U.S. SECURITIES AND EXCHANGEEXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the quarterly period ended June 30,March 31, 20189

or

For the Transition Period from              to

Commission file number 1-13463

BIO-KEY INTERNATIONAL, INC.

(Exact Name of Registrantregistrant as Specifiedspecified in Its Charter)its charter)

3349 HIGHWAY 138, BUILDING A, SUITE E, WALL, NJ  07719

(Address of Principal Executive Offices)

(732) 359-1100

(Issuer’s Telephone Number)Registrant’s telephone number, including area code)

Securities registered pursuance to Section 12(b) of the Act:

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Non-accelerated filer ☐ (Do not check if a smaller reporting company)

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined by rule 12b-2 of the Exchange Act)  Yes  ☐   No  ☒

Number of shares of Common Stock, $.0001 par value per share, outstanding as of AugustMay 13, 2018 is 12,591,279. 2019 was 14,081,688.

BIO-KEY INTERNATIONAL, INC. AND SUBSIDIARY

INDEX

PART I -- FINANCIAL INFORMATION

BIO-KEY INTERNATIONAL, INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED BALANCE SHEETS

The accompanying notes to the condensed consolidated financial statements are an integral part of these statements.

Nature of Business

BIO-key International, Inc.,The Company, founded in 1993, develops and markets proprietary fingerprint identification biometric technology and software solutions. The Company was a pioneer in developing automated, finger identification technology that supplements or compliments other methods of identification and verification, such as personal inspection identification, passwords, tokens, smart cards, ID cards, PKI, credit card, passports, driver’s licenses, OTP or other form of possession or knowledge-based credentialing. Additionally, advanced BIO-key® technology has been, and is, used to improve both the accuracy and speed of competing finger-based biometrics.

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Basis of Presentation

The accompanying unaudited interim condensed consolidated financial statements include the accounts of BIO-key International, Inc. and its wholly-owned subsidiary (collectively, the “Company” or “BIO-key”) and are stated in conformity with accounting principles generally accepted in the United States of America, pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). The operating results for interim periods are not necessarily indicative of results that may be expected for any other interim period or for the full year. Pursuant to such rules and regulations, certain financial information and footnote disclosures normally included in the financial statements have been condensed or omitted. Significant intercompany accounts and transactions have been eliminated in consolidation.

In the opinion of management, the accompanying unaudited interim consolidated financial statements contain all necessary adjustments, consisting only of those of a recurring nature, and disclosures to present fairly the Company’s financial position and the results of its operations and cash flows for the periods presented. The balance sheet at June 30, 2018March 31, 2019 was derived from the audited financial statements, but does not include all of the disclosures required by accounting principles generally accepted in the United States of America. These unaudited interim condensed consolidated financial statements should be read in conjunction with the financial statements and the related notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2017,2018, filed with the SEC on April 2, 2018. 1, 2019. 

Updated Significant Accounting Policies

Recently Issued Accounting PronouncementsLeases

In May 2014, ASU No. 2014-09, “Revenue from Contracts with Customers” was issued. The Company adopted ASU 2014-09 and its related amendments (collectively known as ASC 606) effective on January 1, 2018 using the modified retrospective method. Please see Note 3 "Revenue from Contracts with Customers" for the required disclosures related to the impact of adopting this standard and a discussion of the Company's updated policies related to revenue recognition and accounting for costs to obtain and fulfill a customer contract.

In February 2016, the FASBFinancial Accounting Standards Board (FASB) issued ASUAccounting Standards Update (ASU) 2016-02, “Leases” (Topic 842), as amended (ASC 842).  The new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classifiedmonths and classify as either operating or finance leases.  We adopted this standard effective January 1, 2019 using the modified retrospective approach for all leases entered into before the effective date.  Adoption of the ASC 842 had a significant effect on our balance sheet resulting in increased non-current assets and increased current and non-current liabilities.  There was no impact to retained earnings upon adoption of the new standard. We did not have any finance leases (formerly referred to as capital leases prior to the adoption of ASC 842), therefore there was no change in accounting treatment required.  For comparability purposes, we will continue to comply with the previous disclosure requirements in accordance with the existing lease guidance and prior periods are not restated.

We elected the package of practical expedients as permitted under the transition guidance, which allowed us: (1) to carry forward the historical lease classification; (2) not to reassess whether expired or existing contracts are or contain leases; and, (3) not to reassess the treatment of initial direct costs for existing leases.

In accordance with ASC 842, at the inception of an arrangement, we determine whether the arrangement is or contains a lease based on the unique facts and circumstances present and the classification of the lease including whether the contract involves the use of a distinct identified asset, whether we obtain the right to substantially all the economic benefit from the use of the asset, and whether we have the right to direct the use of the asset. Leases with a term greater than one year are recognized on the balance sheet as right-of-use (ROU) assets, lease liabilities and, if applicable, long-term lease liabilities. We have elected not to recognize on the balance sheet leases with terms of one year or less under practical expedient in paragraph ASC 842-20-25-2. For contracts with lease and non-lease components, we have elected not to allocate the contract consideration and to account for the lease and non-lease components as a single lease component.

Lease liabilities and their corresponding ROU assets are recorded based on the present value of lease payments over the expected lease term. The implicit rate within our operating leases are generally not determinable and therefore we use the incremental borrowing rate at the lease commencement date to determine the present value of lease payments. The determination of our incremental borrowing rate requires judgment. We determine our incremental borrowing rate for each lease using our estimated borrowing rate, adjusted for various factors including level of collateralization, term and currency to align with classification affecting the patternterms of the lease. The operating lease ROU asset also includes any lease prepayments, offset by lease incentives.

An option to extend the lease is considered in connection with determining the ROU asset and lease liability when it is reasonably certain we will exercise that option. An option to terminate is considered unless it is reasonably certain we will not exercise the option.

For periods prior to the adoption of ASC 842, we recorded rent expense based on the term of the related lease. The expense recognition for operating leases under ASC 842 is substantially consistent with prior guidance. As a result, there are no significant differences in our results of operations presented.

The impact of the income statement.adoption of ASC 842 on the balance sheet was:

Recently Issued Accounting Pronouncements

In August 2018, the FASB issued ASU No. 2018-15, Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract(“ASU 2018-15”). ASU 2018-15 aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The newupdate to the standard is effective for fiscal yearsinterim and annual periods beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for capital and operating leases existing at,2019, with early adoption permitted. Entities can choose to adopt the ASU 2018-15 prospectively or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available.retrospectively. The Company is currently evaluatingassessing the impact of its pending adoption of the new standardASU 2018-15 will have on its consolidated financial statements, and expects that it will increase its assets and liabilities for amounts yet to be determined.statements.

In July 2017, the FASB issued ASU 2017-11, Earnings Per Share (Topic 260), Distinguishing Liabilities from Equity (Topic 480) and Derivatives and Hedging (Topic 815): I. Accounting for Certain Financial Instruments with Down Round Features; II. Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Non-controlling Interests with a Scope Exception. Part I of this update addresses the complexity of accounting for certain financial instruments with down round features. Down round features are features of certain equity-linked instruments (or embedded features) that result in the strike price being reduced on the basis of the pricing of future equity offerings. Current accounting guidance creates cost and complexity for entities that issue financial instruments (such as warrants and convertible instruments) with down round features that require fair value measurement of the entire instrument or conversion option. Under ASU 2017-11, down round features do not meet the criteria for derivative accounting and no liability is to be recorded until an actual issuance of securities triggers the down-round feature. Part II of this update addresses the difficulty of navigating Topic 480, Distinguishing Liabilities from Equity, because of the existence of extensive pending content in the FASB Accounting Standards Codification. This pending content is the result of the indefinite deferral of accounting requirements about mandatorily redeemable financial instruments of certain nonpublic entities and certain mandatorily redeemable non-controlling interests. The amendments in Part II of this update do not have an accounting effect. This ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018, with early adoption permitted. The adoption of ASU 2017-11, during the fiscal 2017 year did not have any impact on the condensed consolidated financial statements, however our disclosures with respect to equity instruments with down round features have been updated.   

Management does not believe that any other recently issued, but not yet effective, accounting standard if currently adopted would have a material effect on the accompanying consolidated financial statements.

Reclassification

Reclassifications
Reclassification occurred to certain prior year amounts in order to conform to the current year classifications including segregating the hardware revenues.classifications.  The reclassifications have no effect on the reported net loss.

The Company has incurred significant losses to date, and at June 30, 2018March 31, 2019 had an accumulated deficit of approximately $71$77 million. In addition, broad commercial acceptance of the Company’s technology is critical to the Company’s success and ability to generate future revenues. At June 30, 2018,March 31, 2019, the Company’s total cash and cash equivalents were approximately $304,000,$459,000, as compared to approximately $289,000$324,000 at December 31, 2017.2018.

The Company has financed operations in the past through access to the capital markets by issuing secured and convertible debt securities, convertible preferred stock, common stock, and through factoring receivables. The Company estimates that it currently requires approximately $592,000$537,000 per month to conduct operations, a monthly amount that it has been unable to achieve consistently through revenue generation.

If the Company is unable to generate sufficient revenue to meet its goals, it will need to obtain additional third-party financing to (i) conduct the sales, marketing and technical support necessary to execute its plan to substantially grow operations, increase revenue, and serve a significant customer base; and (ii) provide working capital. No assurance can be given that any form of additional financing will be available on terms acceptable to the Company, that adequate financing will be obtained by the Company, in order to meet its needs, or that such financing would not be dilutive to existing shareholders.

The accompanying condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America ("GAAP"), which contemplate continuation of the Company as a going concern, and assumes continuity of operations, realization of assets and the satisfaction of liabilities and commitments in the normal course of business. The matters described in the preceding paragraphs raise substantial doubt about the Company’s ability to continue as a going concern. Recoverability of a major portion of the recorded asset amounts shown in the accompanying balance sheet is dependent upon the Company’s ability to meet its financing requirements on a continuing basis, and become profitable in its future operations. The accompanying condensed consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded assets or the amounts and classification of liabilities that might be necessary should the Company be unable to continue in existence.

The Company adopted ASC 606 on January 1, 2018 using the modified retrospective method for all contracts not completed as of the date of adoption. The reported results for 2018 reflect the application of ASC 606 guidance while the reported results for 2017 were prepared under the guidance of ASC 605, Revenue Recognition (ASC 605), which is also referred to herein as "legacy GAAP" or the "previous guidance". The adoption of ASC 606 represents a change in accounting principle that will more closely align revenue recognition with the delivery of the Company's services and will provide financial statement readers with enhanced disclosures. In accordance with ASC 606, revenue is recognized when a customer obtains control of promised services. The amount of revenue recognized reflects the consideration to which the Company expects to be entitled to receive in exchange for these services. To achieve this core principle, the Company applies the following five steps:

Disaggregation of Revenue

The following table summarizes revenue from contracts with customers for the three month periodsperiod ended:

Accounts receivable are carried at original amount less an estimate made for doubtful receivables based on a review of all outstanding amounts on a monthly basis. Management determines the allowance for doubtful receivables by regularly evaluating individual customer receivables and considering a customer’s financial condition, credit history, and current economic conditions. Accounts receivable are written off when deemed uncollectible. As a result of the payment delays for a large customer, the Company has continued to reserve $1,000,000reserved $1,720,000 at June 30,March 31, 2019 and December 31, 2018, which represents 58%100% of the remaining balance owed under the contract.contract, respectively. Recoveries of accounts receivable previously written off are recorded when received. Accounts receivable at June 30, 2018March 31, 2019 and December 31, 20172018 consisted of the following:

The following table presents share-based compensation expenses for continuing operations included in the Company’s unaudited condensed interim consolidated statements of operations:

Due from factor consisted of the following as of: 

Inventory is stated at the lower of cost, determined on a first in, first out basis, or net realizable value, and consists primarily of fabricated assemblies and finished goods. Inventory is comprised of the following as of:

On November 11, 2015, the Company entered into a license agreement for the rights to all software and documentation regarding the technology currently known as or offered under the FingerQ name. The license agreement grants the Company the exclusive right to reproduce, create derivative works and distribute copies of the FingerQ software and documentation, create new FingerQ related products, and grant sub-licenses of the licensed technology to end users. The license rights have been granted to the Company in perpetuity, with a stated number of end-user resale sub-licenses allowed under the contract for a total of $12,000,000. The cost of sub-license rights expected to be amortized in the following 12 months is $2,820,000$1,125,000 and is classified as current, with remainder as non-current.

The Company hasoriginally determined the software license rights to be a finite lived intangible asset, and estimated that the software license rights shall be economically used over a 10 year period, with a weighting towards the beginning years of that time-frame. The license rights were acquired during the fourth quarter of 2015, but the usage of such rights in the Company’s products was not generally available until January 2017. Accordingly, amortization began in the first quarter of 2017.

TheThrough 2018, the remaining license rights arewere to be amortized over the greater of the following:following amounts: 1) an estimate of the economic use of such license rights, 2) the amount calculated by the straight line method over ten years or 3) the actual cost basis of sales usage of such rights. The Company believes that the economic use model was front-end focused as a majority of the expected up-take of the FingerQ technology was predicted to occur during the first 4-5 years of the 10-year life cycle of the product. Based on current sales trends, the Company now believes future transactions will be more evenly dispersed over the remaining life cycle of the product, indicating that the greater of the straight-line methodology or or actual unit cost per license sold will more closely align the expense with the remaining useful life of the product. The change in amortization was effective beginning on January 1, 2019 based on the net remaining software license rights balance. The Company believes categorizing the amortization expense under Cost of Sales more closely reflects the nature of the license right arrangement and the use of the technology. A total of $281,250 and $660,000 and $390,000 was expensedcharged to cost of sales during the three month periods ended June 30,March 31, 2019 and 2018, respectively and 2017,of this amount $176 and $586, represent the cost basis of the actual sales, respectively. A total of $1,320,000 and $778,092 was expensed during the six month periods ended June 30, 2018 and 2017, respectively.  The 2018 expense was recorded based on the economic use model. Since the license purchase, a cumulative amount of $2,878,596$4,479,846 has been expensed,charged to cost of sales, with a carrying balance of $9,121,404$7,520,154 as of June 30, 2018.March 31, 2019. The Company's change in methodology was determined to be a change in accounting estimate that is effected by a change in accounting principle.  Pursuant to ASC 250-10-45-17 guidance, this accounting change will not be accounted for as a cumulative effect adjustment on the statement of operations in the period of change and there will be no retroactive application or restatement of prior periods.  Instead, the Company allocates the remaining unamortized balance over the remaining life of the assets using the newly adopted method.

The following compares line items on the statement of operations had the change in amortization methodology not been made:

On December 31, 2015, the Company purchased third-party software licenses in the amount of $180,000 in anticipation of a large pending deployment that has yet to materialize. The Company is amortizing the total cost over the same methodology described above with the greatest of the threetwo approaches being the amortization for the periods.actual unit cost per license sold. A total of $20,642 and $22,020$25,954 was expensedcharged to cost of sales during the three month periodsperiod ended June 30, 2018March 31, 2019, and 2017, respectively. A totala net credit of $8,102 (net of credits of $14,400) and $28,716$12,540 was expensedrecorded during the six month periods ended June 30, 2018 and 2017,period, respectively. Since the license purchase, the actual per unit cost (actual usage) of such license rights in the cumulative amount of $55,698 net of credits$91,748 has been expensed,charged to cost of sales, with a carrying balance of $124,302$88,252 as of June 30, 2018.March 31, 2019. The Company has classified the balance as non-current until a larger deployment occurs. Software license rights is comprised of the following as of:

During the quarter ended March 31, 2019, the Company received a non-interest bearing advance from an executive officer/director, the Company's principal stockholder, in amount of $133,174 to pay current liabilities. The advance is payable upon demand.

The Company’s leases office space in New Jersey, Hong Kong and Minnesota with lease termination dates of 2023, 2019, and 2020, respectively. The Minnesota lease is under 12 months, thus classified as short-term and not reported on the balance sheet under ASC 842. The Hong Kong and the New Jersey leases include non-lease components with variable payments. The following tables present the components of lease expense and supplemental balance sheet information related to the operating leases, for the three months ended and as of:

Supplemental cash flow information related to leases were as follows, for the three months ended March 31, 2019:

Maturities of operating lease liabilities were as follows:

The Company’s basic EPS is calculated using net lossincome (loss) available to common shareholders and the weighted-average number of shares outstanding during the reporting period. Diluted EPS includes the effect from potential issuance of common stock, such as stock issuable pursuant to the exercise of stock options and warrants and the assumed conversion of convertible preferred stock.

The reconciliation of the numerator of the basic and diluted EPS calculations was as follows for both of the following three and six month periods ended June 30, 2018March 31, 2019 and 2017:2018: