Intellicheck, Inc. (IDN) Q2 2018 Earnings Report, Transcript and Summary

Greetings, and welcome to the Intellicheck Second Quarter 2018 Earnings Call. [Operator Instructions]. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host today, Mr. Gar Jackson, Investor Relations. Please proceed.

Good afternoon, and thank you for joining us today for the Intellicheck second quarter 2018 earnings call. Before we get started, I will take a few minutes to read the forward-looking statement. Certain statements in this conference call constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 as amended. When used in this conference call, words such as will, believe, expect, anticipate, encourage and similar expressions as they relate to the company or its management as well as assumptions made by and information currently available to the company's management identify forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on management's current expectations and beliefs about future events. As with any projection or forecast, they are inherently susceptible to uncertainty and changes in circumstances. And the company undertakes no obligation to and expressly disclaims any obligation to update or alter its forward-looking statements, whether resulting from such changes, new information, subsequent events or otherwise. Additional information concerning forward-looking statements is contained under the headings of Safe Harbor Statement and Risk Factors listed from time to time in the company's filings with the Securities and Exchange Commission. Statements made on today's call are as of today, August 14, 2018. The management will use the term adjusted EBITDA in today's call. Please refer to the company's press release issued this afternoon for further definition, reconciliation and context for the use of this term. We will begin today's call with Bryan Lewis, Intellicheck's' Chief Executive Officer; and then Bill White, Intellicheck's Chief Financial Officer, who will discuss the Q2 financial results. Following their prepared remarks, we will take questions from our analysts and institutional investors. Today's call will be limited to 1 hour, and I will now turn the call over to Bryan.

Thank you, Gar. Good afternoon, and thank you all for joining us today. I've been in Intellicheck for about 6 months now, and just as I started the call last time, I would like to reiterate that I continue to be excited about what we are doing on multiple fronts here at Intellicheck each day. Our core technology, authenticating government issued IDs, is proving to be the most vital step in combating identity fraud, underage use of age-restricted products and in helping law enforcement do their jobs. As you know, we received an important independent endorsement of our product accuracy with the recent announcement by the New York DMV that they ran 1,000 fake IDs through our core authentication technology, and we caught all 1,000. We say we are 99.9% accurate, but in this case, we were batting 1,000. As I said last call, we believe that the market is truly coming our way and I'm going to start by talking about why in the context of the two verticals that we sell into, consumer transaction space and the law space. I will start with the consumer space, specifically retail, where we believe we have the most immediate revenue opportunity. While most only read the news and on any given day, you will see an article or research report detailing how identity theft and the creation of synthetic identities is costing billions of dollars a year and has taken countless hours for victims to clear their records. For those of you who don't know, synthetic identities are created when a criminal combines typically stolen, real information about individuals, think the Equifax breach, to create identities that are then used to open fraudulent accounts. Take a moment to think about the frequency of announced data breaches, and you will quickly understand the severity of the situation. For example, in the second quarter of this year, 9 of the largest breaches in the U.S. led to 681 million records being stolen. Additionally, 15 of the top retailers in the country were hacked so far in 2018. This is in addition to the more than 145 million names, Social Security numbers and dates of birth that were breached at Equifax last year. The amount of data stolen and available on each of us makes it far too easy for criminals to steal our identities. Combine the availability of this information with the simplicity of obtaining a fake ID that looks real and coordinates perfectly with the stolen information, and you have a severe problem that cause retailers, consumers and banks billions annually. This is where Retail ID provides a simple and effective solution. We authenticate the ID at the beginning of the transaction. We stop fraud before it starts. Let's put a number to the size of this fraud and then we see the impact of all of these breaches. Javelin Strategy & Research puts the total value of identity theft at nearly $17 billion in 2017. What scares me the most though is the Accenture study that found at the time from data breach to when the data is used for fraud is 12 to 18 months. The trove of data in hacker's hands from the Equifax breach alone should be hitting the market for the holiday shopping season and the amount of records breached already this year suggests there is no end in sight. The good news is that Intellicheck Retail ID solutions stop this fraud in-store at the point-of-sale, online and on mobile devices. We do it by integrating with the retailer's existing hardware, making it a simple and low-cost solution. With that in mind, let's talk about what we did for our clients in Q2. If you remember from the last call, we polled our clients to ask them how much this fraud caused them per transaction before they installed Retail ID. Department stores averaged $2,100 per fraudulent transaction. Tool and equipment stores averaged $2,569. Furniture and home furnishings stores average loss was $2,908. And jewelery stores topped the average losses at $3,574 per transaction. We looked at a sampling of 17 of our clients across these client types for Q2 2018. Based on catching fake IDs and stopping transactions before they started, we estimated that Retail ID stopped just over 29,000 transactions that we project resulted in just over $62 million in savings. These numbers serve us well as we speak to prospective clients looking for a solution to combat fraud in their businesses. We stop fraud before it starts. Ultimately, what is most important is that these statistics show that Retail ID works. Quarter-over-quarter usage shows increasing momentum. We did 3,008% more scans to authenticate IDs in a retail use case in Q2 2018 than we did in Q2 2017. With these numbers in mind, let me reiterate an important point that is key to viewing the competitive marketplace as a whole. A key competitive advantage is that our SaaS products typically do not require a hardware investment as a biometric solution would. The simplicity of our solution is an important competitive strength. Our Retail ID technology works with 2 things that already exists. The one you carry with you in your wallet, and the other is a store's existing point-of-sale, online or mobile device selling channels. Retail ID is easy to implement and frictionless to the consumer. It is not unfamiliar and that's off-putting because we are all used to providing a license to prove our identity. With Retail ID, we authenticate the ID to stop crime and protect the consumer, the retailer and the credit card company. We effectively stop fraud before it starts. Turning now to the changes I initiated when I started at Intellicheck about 6 months ago. We have made several revisions to how we sell Retail ID. In evaluating our key verticals, it was apparent that banks and retailers typically have a few primary use cases for Retail ID. These include new account acquisition such as credit card applications and loyalty programs; account lookup for card-not-present transactions; nonreceipted merchandise returns; and omnichannel transactions, including buy online and pick up in store. Surprisingly, some clients simply want a pricing solution to read the barcode and automatically prefill a form or application with the data but are not interested in authenticating it. With this understanding, we refocused our approach and are selling solutions for each use case. To bring greater clarity, here are 2 examples of clients we're bringing on board with one of our primary use case pricing models. The first is a 3,000-plus location North America retailer whose credit card issuers are issued by a card issuer we are not working with yet. This client wanted to enhance the customer experience by speeding up the credit application process. They wanted the data first and the form filled out. They did not care to pay for authentication because they do not bear the cost of new account fraud. The card issuer does. We will track how often the ID used was fraudulent. This retailer's bank will be monitoring this with us. And given the fraud at comparable companies, we believe we should easily prove the ROI to the bank and sign them up for use cases at their other retailers where they bear the cost of fraud. Part of our reinvigorated sales process now focuses on the pain point of who ultimately eats the cost of fraud. This is the group most incentivized to pay for the service. An additional example is a 1,000-location retailer that will be paying for the use case of nonreceipted returns, a use case where they eat the loss. This is our first major player to purchase a fraud use case solution where the retailer bears the entire cost of the fraud. Again, the retailer has the pain point and wants to stop the fraud before it starts. I want to be clear that single use cases sell at a discount to full authentication or all use cases, but we believe it brings significant upsell opportunities within the retailer and cross-sell to the credit card issuers. Another important change we have recently made to how we sell Retail ID is the pricing model for credit card issuers. For credit card issuers, we are offering a transactional or per scan model. We believe this will generate more revenue for the company as in the past. Some clients are hesitant to install Retail ID in what they termed low fraud stores. And as I have mentioned, our scan volumes have gone up tremendously. We have come to commercial terms with one major credit card issuer and we are negotiating their renewal contract converting to this model for their January 2019 renewal. The advantage of this transactional model is that it's able to be rolled out with all stores, including those with low volume. Moving to the law vertical. We are seeing a significant growth in interest based on the press release we shared with you that was issued by New York Governor, Cuomo, regarding the New York DMV using Law ID. It lends important credence when a governor of a significant state offers unequivocal validation that was strongly reinforced with the DMV stating that Law ID caught all 1,000 fake IDs that were tested. This generated a surge of press coverage and an influx of requests to learn more about our state-of-the-art solutions from law enforcement agencies and sellers of age-restricted products from across the nation. In addition to appearing in more than 100 articles, I've been interviewed by a number of broadcast organizations offering further opportunity to showcase Law ID and Age ID. We're going to continue to capitalize on this and the changes we have implemented to the structure of our sales force, we believe, will make this happen. Most recently, we have completed an initial build of an inside sales team. This new organizational approach will help us with inbound calls as well as lead generation for the entire sales team. Looking at the current switch connectivity status. We have the switch connections completed in 6 states that include New York, Massachusetts, Delaware, Virginia, Tennessee and Mississippi. In addition, South Carolina has finally cleared us to proceed with the connection to that state and we have pilots underway or scheduled in each of the aforementioned states. Feedback on the pilots has been extremely positive, although I want to be clear that the initial pilots have been with smaller agencies. Several of these agencies have signed up or told us they are in the process of generating a purchase order. To date, sales are small but we continue to aggressively pursue opportunities. In the coming weeks, there are several large-scale pilots due to commence. In the states where we do not have the switch activated, we are selling Age ID to the ABC enforcement agencies and police departments. Currently, 37 enforcement and compliance agencies in 19 states have deployed Age ID. Keeping age-restricted products out of the hands of minors remains a complex and challenging problem for retailers and enforcement agencies. This has become more apparent with the growing use and abuse of vaping products, again, against the background of sophisticated fake IDs that are so easily and inexpensively available. This underscores the challenges for law enforcement and retail and at the same time, demonstrates the importance of our solution and the successes we are having here. We believe that by arming law enforcement with the tool to crackdown on fake IDs also serves to provide incentives for bars and restaurants and other retail outlets to utilize the same tools, to prevent the use of fake IDs in their establishments. We remain confident that the market is coming our way. Virtually every day, you read about another breach. Retailers and banks know they need to protect themselves and the consumer and we have the data to prove we do just that with our reference clients to back us up with what we say. We believe that our continuing press coverage and the validation of our products should help us open new doors and speed up adoption. The changes we have made to our sales team, process and products are all showing results. I continue to stand by my initial testament of Intellicheck at the time when we first spoke. In conclusion, I remain excited and energized by the opportunities ahead and what we believe is a bright future for this innovative company. I will now turn the call over to our CFO, Bill White, to discuss our second quarter financial results

Thank you, Bryan, and good day to our shareholders, guests and listeners. I'd like to discuss some of the financial information that was contained in our press release for the second quarter ended June 30, 2018, that we released a short while ago. We anticipate that our Form 10-Q will be filed with the SEC later today. I will begin with our second quarter results. Revenue for the second quarter ended June 30, 2018, grew 5% to $1,001,000 versus $951,000 for the same period last year. Our Software-as-a-Service revenue was $625,000 for Q2 of '18 which increased 107% from approximately $302,000 for Q2 2017 and was a 5% sequential increase from approximately $595,000 in Q1 of 2018. Gross profit as a percentage of revenue increased to 91.8% for the quarter ending June 30, 2018, compared to 78.5% for the quarter ending June 30, 2017, and 90.5% in the prior sequential quarter. The increase in percentage is due to higher revenues on our SaaS products and our product mix. Operating expenses consist of selling, general and administrative and research and development expenses increased by 12% or $216,000 to $2,063,000 for the 3 months ending June 30, 2018, versus $1,847,000 for the 3 months ending June 30 2017. This increase was primarily driven by a higher headcount for our sales and development personnel and accelerated marketing and research and development expenses. The company posted a net loss of $1,100,000 for the 3 months ending June 30, 2018, that was flat compared to a net loss of $1,099,000 for the quarter ending June 30, 2017. The net loss per diluted share was $0.07 versus $0.10 in the prior period. Adjusted EBITDA for the quarter ending June 30, 2018, was negative $1,018,000 compared to negative $902,000 in the quarter ending June 30, 2017. A reconciliation of our adjusted EBITDA can be found in the tables of our earnings release issued today. Interest and other income was negligible for the quarter ending June 30, 2018, and June 30, 2017. I'd like to now focus on the company's liquidity and capital resources. As of June 30, 2018, the company had cash of $6.5 million, working capital defined as current assets minus current liabilities of $5.9 million. Total assets of $16.3 million and stockholders' equity of $14.7 million. During the 6 months ending June 30, 2018, the company used net cash of $1,548,000 compared to a net cash use of $2,057,000 during the 6 months ending June 30, 2017. Net cash used in operating activities was $2,127,000 for the 6-month period June 30, 2018, compared to $2,211,000 for the same period in 2017. Net cash provided by investing activities of $6,000 for the 6-month period ending June 30, 2017, and we generated cash of $688,000 from financing activities for the 6 months ending June 30, 2018, compared to $148,000 for the 6 months ending June 30, 2017. We have a revolving credit facility with Northwest Bank that allows for a maximum borrowing of $2 million and is secured by collateral accounts. The facility bears interest at Northwest money market rate plus 3%. As of today, there are no amounts outstanding under this facility. We currently anticipate that our available cash as well as expected cash from operations and available under the revolving credit facility will be sufficient to meet our anticipated working capital and capital expenditure requirements for at least the next 12 months. As of December 31, 2017, we had a net operating loss carryforward of approximately $11 million. I'll now turn the call over to the operator, who will take questions from our analysts and institutional investors. Operator?

[Operator Instructions]. Our first question comes from Mike Grondahl with Northland Capital.

This is Mike Micucci on for Michael Grondahl [ph]. Maybe just on the reseller channel for Age ID. You had an announcement last month with -- in Massachusetts. Maybe an early read on that. And -- well, that looks like more opportunities in that space.

Mike, it's Bryan. I'd say, early days, the resellers, often times, it will take them a little bit to get up to speed. It's a lot of good introduction, also a lot of good press that we plan on making use of with that inside sales team that is really helping the sales, the regular salespeople to focus on larger deals. And then I have the new guys focusing on things like the Age ID and again, specifically, in states where we've made an announcement.

Okay. And then also the rest of the pipeline, the aforementioned bank partner and the large electronics retailer. Is there any news there?

What I'd say is that discussions are continuing. I'm optimistic. I'm not going to make any promises or put numbers out there. I'm an old sales dog at heart and I hate to jinx things but we are making progress with these bank partners and the retailers that have been spoken to in the past. One of the things I think I said it last time is previously, we've been selling this sort of through another channel. We are now in control and running it. So I'm much more confident than I was previous to us being in control.

That's helpful. I think on the last call, you mentioned direct mail marketing for Age ID. Is there any color you can give us there on how that's doing?

Yes, it's a very cheap method of hitting a lot of retailers right away. We see, after we sent out our mailing, a lot of people coming into to become a consumer. I think we see that a few times. One, when we do a mailing into a state. Two, whenever there is an announcement of any type. And three, what I'd say is the national coverage that we got from the New York DMV had us -- people coming in from coast-to-coast looking for more information. So I think that the more pressed we get about it, the better name recognition that we get. Certainly, our search engine optimization has improved. We actually show up in some of these searches now, so I think we're seeing benefit from all of that. And then again, having this inside sales team to focus on it, I think, means that we're converting these guys faster.

Our next question comes from Tanner Hoban with Oppenheimer.

Just first, I just wanted to -- wondering if you can talk a little bit about this new per scan model? And how you expect this new pricing dynamic to impact some of your higher volume customers? And if you anticipate any changes to your overall renewal rate, any color on that would be fantastic.

Sure. What I can say is we are going through a renewal right now with this model where we've agreed to the first scan minimums, the tiers for each of the scans. We've modeled it out. We believe it will be good for our bottom line. And I think it's part of what we're doing in terms of selling into different parts of the organization. One of the things that I talked about in the past is depending who we sell to in the organization, they understand what they're getting from this product. And in this case, we brought -- the fraud people started to take notice and they're like, yes, we need to renew. So I think it's going to be very good for us.

Maybe next one is for Bill. Since the total deferred revenue fell in the high teens on a year-over-year basis this quarter, can you just help us understand this movement? Was there some form of a seasonality component to it? Maybe just tough year-over-year comps?

Yes, Tanner, as we -- as staffs becomes a higher percentage of our overall revenue and our long-term contracts with the military are falling off, our deferred revenue is dropping. We're billing new SaaS primarily -- mostly on a monthly basis so we don't have the deferred revenue component like we have historically.

Got you. That's very helpful. And could you touch on a little bit on the health of the overall pipeline and just the status of some of the deals in the past that have been delayed. I know Mike touched on it a little bit before but just some additional color on that would be very helpful.

I'm very confident in the pipeline, what's being added to the pipeline. I continue to say that Paul and the new team are doing a very good job of not only adding to the pipeline but making sure that the ball is being moved downfield. And all of the clients, prospects, I should say, that we had that seem to be a little bit stagnant. So very confident. Very pleased with what I'm seeing with the sales force restructure.

Got you. And you led me to my next question is just on the progress of the sales reorganization initiative. If you have any color in terms of when you think you could see some of your sales teams to begin to ramp to a little bit more productive levels. Any additional color on that will be very helpful.

Yes, I would say that the sales team that we have now, Paul and one of his salespeople have been here for a while, they're very up to speed. We're bringing people in and teaching them to sell maybe some -- might be turned into an easier product like Age. But also, it is not a huge learning curve to sell retail ID, especially with members that we have to back things up. And the reference clients that we can bring to bear when a prospect wants to really kick our tires and see if what we say is true. I would say that everybody is contributing. I'm always looking for salespeople to contribute more. I think Paul would be laughing as I said this because I say it to him every day. But like I said, I am very pleased and we've got some good, strong clients in the pipeline that any one of these banks represents fairly significant revenue.

[Operator Instructions]. Our next question comes from Roger Liddell with Clear Harbor Asset Management.

I wanted to go back to a question Mike touched on at the beginning was Massachusetts, when the package stores association. In terms of the value proposition, there ought to be reduced exposure or liability with Age ID in place. And even if you win the case, it's expensive and distracting. The news release doesn't touch on the issue of whether insurance premiums can be reduced commensurate with the reduced exposure to liability with this system in place. Could you give us some color on that?

Yes, so we actually -- the question that we asked the association up there, and they are looking into seeing if there is something they could do to help reduce liability. What I can say, which, I think, is also good -- advertisingly good for us, we have -- many of our clients have asked us, can we get stickers that we can put in the front window that say age verified by Age ID Intellicheck or something, to warn people don't even try it. So I think there is the one end that hopefully, the name gets out there, and people realize if you got this tool, don't even try. And that should help us get the bar down the street from the one that we are -- have the product in. But they're looking into that, and they're going to come back and see -- and let us know so that we can use that on our marketing.

Okay. And Bryan, you were on several -- you were interviewed several times and posted on the website. I was interested in something you commented on, the -- in the context of Experian, and I don't recall if it was their data or they simply referred to it. But the context isn't quite a card fraud itself. It is about retaining more of the transactions that have been abandoned by customers scared off by a perceived lack of fraud protection. So if I understand the situation correctly, this is a business retention opportunity separate and distinct from a fraud benefit. Could you cover that? Could you describe that?

Yes, I think what you're probably talking about was that study by the American Institute of CPAs, where they -- I think if I'm going to be talking off the top of my head, but I know both numbers are in the high 60s. It might have been 68% of consumers that they've abandoned online transactions, that they didn't feel safe and secure on the site. And 69% of consumers blame the store, not the fraudsters, for the breach. So I do believe that it's one of the things that retailers are beginning to notice that they have reputational risk if they are not showing that they are protecting the consumer in an online transaction. I think that's what you're talking about, Roger. Was that it?

Yes. I take it somebody will recognize the value of retaining that transaction instead of the customer being scared off.

Yes. People are always worried about abandonment rates, and I think we help with that because people feel protected.

Finally, third quarter would be typically a time with outdoor festivals and rock concerts and whatever. Is there any reasons to think there might be a seasonal bump from those kinds of events? And possibly, if stadiums and arenas are beginning to see the value proposition, maybe they would be coming online as we leave the warm weather months. So do you have any comment on revenue bumps from that kind of offering?

I can tell you that one of the things that we are targeting very strongly right now are the university police forces, where there are large stadiums and lots of tailgating and those things because Age ID is a perfect use for that. And we are seeing a lot of interest. And we're also hitting up there, again, many college campuses. Some of the stadiums are beginning to serve alcohol. And that has their concessionaires interested in the product as well. So we'd already been in discussions with some of them. I think that they are looking very fruitful, and I will again say that, that New York DMV article certainly got us a lot of press with these particular types of people from around the country.

At this time, I would like to turn the call back over to Mr. Lewis for closing comments.

I'd like to thank everybody again for attending our earnings call. I continue to be excited about what we're doing. I know I've said it before, but I truly mean it, the changes that we are putting in place are having an impact. And I look forward to our Q3 call.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. And thank you for your participation.