,957,516 ) -100 % Impairment of assets relates to the write-down of the FingerQ resalable software license rights to zero in the fourth quarter of 2019. Other income (expense) 2020 - 2019 2020 2019 $ Chg % Chg Interest income 30,649 154 30,495 19,802 % Government grant 340,819 - 340,819 n/a Interest expense (4,343,212 ) (1,069,134 ) (3,274,078 ) 306 % Loss of extinguishment of debt (499,076 ) - (499,076 ) n/a $ (4,470,820 ) $ (1,068,980 ) $ (3,401,840 ) 318 % Interest expense for 2020 related to the amortization of debt discounts and debt issuance costs relating to convertible notes of approximately $3,574,000, as well as the amortization of a beneficial conversion feature of approximately $641,000. Also included in other income (expense) for 2020 was a loss on the extinguishment of a convertible note in the approximate amount of $500,000 resulting from the issuance of an amended and restated convertible note, for which the issuer did not grant a concession. These amounts were partially offset by amounts received under the Payment Protection Program (the “Program”) the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) administered by the U.S. Small Business Administration of approximately $341,000 and interest income of approximately $31,000. The 2019 total includes the write-off of unamortized discount and debt issuance costs related to the April 2019 and June 2019 notes repaid prior to maturity. LIQUIDITY AND CAPITAL RESOURCES Operating activities overview Net cash used for operations during the year ended December 31, 2020 was approximately $4,950,000. Items of note included: ● Net positive cash flows related to non-cash expenses of approximately $6,104,000. ● Net negative cash flows related to changes in accounts receivable, prepayments, accounts payable, accruals, lease liabilities, and deferred revenue of approximately $1,457,000 and our net loss for the period. Investing activities overview Approximately $2,230,000 was used for investing activities during the year ended December 31, 2020 and related primarily to the acquisition of PistolStar. Financing activities overview Approximately $24,094,000 was provided by financing activities during the year ended December 31, 2020 consisting of the issuance of common stock and warrants in our underwritten public offering, exercise of warrants and issuance of convertible notes. These amounts were offset by repayment of convertible notes, repayment of notes payable and other related party debt, debt service fees, and costs associated with the issuance of our securities. 22 Sources of Liquidity Since our inception, our capital needs have been principally met through proceeds from the sale of equity and debt securities. We expect capital expenditures to be less than $100,000 during the next twelve months. The following sets forth our primary sources of capital during the previous two years: We entered into an accounts receivable factoring arrangement with a financial institution (the “Factor”) which has been extended to October 31, 2021 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. On April 4, 2019, we issued a $550,000 secured convertible debenture to an institutional investor with a maturity date of November 15, 2019 which was convertible into common stock at a conversion price of $12.00 per share. On July 10, 2019, this debenture was redeemed and repaid in full in connection with the financing described below. On June 14, 2019, we issued a $157,000 principal amount convertible note to an institutional investor with a maturity date of November 14, 2019 which was convertible into common stock at a conversion price of $12.00 per share. On July 10, 2019, this note was redeemed and repaid in full in connection with the financing described below. On July 10, 2019, we issued a $3,060,000 principal amount senior secured convertible note (the “Original Note”) to an institutional investor. At closing, $2,550,000 was funded. The Original Note was secured by a lien on substantially all of our assets and properties and was convertible into shares of our common stock at a fixed conversion price of $12.00 per share. Pursuant to amendments in the first and second quarter of 2020, we amended the Original Note to increase the principal amount to $3,789,000 as a result of interest and penalties, accelerated the maturity date to June 13, 2020, and reduced the conversion price to $5.20 per share (the “Amended Note”). The full balance of the Amended Note has been converted into common stock. On January 13, 2020, we issued a $157,000 principal amount convertible note to an institutional investor with a maturity date of June 13, 2020 which was convertible into common stock at a conversion price of $12.00 per share. This note was paid in full on June 12, 2020 by payment of $211,984. On February 13, 2020, we issued a $126,000 principal amount convertible note to an institutional investor with a maturity date of July 13, 2020 which was convertible into common stock at a conversion price of $9.20 per share. This note was paid in full on July 10, 2020 by payment of $170,442. On April 20, 2020, we entered into a Paycheck Protection Program Term Note (the “SVB Note”) with Silicon Valley Bank (“SVB”) pursuant to the Program. We received total proceeds of approximately $341,000 which was used in accordance with the requirements of the CARES Act. The full amount of the SVB Note has been forgiven. On May 6, 2020, we issued a $2,415,000 principal amount senior secured convertible note. The principal amount was due and payable in five equal monthly installments of $268,333 beginning seven months after the funding date with the remaining balance due twelve months after the date of funding. Following the completion of the underwritten offering consummated in July 2020 discussed below, all outstanding amounts relating this note were paid in full. On June 29, 2020, we issued a $1,811,250 principal amount senior secured convertible note. The principal amount was due and payable in nine equal monthly installments of $201,250 beginning four months after the funding date. Following the completion of the underwritten offering consummated in July 2020 discussed below, all outstanding amounts relating this note were paid in full. On July 23, 2020, we completed an underwritten public offering of shares of common stock and warrants resulting in net proceeds of approximately $22.7 million, inclusive of the over-allotment and after deducting underwriting discounts and commissions and estimated offering expenses. We used approximately $4.2 million of the net proceeds to repay all outstanding amounts due under outstanding convertible promissory notes at that time. 23 Liquidity Outlook At December 31, 2020, our total cash and cash equivalents were approximately $17,000,000, as compared to approximately $79,000 at December 31, 2019. At December 31, 2020 we had working capital of approximately $17,000,000. 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 $735,000 per month to conduct our operations, a monthly amount that we have been unable to consistently achieve through revenue generation. During 2020, we generated approximately $2,837,000 of revenue, which is below our average monthly requirements. 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. As of the date of this report, we do not expect that we will need to obtain additional financing during the next twelve months. 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. OFF-BALANCE SHEET ARRANGEMENTS We do not have any off-balance sheet arrangements that have, or are in the opinion of management reasonably likely to have, a current or future effect on our financial condition or results of operations. CRITICAL ACCOUNTING POLICIES Our financial statements are prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. We evaluate our estimates and assumptions on an ongoing basis. Our actual results may differ significantly from these estimates under different assumptions or conditions. There have been no material changes to these estimates for the periods presented in this Annual Report on Form 10-K. We believe that of our significant accounting policies, which are described in Note A of the notes to our consolidated financial statements included in this Annual Report on Form 10-K, the following accounting policies involve a greater degree of judgment and complexity. Accordingly, these are the policies we believe are the most critical to aid in fully understanding and evaluating our financial condition and results of operations, as listed below: 1. Revenue Recognition 2. Business Combinations 24 3. Goodwill and acquired intangible assets 4. Impairment or Disposal of Long Lived Assets, including Intangible Assets 5. Research and Development Expenditures 6. Income Taxes 7. Accounting for Stock-Based Compensation 25 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Not Applicable. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA See financial statements appearing at pages 37-66 of this Annual Report on Form 10-K. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None.