2. GOING CONCERN

The Company has incurred significant losses to date, and at September 30, ~~2016,~~2017, it had an accumulated deficit of approximately ~~$62~~$67.6 million. In addition, broad commercial acceptance of the ~~Company’s~~Company’s technology is critical to the Company’s success and ability to generate future revenues. At September 30, ~~2016, the Company’s~~2017, total cash and cash equivalents were approximately ~~$177,000,~~$972,000, as compared to approximately ~~$4,321,000~~$1,061,000 at December 31, ~~2015.~~2016.

The Company has financed itself 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 ~~$579,000~~$592,000 per month to conduct operations and pay dividend obligations, 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 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~~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 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.

3.	ACCOUNTS RECEIVABLE

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. During the year ended December 31, 2016, the Company reclassified a past due receivable to non-current as management concluded that collection may not occur in the near term. As a result of the payment delays, the Company had reserved $500,000 at December 31, 2016 and in the nine months ended September 30, 2017, the Company reserved an additional $500,000. The total reserve represents 48% of the remaining balance owed at September 30, 2017. Recoveries of accounts receivable previously written off are recorded when received. Accounts receivable consisted of the following as of:

	September 30,			December 31,
	2017			2016

Accounts receivable - current	$	576,081		$	1,577,031
Accounts receivable - non current		2,070,000			2,070,000
		2,646,081			3,647,031
Allowance for doubtful accounts - current		(13,785	)		(13,785	)
Allowance for doubtful accounts - non current		(1,000,000	)		(500,000	)
Accounts receivable, net of allowance for doubtful accounts	$	1,632,296		$	3,133,246

3. 4. SHARE BASED COMPENSATION

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

	ThreeMonths Ended September 30,		Three Months Ended September 30,		Three Months Ended September 30,		Three Months Ended September 30,
	2016		2015		2017		2016

Selling, general and administrative	$	31,610	$	30,779	$	207,047	$	31,610
Research, development and engineering		25,074		5,271		21,663		25,074
	$	56,684	$	36,050	$	228,710	$	56,684

	Nine Months Ended September 30,		Nine Months Ended September 30,		Nine Months Ended September 30,		Nine Months Ended September 30,
	2016		2015		2017		2016

Selling, general and administrative	$	221,791	$	218,653	$	714,167	$	221,791
Research, development and engineering		59,191		39,644		88,826		59,191
	$	280,982	$	258,297	$	802,993	$	280,982

4.5. FACTORING

Due from factor consisted of the following as of:

September 30,

December 31,

2016

2015

Original invoice value
$ 16,117 $ 149,680
Factored amount
(12,076
)
(112,259
)
Balance due from factor
$ 4,041 $ 37,421

	September 30,			December 31,
	2017			2016

Original invoice value	$	115,001		$	214,556
Factored amount		(86,251	)		(160,918	)
Balance due from factor	$	28,750		$	53,638

As of December 2011, the Company entered into a 24-month accounts receivable factoring arrangement with a financial institution (the “Factor”). In April 2012, the terms were updated from monthly to quarterly, and the 24-month arrangement was extended to August 1, 2014. In July of 2014, the arrangement was extended to July 31, 2016. In June of 2015, the arrangement was extended to October 31, 2017. Pursuant to the terms of the arrangement, the Company, from time to time, ~~sells~~sold to the Factor certain of its accounts receivable balances on a non-recourse basis for credit approved accounts. The Factor ~~remits~~remitted 35% of the foreign and 75% of the domestic accounts receivable balance to the Company (the “Advance Amount”), with the remaining balance, less fees, to be forwarded to the Company once the Factor collects the full accounts receivable balance from the customer. In addition, the Company, from time to time, ~~receives~~received over advances from the Factor. Factoring fees range from 2.75% to 21% of the face value of the invoice factored, and ~~are~~were determined by the number of days required for collection of the invoice. The cost of factoring iswas included in selling, general and administrative expenses. The cost of factoring for the three and nine months ended September 30, 2017 and 2016 was as follows:

Three Months ended
September 30,

Nine Months ended
September 30,

2016

2015

2016

2015

Factoring fees
$ 16,264 $ 87,929 $ 319,627 $ 323,059

	Three Months ended September 30,				Nine Months ended September 30,
	2017		2016		2017		2016

Factoring fees	$	46,409	$	16,264	$	180,126	$	319,627

5.6.

INVENTORY

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

September 30,

December 31,

2016

2015

Finished goods
$ 330,947 $ 246,475
Fabricated assemblies
237,289 102,170
Total inventory
$ 568,236 $ 348,645

	September 30,		December 31,
	2017		2016

Finished goods	$	470,544	$	381,762
Fabricated assemblies		409,048		83,666
Total inventory	$	879,592	$	465,428

6.7.	RESALABLE SOFTWARE LICENSE RIGHTS

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 ~~sold to customers~~amortized in the following 12 months is ~~$2,000,000~~$2,370,000 and is classified as a current asset, and the balance as non-current.

The Company has 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.

The remaining license rights are to be amortized over the greater of the following: 1) an estimate of the economic use of such license rights, 2) straight line method over ten years, or 3) the actual usage of such rights. 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. During the three month period ended September 30, 2017 the Company sold licenses costing $1,319 and amortized $388,681. During the nine month period ended September 30, 2017 the Company sold licenses costing $48,251 and amortized $1,118,436. The license rights had a carrying balance of $10,831,404 as of September 30, 2017.

September 30,

December 31,

2016

2015

Current software license rights
$ 2,000,000 $ 5,000,000
Non-current software license rights
9,999,550 7,000,000
Total software license rights
$ 11,999,550 $ 12,000,000

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 over the same methodology described above with the greatest of the three approaches being the amortization for the periods. A total of $2,640 and $31,356 was expensed for actual sales during the three and nine months ended September 30, 2017, respectively. Since the license purchase, the actual per unit cost (actual usage) of such license rights in the cumulative amount of $51,036 has been expensed, with a carrying balance of $128,964 as of September 30, 2017. The Company has classified the balance as non-current until a larger deployment occurs. Software license rights is comprised of the following as of:

	September 30,		December 31,
	2017		2016


Current software license rights	$	2,370,000	$	1,560,000
Non-current software license rights		8,590,368		10,598,411
Total software license rights	$	10,960,368	$	12,158,411

~~7. EARNINGS (LOSS)~~

The future amortization under the economic use model for the next five years is as follows: 2018 - 2.6 million, 2019 - 3.0 million, 2020 - 2.4 million, 2021 - 1.2 million, and 2022 - 720,000.

8. LOSS PER SHARE COMMON STOCK (“EPS”)

The ~~Company’s~~Company’s basic EPS is calculated using net 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 notes and preferred stock.

The reconciliation of the numerators of the basic and diluted EPS calculations was as follows for both of the following three and nine month periods ended September ~~30:~~30, 2017 and 2016:

	Three Months ended September 30,						Nine Months ended September 30,						Three Months ended September 30,						Nine Months ended September 30,
	2016			2015			2016			2015			2017			2016			2017			2016

Basic Numerator:
Net loss	$	(1,134,422	)	$	(1,079,584	)	$	(3,673,125	)	$	(1,250,539	)	$	(1,605,784	)	$	(1,134,422	)	$	(4,751,301	)	$	(3,673,125	)
Convertible preferred stock dividends		(200,625	)		-			(601,875	)		-			(200,625	)		(200,625	)		(601,875	)		(601,875	)
Net loss available to common stockholders	$	(1,335,047	)	$	(1,079,584	)	$	(4,275,000	)	$	(1,250,539	)	$	(1,806,409	)	$	(1,335,047	)	$	(5,353,176	)	$	(4,275,000	)
Basic Denominator		66,360,445			66,038,941			66,253,808			66,013,958			6,535,449			5,530,105			6,333,530			5,521,218
Per Share Amount	$	(0.02	)	$	(0.02	)	$	(0.06	)	$	(0.02	)	$	(0.28	)	$	(0.24	)	$	(0.85	)	$	(0.77	)

All potential common shares were antidilutive, and accordingly diluted EPS equaled basic EPS for all periods presented in the accompanying financial statements.

The following table sets forth the options and warrants which were excluded from the diluted per share calculation even though the exercise prices were less than the average market price of the common shares because the effect of including these potential shares was antidilutive due to the net losses for the three and nine months ended September ~~30:~~30, 2017 and 2016:

	Three Months ended September 30,				Nine Months ended September 30,
	2017		2016		2017		2016

Preferred stock		5,416,667		5,416,667		5,416,667		5,416,667
Stock options		205,497		28,992		101,327		13,398
Warrants		9,492		6,529		5,608		-
Total		5,631,656		5,452,188		5,523,602		5,430,065

Three Months ended
September 30,

Nine Months ended
September 30,

2016

2015

2016

2015

Preferred stock
65,000,000 - 65,000,000 -
Stock options
347,897 12,917 160,770 68,227
Warrants
78,342 - - -
Total
65,426,239 12,917 65,160,770 68,227

Items excluded from the diluted per share calculation because the exercise price was greater than the average market price of the common shares:

	Three Months ended September 30,				Nine Months ended September 30,				Three Months ended September 30,				Nine Months ended September 30,
	2016		2015		2016		2015		2017		2016		2017		2016

Stock options		2,580,000		3,991,332		2,780,000		2,888,332		262,094		215,000		278,761		231,667
Warrants		19,880,414		20,455,414		20,455,414		20,455,414		1,351,052		1,656,702		1,351,052		1,704,618
Total		22,460,414		24,446,746		23,235,414		23,343,746		1,613,146		1,871,702		1,629,813		1,936,285

8.9.	~~STOCKHOLDERS’~~STOCKHOLDERS’ EQUITY

Preferred Stock

Within the limits and restrictions provided in the ~~Company’s~~Company’s Certificate of Incorporation, the Board of Directors has the authority, without further action by the shareholders, to issue up to 5,000,000 shares of preferred stock, $.0001 par value per share, in one or more series, and to fix, as to any such series, any dividend rate, redemption price, preference on liquidation or dissolution, sinking fund terms, conversion rights, voting rights, and any other preference or special rights and qualifications. As of September 30, ~~2016,~~2017, 100,000 shares of preferred stock have been designated as Series A-1 Convertible Preferred Stock (the “Series A-1 Shares), of which 90,000 shares are issued and outstanding, and 105,000 shares of preferred stock have been designated as Series B-1 Convertible Preferred Stock (the “Series B-1 Shares”), all of which are issued and outstanding.

Series A-1 Convertible Preferred Stock

On October 22 and 29, 2015, the Company issued 84,500 shares of Series A-1 Convertible Preferred Stock at a purchase price of $100.00 per share, for aggregate gross proceeds of $8,450,000. On November 11, 2015, 5,500 additional shares of Series A-1 Convertible Preferred Stock were issued at a purchase price of $100.00 per share, for gross cash proceeds of $550,000. Shares of the Series A-1 Convertible Preferred Stock are convertible at any time at the option of the holder into shares of common stock by dividing the Series A-1 Original Issue Price by an initial conversion price of ~~$0.30~~$3.60 per share, subject to adjustment for stock dividends, stock splits, combinations, and reclassifications of the Company’s capital stock, and subject to a “blocker provision” which prohibits conversion if such conversion would result in the holder being the beneficial owner of in excess of 9.99% of the Company’s common stock. The Series A-1 Shares accrue dividends at the rate of 6% per annum payable quarterly on April 1, July, 1, October 1, and January 1 of each year. ~~Until~~Unless holders of at least a majority of the outstanding shares of Series A-1 Preferred Stock elect otherwise by written notice to the Company, until October 1, 2017, the dividends are payable in cash provided that if payment in cash would be prohibited under applicable Delaware corporation law or cause the Company to breach any agreement for borrowed money, such dividends are payable in kind through the issuance of additional shares of common stock having a value equal to the volume weighted average trading price of the Company’s common stock for the ten (10) days preceding the applicable dividend payment date. Commencing January 1, 2018, dividends are payable at the option of the Company in cash or kind through the issuance of additional shares of common valued as described above.

The holders of the Series A-1 shares are entitled to designate one person to serve on the Board of Directors of the Company. The holders of the Series A-1 Shares are entitled to vote on an as converted to common stock basis together with the holders of our common stock on all matters presented to our stockholders. Upon any liquidation or dissolution of the Company, any merger or consolidation involving the Company or any subsidiary of the Company in which the shares of capital stock of the Company outstanding immediately prior to such merger or consolidation do not represent immediately following such merger or consolidation at least a majority of the voting power of the capital stock of the resulting or surviving corporation, or the sale of all or substantially all assets in a single transaction or a series of related transactions, unless the holders of at least a majority of the outstanding Series A-1 Shares elect otherwise, holders of Series A-1 Shares shall be entitled to receive prior to any payment to any holders of the ~~Company’s~~Company’s common stock an amount per share equal to $100.00 per share plus any declared and unpaid dividends (pari-passu with the holders of Series B-1 ~~holders)~~Shares). On September 22, 2017, a holder of the Series A-1 Shares elected to convert $540,000 in accrued dividends payable into 150,000 shares of common stock at a conversion price of $3.60 as agreed, due to the conversion before the December 31, 2017 contractual term. As of September 30, 2017, $135,000 was accrued for the holders of the Series A-1 Shares, for October 1, 2017 dividends. As of December 31, 2016, ~~$135,000~~$270,000 of dividends were accrued for the holders of the Series A-1 ~~shares,~~Shares for October 1, 2016 and ~~have not been paid as of the date of this filing.~~January 1, 2017 dividends.

The Series A-1 Preferred Stock contains options that based on an evaluation of FASB ASC 815-15, “Embedded Derivatives” and FASB ASC 815-40-15, “Contracts in Entity’s Own Equity - Scope and Scope Exceptions,” are considered embedded features: Preferred Stock’s conversion option: The Preferred Stock is convertible at the Holder’s option at any time at the fixed conversion price of ~~$0.30~~$3.60 per share; Quarterly Dividend Conversion Option: From issuance until December 31, 2017, the majority of Holders may elect to have the Stock’s Quarterly dividend payment made in shares of Common Stock, having a value equal to the volume weighted average trading price of the Common Stock during the ten (10) trading day period preceding the applicable dividend payment date. These features were analyzed by the Company and determined that they were not required to be bifurcated from the preferred stock and recorded as derivatives as they are clearly and closely related to an equity host.

Series B-1 Convertible Preferred Stock

On November 11, 2015, the Company issued 105,000 shares of Series B-1 Convertible Preferred Stock at a purchase price of $100.00 per share, for gross proceeds of $10,500,000. Shares of the Series B-1 Convertible Preferred Stock are convertible at any time at the option of the holder into shares of common stock by dividing the Series B-1 Original Issue Price by an initial conversion price of ~~$0.30~~$3.60 per share, subject to adjustment for stock dividends, stock splits, combinations, and reclassifications of the Company’s capital stock, and subject to a “blocker provision” which prohibits conversion if such conversion would result in the holder being the beneficial owner of in excess of 9.99% of the Company’s common stock. The Series B-1 Shares accrue dividends at the rate of 2.5% per annum payable quarterly on April 1, July, 1, October 1, and January 1 of each year payable in cash provided that if payment in cash would be prohibited under applicable Delaware corporation law or cause the Company to breach any agreement for borrowed money, or if the majority of the outstanding shares of the Series B-1 Shares elect otherwise, such dividends are payable in kind through the issuance of additional shares of common stock having a value equal to the volume weighted average trading price of the Company’s common stock for the ten (10) days preceding the applicable dividend payment date.

The holders of the Series B-1 ~~shares~~Shares are entitled to designate one person to serve on the Board of Directors of the Company. The holders of the Series B-1 Shares are entitled to vote on an as converted to common stock basis together with the holders of our common stock on all matters presented to our stockholders. Upon any liquidation or dissolution of the Company, any merger or consolidation involving the Company or any subsidiary of the Company in which the shares of capital stock of the Company outstanding immediately prior to such merger or consolidation do not represent immediately following such merger or consolidation at least a majority of the voting power of the capital stock of the resulting or surviving corporation, or the sale of all or substantially all assets in a single transaction or a series of related transactions, unless the holders of at least a majority of the outstanding Series B-1 Shares elect otherwise, holders of Series B-1 Shares shall be entitled to receive prior to any payment to any holders of the ~~Company’s~~Company’s common stock an amount per share equal to $100.00 per share plus any declared and unpaid dividends (pari-passu with the Series A-1 holders). As of September 30, 2017, $328,125 was accrued for the holders of the Series B-1 Shares, for October 1, 2016, ~~$65,625~~January 1, 2017, April 1, 2017, July 1, 2017, and October 1, 2017 dividends. As of December 31, 2016, $131,250 of dividends were accrued for the holders of the Series B-1 ~~shares,~~Shares for October 1, 2016 and ~~have not been paid as of the date of this filing.~~January 1, 2017 dividends.

The Series B-1 ~~Preferred Stock contains~~Shares contain options that based on an evaluation of FASB ASC 815-15, “Embedded Derivatives” and FASB ASC 815-40-15, “Contracts in Entity’s Own Equity - Scope and Scope Exceptions,” are considered embedded features: Preferred Stock’s conversion option: The Preferred Stock is convertible at the Holder’s option at any time at the fixed conversion price of ~~$0.30~~$3.60 per share; Quarterly Dividend Conversion Option: The majority of Holders may elect to have the Stock’s Quarterly dividend payment made in shares of Common Stock, having a value equal to the volume weighted average trading price of the Common Stock during the ten (10) trading day period preceding the applicable dividend payment date. These features were analyzed by the Company and determined that they were not required to be bifurcated from the preferred stock and recorded as derivatives as they are clearly and closely related to an equity host.

Common Stock

Effective December 29, 2016, the Company implemented a reverse stock split of its outstanding common stock at a ratio of 1-for-12.~~Common Stock~~ The number of authorized shares and the par value of the Company's common stock and preferred stock were not affected by the reverse stock split. Stockholders who otherwise would be entitled to receive fractional shares were rounded up to the nearest whole share. The reverse stock split became effective on the OTCQB at the opening of trading on December 29, 2016.

On March ~~8, 2016,~~15, 2017, the ~~company~~Company issued ~~100,000~~1,895 shares of common stock to its directors in payment of board fees, valued at $5,003. On March 8, 2016, the company issued 8,333 shares of common stock to its directors in payment of board fees valued at $16,000.

On April 28, 2017, the Company issued to Wong Kwok Fong, a director and executive officer of the Company, 277,778 shares of common stock at a purchase price of $3.60 per share for gross cash proceeds of $1,000,000.

On May 2, 2017, the Company entered into a committed equity facility pursuant to which it may issue and sell up to $5.0 million worth of shares of common stock, subject to certain limitations and satisfaction of certain conditions, over a 36-month term following the effectiveness of a registration statement covering the public resale of the shares of common stock issued under the facility. From time to time over the term of the facility, the Company may issue requests to the investor to purchase a specified dollar amount of shares up to a maximum of $100,000 over a five trading day period based on the daily volume weighted average price of the Company’s common stock (VWAP) to the extent the VWAP equals or exceeds the greater of a formula amount or $3.83 per share. The per share purchase price for the shares issued under the facility will be equal to 94% of the lowest VWAP that equals or exceeds $3.83 per share. Aggregate sales under the facility are limited to 19.99% of the total outstanding shares of the Company’s common stock as of May 2, 2017, unless stockholder approval is obtained, and sales under the facility are prohibited if such a sale would result in beneficial ownership by the investor of more than 9.99% of the Company’s common stock.

On May 11, 2017, the Company issued 1,925 shares of common stock to its directors in payment of board fees, valued at $5,005. On May 11, 2016, the Company issued ~~41,174~~3,431 shares of common stock to its directors in payment of board fees valued at $6,999. On May 11, 2016, the Company issued ~~100,000~~8,333 shares of common stock to the Chief Executive Officer as compensation valued at $17,000.

In May 2017, the Company issued 55,000 shares of common stock in payment of a commitment fee for the equity facility valued at $198,000. The Company immediately expensed the fee as it relates to the contingent use of the equity committed equity facility.

In May 2017, the Company issued 61,667 shares of common stock to a consultancy firm in lieu of payment for services with respect to the equity facility agreement. The fair value at issuance averaged $2.54 per share, with the total amount of $156,584. The Company deferred the cost to prepaid expense and is amortizing the expense over the length of the consultancy service agreement.

On August 9, 2017, the Company issued 5,148 shares of common stock to its directors in payment of board fees valued at $18,018. On August 10, 2016, the Company issued ~~37,501~~3,125 shares of common stock to its directors in payment of board fees valued at $9,000.

On September 22, 2017, the Company issued to Wong Kwok Fong (Kelvin), a director and executive officer of the Company, 427,778 shares of common stock and warrants to purchase 138,889 shares of common stock for the aggregate purchase price of $1,540,000,or $3.60 per share. The purchase price was paid via a cash payment of $1,000,000 and the conversion of an accrued dividend payable in the amount of $540,000 on the Company’s Series A-1 Convertible Preferred Stock.

During the three and the nine months ended September 30, 2017, 4,167 employee stock options were exercised resulting in the cashless issuance of 1,610 shares of common stock. There were no stock options exercised during the three and nine months ended September 30, 2016.

Stock Issuance Costs

For the nine months ended September 30, 2017, $80,366 were incurred in relation to the issuance of stock.

Derivative Liabilities

In connection with the issuances of equity instruments or debt, the Company may issue options or warrants to purchase common stock. In certain circumstances, these options or warrants may be classified as liabilities, rather than as equity. In addition, the equity instrument or debt may contain embedded derivative instruments, such as conversion options or listing requirements, which in certain circumstances may be required to be bifurcated from the associated host instrument and accounted for separately as a derivative liability instrument. The Company accounts for derivative liability instruments under the provisions of FASB ASC 815, “Derivatives and Hedging.”

Securities Purchase Agreements dated October 25, 2013 and November 8, 2013

Pursuant to a series of Private Investors Securities Purchase Agreements (the “PI SPA”), on October 25, 2013 and November 8, 2013, the Company issued to certain private investors an aggregate of ~~12,323,668~~1,026,972 units consisting of ~~12,323,668 post-split~~1,026,972 shares of common stock (the “Shares”) and warrants to purchase an additional ~~12,323,668 post-split~~1,026,972 shares of common stock (the “Warrants”) for an aggregate purchase price of ~~$3,697,100~~$3,697,100. The warrants were immediately exercisable at an exercise price of $6.00 per share, and had a term of three years which expired in 2016.

In connection with the share issuances described above, and pursuant to a placement agency letter agreement, the Company paid the placement agent cash commissions equal to 8% of the gross proceeds of the offering, reimbursed the placement agent for its reasonable out of pocket expenses, and issued to the placement agent warrants (the “Placement Agent Warrants”) to purchase an aggregate of ~~985,893 post-split~~82,158 shares of common stock. The Placement Agent Warrants have substantially the same terms as the warrants issued to the investors, except the Placement Agent Warrants ~~are~~were immediately exercisable on a cashless basis.

The cashless exercise features contained in the warrants ~~are~~were considered to be derivatives and the Company recorded warrant liabilities on the consolidated balance sheet. The Company initially recorded the warrant liabilities equal to their estimated fair value of $325,891. Such amount was also recorded as a reduction of additional paid-in capital. The Company is required to mark-to-market the warrant liabilities at the end of each reporting period. For the ~~quarter~~three months ended September 30, 2016, the Company recorded a gain on the change in fair value of the cashless exercise features of $4,368. For the nine months ended September 30, 2016, the Company recorded a gain on the change in the fair value of the cashless exercise feature of $6,272. As of ~~September 30,~~December 31, 2016, the fair value of the cashless exercise features was ~~$1,206. The fair value~~$0 as the underlying warrants expired during the fourth quarter of ~~the cashless exercise features was $7,478 as of December 31, 2015.~~2016.

Securities Purchase Agreement dated November 13, 2014

Pursuant to a Securities Purchase Agreement, dated November 13, 2014, by and between the Company and a number of private and institutional investors (the “November 2014 Private Investor SPA”), the Company issued to certain private investors ~~7,974,999 post-split~~664,584 shares of common stock and warrants to purchase an additional ~~11,962,501 post-split~~996,877 shares of common stock for aggregate gross proceeds of $1,595,000. In addition, for each share purchased in this offering, the investors surrendered to the Company for cancellation a warrant to acquire one share of our common stock which we previously issued in a private placement transaction in November 2013. This resulted in the cancellation of warrants to purchase an aggregate of 7,974,999 post-split shares of common stock.

The common stock ~~has~~had a purchase price reset feature. If at any time prior to the two year anniversary of the effective date of the registration statement covering the public resale of such shares (January 29, 2015), the Company sells or issues shares of common stock or securities that are convertible into common stock at a price lower than ~~$0.20~~$2.40 per share, the Company will be required to issue additional shares of common stock for no additional consideration.

The warrants have a term of five years, an exercise price of $0.30 per post-split share and are currently exercisable in full. The warrants have customary anti-dilution protections including a “full ratchet” anti-dilution adjustment provision which are triggered in the event the Company sells or grants any additional shares of common stock, options, warrants or other securities that are convertible into common stock at a price lower than $0.30 per share, The anti-dilution adjustment provision is not triggered by certain “exempt issuances” which among other issuances, includes the issuance of shares of common stock, options or other securities to officers, employees, directors, consultants or service providers. The warrants are exercisable on a cashless basis if at any time there is no effective registration statement covering the resale of the shares of common stock underlying the warrants. See below.

Based on an evaluation as discussed in FASB ASC 815-15, “Embedded Derivatives” and FASB ASC 815-40-15, “Contracts in Entity’s Own Equity – Scope and Scope Exceptions,” the Company determined that the purchase price reset feature in the common stock and the full ratchet anti-dilution feature in the warrants issued were not considered indexed to its own stock because neither the occurrence of a sale of equity securities by the issuer at market nor the issuance of another equity contract with a lower strike price is an input to the fair value of a fixed-for-fixed option or forward on equity shares. As such, the purchase price reset feature and the full ratchet anti-dilution feature should be bifurcated from the common stock and accounted for as a derivative liabilities.

The Company valued the purchase price reset feature using a Monte Carlo simulation at the date of issuance, and determined that the purchase price reset feature had no value as the calculated price of the common stock was not below $0.20 per share. At December 31, 2015, the calculated price was below $0.20, and on September 30, 2016 the calculated price was above $0.20 based on the Monte Carlo simulation.

The Company did not value the derivative liabilities. One of the key determinants of the Company’s decision to not value the derivative liabilities was the high likelihood that a future financing would not occur that would trigger the down round feature. Whether a future equity financing would occur would be determined by the cash needs of the Company and management’s willingness to trigger the down round feature. The Company did not value the purchase price reset feature. The Company’s reason was based on the issuance of Series A and Series B preferred stock in October and November of 2015, issued at a conversion price of $0.30.

Under GAAP, the Company is required to mark-to-market the derivative liability at the end of each reporting period. The Company did not value the derivative liabilities at the dates of issuance through September 30, 2016. Such conclusion was based upon the discussion noted above.

The Company filed a registration statement on Form S-1 with the SEC to register the public resale of 13,956,250 of the shares of common stock issued in the November 2014 Private Investor SPA. The registration statement was declared effective on January 29, 2015. Post reverse split, the Company filed a registration statement on Form S-1 with the SEC to register the balance of the shares of common stock issued under the November 2014 Private Investor SPA which was declared effective on May 4, 2015.

~~Warrants~~

On March 9, 2015, the Company issued a warrant to purchase 575,000 shares of common stock to a consultant which vested in equal quarterly installments over one year and is exercisable at $0.21 per share through March 8, 2020.

The fair value of the warrants was estimated on the date of grant at $98,065 using the Black-Scholes option-pricing model with the following assumptions: risk free interest rate: 1.66%, expected life of options in years: 5, expected dividends: 0, volatility of stock price: 115.7%.

Share based expense related to the value of the stock warrants is recorded over the requisite service period, which is generally the vesting period for each tranche. Stock warrants issued by the Company are valued using the Black-Scholes option-pricing model. For the three and nine months ended September 30, 2016, the Company recorded an expense of $0 and $11,625 respectively, related to the stock warrants, which completed the service period expense.

~~On September 23, 2015, the Company issued a warrant to purchase 833,333 shares of common stock in connection with the issuance of a promissory note.The warrants are immediately exercisable at an exercise price of $0.30 per share and have a term of five years.~~

The warrants have customary anti-dilution protections including a "full ratchet" anti-dilution adjustment provision which are triggered in the event the Company sells or grants any additional shares of common stock, options, warrants or other securities that are convertible into common stock at a price lower than $0.30 per share. The anti-dilution adjustment provision is not triggered by certain "exempt issuances" which among other issuances, includes the issuance of shares of common stock, options or other securities to officers, employees, directors, consultants or service providers.

Based on an evaluation as discussed in FASB ASC 815-15, “Embedded Derivatives” and FASB ASC 815-40-15, “Contracts in ~~Entity’s~~Entity’s Own Equity –- Scope and Scope Exceptions,” the Company determined that the ~~full ratchet anti-dilution~~purchase price reset feature inon the common stock issued was not considered indexed to its own stock because neither the occurrence of a sale of equity securities by the issuer at market nor the issuance of another equity contract with a lower strike price is an input to the fair value of a fixed-for-fixed option or forward on equity shares. As such, the ~~full ratchet anti-dilution~~purchase price reset feature should be bifurcated from the common stock and accounted for as a derivative liability.

The Company ~~did not value~~valued the ~~derivative liability. One~~purchase price reset feature using a Monte Carlo simulation at the date of issuance, and at quarterly reporting intervals until the expiration of the ~~key determinants of~~feature in January 2017, and determined that the ~~Company’s decision to not~~purchase price reset feature had no value the derivative liability was the high likelihood that a future financing would not occur that would trigger the down round feature. Whether a future equity financing would occur would be determined by the cash needs ofas the Company ~~and management’s willingness to trigger the down round feature. The Company’s reasons were based on the issuance of~~issued Series AA-1 and Series BB-1 preferred stock in October and November of 2015, ~~issued~~ at a conversion price of ~~$0.30.~~$3.60, and issued common stock in November 2016 and April 2017 also at a price of $3.60.

The warrants have a term of five years and an exercise price of $3.60 per share, and have been fully exercisable since February 2015. The warrants have customary anti-dilution protections including a “full ratchet” anti-dilution adjustment provision which are triggered in the event the Company sells or grants any additional shares of common stock, options, warrants or other securities that are convertible into common stock at a price lower than $3.60 per share. The anti-dilution adjustment provision is not triggered by certain “exempt issuances” which among other issuances, includes the issuance of shares of common stock, options or other securities to officers, employees, directors, consultants or service providers.

As a result of the early adoption of ASU 2017-11 referred to in Note 1 – Recently Issued Accounting Pronouncements, the “full ratchet” anti-dilution feature is no longer a determinant for derivative liability accounting. As the “full ratchet” anti-dilution feature was determined to have no value in the past, the adoption had no effect on the balance sheets or statements of operations.

Warrants

On March 9, 2015, the Company issued a warrant to purchase 47,917 shares of common stock to a consultant which vested in equal quarterly installments over one year and is exercisable at $2.52 per share through March 8, 2020. For the three and nine months ended September 30, 2016, the Company recorded an expense of $0 and $11,625 related to the stock warrants. The service period was completed on March 8, 2016.

On September 23, 2015, the Company issued a warrant to purchase 69,445 shares of common stock in connection with the issuance of a promissory note. The warrants are immediately exercisable at an exercise price of $3.60 per share and have a term of five years.

The warrants have customary anti-dilution protections including a "full ratchet" anti-dilution adjustment provision which are triggered in the event the Company sells or grants any additional shares of common stock, options, warrants or other securities that are convertible into common stock at a price lower than $3.60 per share. The anti-dilution adjustment provision is not triggered by certain "exempt issuances" which among other issuances, includes the issuance of shares of common stock, options or other securities to officers, employees, directors, consultants or service providers.

The cashless exercise features contained in the warrants were initially considered to be derivatives and the Company recorded a warrant liability of $92,199 on the consolidated balance sheet. The warrants issued by the Company were valued using an option-pricing model. The Company marked-to-market the warrant liabilities at the end of each reporting period. During the quarter ended September 30, 2016, the Company determined the cashless exercise features did not meet the criteria for recording a warrant liability. Accordingly, the grant date fair value of the warrant liability was transferred to additional paid-in capital and the cumulative loss due to change in the recorded fair value of the liability was reversed during the quarter. For the quarter ended September 30, 2016 the Company recorded income of $56,017 in order to reverse the net cumulative loss on the warrant liability that had been previously recorded. For the nine months ended September 30, 2016 the Company recorded income on the change in warrant liability of $4,607. The warrant liability was ~~$96,806~~$0 as of December 31, ~~2015.~~2016.

On September 22, 2017, the Company issued to Wong Kwok Fong, a director and executive officer of the Company, warrants to purchase 138,889 shares of Common Stock in connection with the purchase of 427,778 shares of common stock by Mr. Fong. The warrants are immediately exercisable at an exercise price of $3.60 per share and have a term of five years.

Issuances ~~and Exercise~~ of Stock Options

~~During the three and nine months ended September 30, 2016,~~On March 15, 2017, the Company ~~granted 200,000 and 275,000~~issued options to purchase 40,000 shares of the Company’s common stock to four non-employee members of the Board of Directors. On March 15, 2017, the Company also issued options ~~respectively,~~ to ~~new employees under~~purchase 4,167 shares of the ~~2015 Equity Plan.~~Company’s common stock to an employee. The options ~~are exercisable for a term of seven years and vest in equal annual installments over~~have a three-year vesting period, ~~commencing on the date~~seven-year term, and exercise price of ~~grant.~~$2.64. The options ~~are exercisable at $0.17-0.24 per share. The weighted average fair value of the options granted during the quarter was $0.164.~~

~~The fair value of the options issued during the three months ended June 30, 2016 was~~were estimated on the date of grant at ~~$8,644~~$100,602 using the Black-Scholes option-pricing model with the following assumptions: risk free interest rate: ~~1.12%~~1.91 %, expected life of options in years: 4.5, expected dividends: 0, volatility of stock price: 138 %.

On March 16, 2017, the Board of Directors issued options to purchase 1,120,000 shares of the Company’s common stock to certain officers, employees, and contractors. The options have a three-year vesting period, seven-year term, and exercise price of $2.65. The options were estimated on the date of grant at $2,560,081 using the Black-Scholes option-pricing model with the following assumptions: risk free interest rate: 1.91 – 2.11 %, expected life of options in years: 4.5 – 7.0, expected dividends: 0, volatility of stock price: 138 %.

On April 10, 2017, the Company issued options to purchase 10,000 shares of the Company’s common stock to a newly appointed Director. The options have a three-year vesting period, seven-year term, and exercise price of $2.64. The options were estimated on the date of grant at $20,538 using the Black- Scholes option-pricing model with the following assumptions: risk free interest rate: 1.81%, expected life of options in years: 4.5, expected dividends: 0, volatility of stock price: ~~93.7%~~138%.

On August 9, 2017, the Company issued options to purchase 60,000 shares of the Company’s common stock to certain officers, employees, and contractors. The options have a three-year vesting period, seven-year term, and exercise price of $3.50.

The fair value of the options issued during the three months ended September 30, ~~2016~~2017 on August 9, 2017 was estimated on the date of grant at ~~$32,830~~$179,220 using the Black-Scholes option-pricing model with the following assumptions: risk free interest rate: ~~1.08%~~1.73%, expected life of options in years: 4.5, expected dividends: 0, volatility of stock price: ~~93%~~135%.

9.10.

SEGMENT INFORMATION

The Company has determined that its continuing operations are one discrete segment consisting of biometric products. Geographically, North American sales accounted for approximately ~~90%~~81% and ~~56%~~90% of the Company’s total sales for the three months ended September 30, ~~2016~~2017 and ~~2015,~~2016, respectively, and were approximately ~~84%~~75% and ~~32%~~84% of the Company’s total sales for the nine months ended September 30, 2017 and 2016, ~~and 2015,~~ respectively.

~~10.~~11.

FAIR VALUES OF FINANCIAL INSTRUMENTS

Cash and cash equivalents, accounts ~~and notes~~ receivable, accounts payable, accrued liabilities, and ~~notes payable,~~due from factor, are carried at, or approximate, fair value because of their short-term nature.

~~The fair value of the warrant liabilities at September 30, 2016 were measured using the following assumptions:~~

Risk-free interest rate
0.20 - 0.21%
Expected term
0.07 - 0.11
Expected dividends
0
Volatility of stock price
62.9 - 69.0%

The warrant liabilities are considered Level 3 liabilities on the fair value hierarchy as the determination of fair value includes various assumptions about of future activities and the Company’s stock prices and historical volatility as inputs.

Warrant issued under PI SPA

Fair value at January 1, 2016
$ 7,478
Gain on derivative
(6,272
)
1,206

Warrant issued under September 2015 SPA

Fair value at January 1, 2016
96,806
Gain on derivative
(4,607 )
Transfer to additional paid-in capital (92,199 )
-

Balance, September 30, 2016
$ 1,206

~~11.~~12.

MAJOR CUSTOMERS AND ACCOUNTS RECEIVABLE

For the three months ended September 30, ~~2016~~2017 and ~~2015,~~2016, two customers accounted for ~~44%~~45% and ~~three~~two customers accounted for ~~65%~~44% of revenue, respectively. For the nine months ended September 30, 2017 and 2016, two customers accounted for 32% and ~~2015,~~ one customer accounted for 22% ~~and~~of revenue, respectively.

At September 30, 2017, one customer accounted for ~~53%~~44% of ~~revenue, respectively.~~

~~At September 30, 2016, one~~accounts receivable. One customer accounted for ~~85%~~100% of non-current accounts ~~receivable. This~~ receivable ~~has been past due per the terms of the invoice for fifteen months~~ as of September 30, 2017 and December 31, 2016. Based on prior history with this customer, the Company believes the amount is fully collectable, ~~and~~however, the Company has ~~determined that a reserve is not necessary. During~~reserved $1,000,000 which represents 48% of the ~~quarter ended September 30, 2016,~~remaining balance owed under the ~~company reclassified~~contract, due to the ~~past due~~length of time the receivable ~~to long-term as management concluded that collection may not occur in the near term.~~has been outstanding. At December 31, ~~2015, three customers~~2016, one customer accounted for ~~87%~~81% of current accounts receivable.

~~12.~~13.

SUBSEQUENT EVENTS

On August 7, 2017, the Company received written notice from Wong Kwok Fong, the holder of an aggregate of 90,000 shares of the Company’s Series A-1 Convertible Preferred Stock, of his desire to increase the maximum percentage of shares of common stock issuable upon conversion of the Series A-1 Convertible Preferred Stock from 9.99% to 35%. In accordance with the Certificate of Designation of the Series A-1 Shares, such notice became effective on the 61st day following the date such notice was provided to the Company. On October 17, 2017, Wong Kwok Fong converted 27,404 of the Series A-1 Shares at a conversion price of $3.60 per share resulting in the acquisition of 761,222 shares of the Company’s Common Stock

On November ~~7, 2016, the Company~~6, 2017, we issued ~~48,148~~a warrant to purchase 100,000 shares of common stock to ~~its~~a consultancy firm in payment of consulting services.

On November 13, 2017, we issued 2,276 shares of common stock to four non-employee directors in payment of ~~board~~directors’ fees.On November 11, 2016, we entered into a Securities Purchase Agreement with a stockholder/director for the purchase and sale of 6,200,000 shares of our common stock at an aggregate purchase price of $1,860,000 or $0.30 per share.

The Company has reviewed all other subsequent events through the date of filing.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS

CAUTIONARY STATEMENT FOR FORWARD-LOOKING STATEMENTS

The information contained in this Report on Form 10-Q and in other public statements by usthe Company and ~~our~~Company officers include or may contain certain forward-looking statements. All statements other than statements of historical facts contained in this Report on Form 10-Q, including statements regarding our future financial position, business strategy and plans and objectives of management for future operations, are forward-looking statements. The words “anticipate,” “believe,” “estimate,” “will,” “may,” “future,” “plan,” “intend” and “expect” and similar expressions generally identify forward-looking statements. These forward-looking statements are not guarantees and are subject to known and unknown risks, uncertainties and assumptions that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements. Although we believe that our plans, intentions and expectations reflected in the forward-looking statements are reasonable, we cannot be sure that they will be achieved. Particular uncertainties that could cause our actual results to be materially different than those expressed in our forward-looking statements include: our history of losses and limited revenue; our ability to raise additional capital; our ability to protect our intellectual property; changes in business conditions; changes in our sales strategy and product development plans; changes in the marketplace; continued services of our executive management team; security breaches; competition between us and other companies in the biometric technology industry; market acceptance of biometric products generally and our products under development; our ability to expand into the Asian market; delays in the development of products and statements of assumption underlying any of the foregoing, as well as other factors set forth under the caption “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, ~~2015~~2016 filed with the Securities and Exchange Commission. All subsequent written and oral forward-looking statements attributable to us, or persons acting on our behalf, are expressly qualified in their entirety by the foregoing. Except as required by law, we undertake no obligation to update or revise any forward-looking statement, whether as a result of new information, future events or otherwise.

OVERVIEW

We develop and market advanced fingerprint biometric identification and identity verification technologies, cryptographic authentication-transaction security technologies, as well as related identity management and credentialing software solutions. We were pioneers 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~~driver’s licenses, OTP or other form of possession or knowledge-based credentialing. Advanced BIO-key® technology has been and is used to improve both the accuracy and speed of competing finger-based biometrics. Our solutions are used by many customers in numerous sectors of our economy, including government, retail, healthcare and financial services.

In ~~partnerships with OEMs, integrators, and solution providers,~~2016, we provide biometric software solutions to private and public sector customers. We provide the ability to positively identify and authenticate individuals before granting access to valuable corporate resources, web portals or applications in seconds. Powered by our patented Vector Segment Technology™ or VST™, WEB-key® and BSP development kits are fingerprint biometric solutions that provide interoperability with all major reader manufacturers, enabling application developers and integrators to integrate fingerprint biometrics into their applications.

~~More recently, we have begun~~began to distribute directly to consumers and commercial users our SideSwipe™, ~~SideTouch~~SideTouch™, and EcoID™ products. SideSwipe, SideTouch, and EcoID are stand-alone fingerprint readers that can be used on any laptop, tablet or other device with a USB port.

At the Consumer Electronics Show 2017, we introduced a number of new products. These included TouchLock, fingerprint biometric and bluetooth enabled padlocks, FreePass, a wearable, mobile USB fingerprint reader, Q-180 Touch, a Micro USB compatible fingerprint reader for Android devices, and SidePass, a compact, square, touch reader for Windows devices. We started distribution of the TouchLock padlock in the Asia Pacific market in June of 2017 and August of 2017 in the US.

We have developed what we believe is the most discriminating and effective commercially available finger-based biometric technology. Our primary focus is in marketing and selling this technology into commercial logical and physical privilege entitlement & access control markets. Our primary market focus includes, among others, mobile payments & credentialing, online payments and credentialing, and healthcare record and payment data security. Our secondary focus includes government and educational markets.

We continue to develop advancements in our capabilities, as well as explore potential strategic relationships, including business combinations and acquisitions, which could help us leverage our capability to deliver our solutions. We have built a direct sales force, and also utilize distributors, resellers, integrators and partners with substantial experience in selling technology solutions to government and corporate customers in their respective markets.

STRATEGIC OUTLOOK AND RECENT DEVELOPMENTS

Historically, our largest market has been access control within highly regulated industries such as healthcare. However, we believe the mass adoption of advanced smart-phone and hand-held wireless devices have caused commercial demand for advanced user authentication to emerge as viable. The introduction of smart-phone capabilities, like mobile payments and credentialing, could effectively require biometric user authentication on mobile devices to reduce risks of identity theft, payment fraud and other forms of fraud in the mobile or cellular based world wide web. As more services and payment functionalities, such as mobile wallets and near field communication (NFC), migrate to smart-phones, the value and potential risk associated with such systems should grow and drive demand and adoption of advanced user authentication technologies, including fingerprint biometrics and BIO-key solutions.

As devices with onboard fingerprint sensors continue to deploy to consumers, we expect that third party application developers will demand the ability to authenticate users of their respective applications ~~(app’s)~~(app’s) with the onboard fingerprint biometric. We further believe that authentication will occur on the device itself for potentially low-value, and therefore low-risk, use-transactions and that user authentication for high-value transactions will migrate to the application provider’s authentication server, typically located within their supporting technology infrastructure, or ~~Cloud.~~cloud. We have developed our technology to enable on-device authentication as well as network or cloud-based authentication and believe we may be the only technology vendor capable of providing this flexibility and capability. Our core technology works on over 40 commercially available fingerprint readers, across both Windows and Linux platforms, and Apple iOS and Android mobile operating systems. This interoperability, coupled with the ability to authenticate users via the device or cloud, is unique in the industry, provides a key differentiator for us, and in our opinion, makes our technology more viable than competing technologies and expands the size of the overall market for our products.

The introduction of the TouchLock, fingerprint biometric and bluetooth (cell phone) enabled padlocks, opens up an additional consumer market for us. As a security solution, we also have a version of the lock that is TSA compatible, to allow travelers to lock their luggage which TSA can open and relock.

We believe there is potential for significant market growth in ~~five~~six key areas:

●

Corporate network access control, including corporate campuses, computer networks and applications;

●

Consumer mobile credentialing, including mobile payments, credit and payment card programs, data and

application access, and commercial loyalty programs;

●

Government services and highly regulated industries including, Medicare, Medicaid, Social Security,

drivers licenses, campus and school ID, passports/visas;

	●
	●	Direct sales of fingerprint readers to consumers and commercial customers; ~~and~~

	●
	●	Direct sales of biometric locks to consumers and commercial customers; and

	●	Growth in the Asia Pacific region.

In the near-term, we expect to grow our business within government services and highly-regulated industries in which we have historically had a strong presence, such as the healthcare industry. We believe that continued heightened security and privacy requirements in these industries will generate increased demand for security solutions, including biometrics. In addition, we expect that the integration of our technology into Windows 10, will accelerate the demand for our computer network log-on solutions and fingerprint readers. We are also experiencing growth in our hardware offerings as we continue to develop our products business. Finally, our entry into the Asian market and licensing arrangement with China Goldjoy Group ~~is expected to~~has further ~~expand~~expanded our business, particularly our hardware business, by opening new markets.

Over the longer term, we intend to expand our business into the cloud and mobile computing industries. The ~~continued~~ emergence of cloud computing and mobile computing are primary drivers of commercial and consumer adoption of advanced authentication applications, including biometric and BIO-key authentication capabilities. As the value of assets, services and transactions increases on such networks, we expect that security and user authentication demand should rise proportionately. Our integration partners include major web and network technology providers, who we believe will deliver our cloud-applicable solutions to interested service-providers. These service-providers could include, but are not limited to, financial institutions, web-service providers, consumer payment service providers, credit reporting services, consumer data service providers, healthcare providers and others. Additionally, our integration partners include major technology component providers and OEM manufacturers, who we believe will deliver our device-applicable solutions to interested hardware manufacturers. Such manufacturers could include cellular handset and smartphone manufacturers, tablet manufacturers, laptop and PC manufacturers, among other hardware manufacturers.

CRITICAL ACCOUNTING POLICIES

For detailed information regarding our critical accounting policies and estimates, see our financial statements and notes thereto included in this Report and in our Annual Report on Form 10-K for the year ended December 31, ~~2015.~~2016. There have been no material changes to our critical accounting policies and estimates from those disclosed in our most recent Annual Report on Form 10-K.

RECENT ACCOUNTING PRONOUNCEMENTS

For detailed information regarding recent account pronouncements, see Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 of this report.

RESULTS OF OPERATIONS

THREE MONTHS ENDED SEPTEMBER 30, ~~2016~~2017 AS COMPARED TO SEPTEMBER 30, ~~2015~~2016

Consolidated Results of Operations -Percent Trend

	Three Months Ended September 30,						Three Months Ended September 30,
	2016			2015			2017			2016
Revenues
Services		43	%		37	%		40	%		43	%
License fees and other		57	%		63	%		6	%		6	%
Hardware								54	%		51	%
		100	%		100	%		100	%		100	%
Costs and other expenses
Cost of services		11	%		5	%		20	%		11	%
Cost of license fees and other		29	%		51	%
Cost of license fees, hardware and other								78	%		29	%
		40	%		56	%		98	%		40	%
Gross Profit		60	%		44	%		2	%		60	%

Operating expenses
Selling, general and administrative		214	%		151	%		131	%		214	%
Research, development and engineering		123	%		55	%		41	%		123	%
		337	%		206	%		172	%		337	%
Operating loss		-277	%		-162	%		-170	%		-277	%

Other income (deductions)
Total other income		14	%		1	%		-	%		14	%
Net loss		-263	%		-161	%		-170	%		-263	%

Revenues and cost of goods sold

	Three months ended September 30,										Three months ended September 30,
	2016		2015		$ Change			% Change			2017		2016		$ Change		% Change

Revenues
Service	$	187,025	$	250,191	$	(63,166	)		-25	%	$	377,113	$	187,025	$	190,088		102	%
License & other		244,438		419,655		(175,217	)		-42	%		53,023		25,435		27,588		108	%
Hardware												512,281		219,003		293,278		134	%
Total Revenue	$	431,463	$	669,846	$	(238,383	)		-36	%	$	942,417	$	431,463	$	510,954		118	%

Cost of goods sold
Service	$	46,257	$	30,283	$	15,974			53	%	$	190,889	$	46,257	$	144,632		313	%
License & other		125,526		344,557		(219,031	)		-64	%
License, hardware & other												732,192		125,526		606,666		483	%
Total COGS	$	171,783	$	374,840	$	(203,057	)		-54	%	$	923,081	$	171,783	$	751,298		437	%

Revenues

For the three months ended September 30, 2017 and 2016, service revenues included approximately $117,000 and $182,000, respectively, of recurring maintenance and support revenue, and approximately $260,000 and $5,400 respectively, of non-recurring custom services revenue. Recurring service revenue decreased 36% in 2017 due to the non-renewal of two large maintenance contracts. The increase in non-recurring custom services revenues resulted from a special software requirement from an existing customer.

For the three months ended September 30, 2016 and 2015, service revenues included approximately $182,000 and $229,000, respectively, of recurring maintenance and support revenue, and approximately $5,000 and $21,000 of non-recurring custom services revenue, respectively. Recurring service revenue decreased 21% during the current period primarily due to the delayed renewal of a maintenance agreement from the large shipment in the second quarter of 2015. The non-recurring custom services decreased 75% due to fewer customized requirements.

~~License~~2017, license and other revenue ~~(comprised~~(royalties) increased 108% from the corresponding period in 2016, from both new and existing customers.

Hardware sales increased by approximately $293,000 (134%), as a result of ~~hardware and royalties) decreased during the three months ended September 30, 2016. The decrease consisted of~~ an ~~approximate $157,000 or 42% decrease in our hardware sales, however, with the removal of a one-time sensor sale in 2015, hardware revenue increased approximately 100%. There was a $5,703 or 29%~~ increase in ~~core software. Royalty revenue decreased 100% as the OEM agreement was completed~~existing and ~~was not renewed.~~

~~Costs of goods sold~~

new customer deployments. During the three months ended September 30, ~~2016,~~2017, we continued to ship our new line of biometric locks in the amount of approximately $164,000.

Costs of goods sold

For the three months ended September 30, 2017, cost of ~~services~~service increased ~~approximately $16,000 from the corresponding period in 2015~~313%, due to ~~increased costs associated with third party software costs~~added resources and reallocated research and development personnel ~~costs.~~to support the custom services revenue.

License, hardware and other costs for the three months ended September 30, ~~2015 decreased $219,000 from~~2017 increased approximately 483%. The increase was directly associated with the ~~corresponding period in 2015 due to~~costs of the ~~sensors cost in 2015.~~hardware mix, and $388,681 was directly associated with the amortization of the software rights.

Selling, general and administrative

Three months ended
September 30,

2016

2015

$ Change

% Change

Selling, general and administrative
$ 925,939 $ 1,013,778 $ (87,839
)
-9
%

Three months ended
September 30,

2017

2016

$ Change

% Change

Selling, general and administrative
$ 1,238,296 $ 925,939 $ 312,357 34
%

Selling, general and administrative ~~expenses decreased 9% during~~costs for the three months ended September 30, ~~2016~~2017 increased 34% from the corresponding period in ~~2015. Decreases consisted of lower professional~~2016. The increase is attributable to additional expenses related to our Hong Kong subsidiary, commitment fees, non- cash compensation, Nasdaq related fees, and ~~costs related to the settlement of the LifeSouth lawsuit in 2015, and factoring fees,~~commissions, offset by ~~higher marketing costs.~~lower legal fees.

Research, development and engineering

Three months ended
September 30,

2016

2015

$ Change

% Change

Research, development and engineering
$ 528,554 $ 368,788 $ 159,766 43
%

Three months ended
September 30,

2017

2016

$ Change

% Change

Research, development and engineering
$ 386,830 $ 528,554 $ (141,724
)
-27
%

~~During~~For the three months ended September 30, ~~2016,~~2017, research, development and engineering costs ~~increased 43% over~~decreased 27% as compared to the corresponding period in ~~2015,~~2016, as a result of ~~increased new personnel costs,~~decreased temporary outside services, and ~~non-cash compensation.~~recruiting expenses, and reallocated personnel expenses to support custom services revenue, offset by an increase in personnel and related costs.

Other income and expense

Three months ended
September 30,

Three months ended
September 30,

2016

2015

$ Change

% Change

2017

2016

$ Change

% Change

Interest income
6 1 5 500
%
$ 6 $ 6 $ - 0
%
Interest expense
- (20,000
)
20,000 -100
%
Gain on derivative liabilities
60,385 27,975 32,410

116
%
- 60,385 (60,385 ) -100
%

Total
$ 60,391 7,976 $ 52,415 657
%
$ 6 60,391 $ (60,385 ) -100
%

Interest income for the quarter ended September 30, ~~2016~~2017 and September 30, ~~2015~~2016 consisted of bank interest.

~~Interest expense for the quarter ended September 30, 2015 represented the amortized portion of the original issue discount and the interest charge of the loan.~~
During the fourth quarters of 2013 and 2014 and third quarter of 2015, we issued various warrants that contained derivative liabilities. Such derivative liabilities are required to be marked-to-market each reporting period. In the ~~current~~third quarter of 2016, we determined the warrant liability recorded during the third quarter of 2015 did not meet the criteria to record a derivative liability and therefore, the related cumulative loss on the derivative was reversed.

NINE MONTHS ENDED SEPTEMBER 30, ~~2016~~2017 AS COMPARED TO SEPTEMBER 30, ~~2015~~2016

Consolidated Results of Operations -Percent Trend

Nine Months Ended
September 30,

Nine Months Ended
September 30,

2016

2015

2017

2016

Revenues

Services
54
%
21
%
26
%
54
%
License fees and other
46
%
79
%
21
%
11
%
Hardware
53
%
35
%
100
%
100
%
100
%
100
%
Costs and other expenses

Cost of services
13
%
4
%
9
%
13
%
Cost of license fees and other
20
%
14
%
64
%
20
%
33
%
18
%
73
%
33
%
Gross Profit
67
%
82
%
27
%
67
%

Operating expenses

Selling, general and administrative
231
%
84
%
132
%
231
%
Research, development and engineering
124
%
33
%
41
%
124
%
355
%
117
%
173
%
355
%
Operating loss
-288
%
-35
%
-146
%
-288
%

Other income (deductions)

Total other income
1
%
0
%
0
%
1
%
Net Income (loss)
-288
%
-37
%
-146
%
-288
%

Revenues and costs of goods sold

Nine months ended
September 30,

Nine months ended
September 30,

2016

2015

$ Change

% Change

2017

2016

$ Change

% Change

Revenues

Service
$ 692,677 $ 755,813 $ (63,136
)
-8
%
$ 831,761 $ 692,677 $ 139,084 20
%
License & other
585,192 2,835,662 (2,250,470
)
-79
%
677,342 142,651 534,691 375
%
Hardware
1,738,530 442,541 1,295,989 293
%
Total Revenue
$ 1,277,869 $ 3,591,475 $ (2,313,606
)
-64
%
$ 3,247,633 $ 1,277,869 $ 1,969,764 154
%

Cost of goods sold

Service
$ 168,636 $ 154,251 $ 14,385 9
%
$ 285,369 $ 168,636 $ 116,733 69
%
License & other
251,485 505,339 (253,854
)
-50
%
License, hardware & other
2,094,608 251,485 1,843,123 733
%
Total COGS
$ 420,121 $ 659,590 $ (239,469
)
-36
%
$ 2,379,977 $ 420,121 $ 1,959,856 466
%

Revenues

For the nine months ended September 30, ~~2016~~2017 and ~~2015,~~2016, service revenues included approximately ~~$593,000~~$381,000 and ~~$506,000,~~$593,000, respectively, of recurring maintenance and support revenue, and approximately ~~$99,000~~$451,000 and ~~$250,000,~~$99,000, respectively, of non-recurring custom services revenue. Recurring service revenue ~~increased 17%~~decreased 36% from ~~2015~~2016 due to ~~2016 as we continued to expand our customer base. The non-recurring~~the non-renewal of two large maintenance contracts. Non-recurring custom services ~~decreased 60% due~~increased 353% as a result of increased custom software requirements for the first nine months of 2017, compared to ~~fewer customized sales.~~the same period in the 2016.

For the nine months ended September 30, ~~2016,~~2017, license and other revenue ~~(comprised~~(royalty) increased 375% from both new and existing customers, which includes an offsetting decrease in royalty income of third party hardware and royalty) decreased approximately 79% as a result of several contributing factors. Software license revenue decreased approximately $2,016,000 or 94% primarily as a result of a single large order in 2015 without a comparable order in 2016. Hardware sales decreased by approximately $177,000 or 29%, however, with the removal of the one-time sensor sale in 2015, hardware revenue increased approximately $90,000 or 25%. Royalty income decreased 75% to approximately $21,000 ~~from $81,000~~ during the corresponding period in ~~2015,~~2016, as ~~the~~an OEM agreement was completed and was not renewed in the second quarter of 2016.
~~Costs of goods sold~~

~~For~~Hardware sales increased by approximately $1,296,000 (293%), as a result of increases in existing and new customer deployments. Additionally, during the nine months ended September 30, ~~2016,~~2017, we shipped our new line of biometric locks in the amount of approximately $322,000.

Costs of goods sold
For the nine months ended September 30, 2017, cost of service increased approximately ~~$14,000 from~~69%, due to added resources and reallocated research and development personnel to support the ~~corresponding period in 2015 primarily as a result of increased costs associated with third party software costs and personnel costs.~~custom services revenue.

License, hardware and other costs for the nine months ended September 30, ~~2016 decreased~~2017 increased approximately ~~$254,000 from the corresponding period in 2015, due~~733%. The increase was primarily attributable to the ~~decrease~~amortization of the software rights in the amount of $1,118,436, as well as costs associated with the hardware ~~revenue specifically the one-time sensor sale.~~mix.


Selling, general and administrative

Nine months ended
September 30,

2016

2015

$ Change

% Change

Selling, general and administrative
$ 2,956,456 $ 3,034,318 $ (77,862
)
-3
%

Nine months ended
September 30,

2017

2016

$ Change

% Change

Selling, general and administrative
$ 4,289,655 $ 2,957,368 $ 1,332,287 45
%

Selling, general and administrative ~~expenses~~costs for the nine months ended September 30, ~~2016 decreased 3%~~2017 increased 45% from the corresponding period in ~~2015.  Decreases included~~2016. The increase was largely due to a bad debt expense related to a contract whose payments are behind schedule.  As a result of the payment delays, we reserved $500,000 which represents 24% of the remaining balance owed under the contract, for a total reserve of $1,000,000. Other increases resulted from additional expenses related to our Hong Kong subsidiary, non-cash, share-based compensation expenses, commitment fees and increased commission expense related to higher revenue. These amounts were offset by a decrease in factoring, legal fees ~~for the LifeSouth settlement from 2015, marketing expenses~~ and ~~sales commission, offset by increases from new personnel in the Hong Kong subsidiary.~~ contractors and temporary labor.

Research, development and engineering

Nine months ended
September 30,

2016

2015

$ Change

% Change

Research, development and engineering
$ 1,584,403 $ 1,169,427 $ 414,976 35
%

Nine months ended
September 30,

2017

2016

$ Change

% Change

Research, development and engineering
$ 1,329,322 $ 1,584,403 $ (255,081
)
-16
%

~~During~~For the nine months ended September 30, ~~2016,~~2017, research, development and engineering costs ~~increased 35% from~~decreased 16% compared to the corresponding period in ~~2015, due to increased new personnel costs,~~2016, as a result of decreased temporary outside services, and recruiting expenses, offset by an increase in personnel and related costs, Hong Kong subsidiary costs and non-cash compensation ~~and recruiting expenses.~~costs.
Other income and expense

Nine months ended
September 30,

Nine months ended
September 30,

2016

2015

$ Change

% Change

2017

2016

$ Change

% Change

Interest income
19 5 14 280
%
$ 20 $ 19 $ 1 5
%
Interest expense
- (20,000
)
(20,000
)
-100
%
Gain on derivative liabilities
10,879

42,228 (31,349
)
-74
%
- 10,879 (10,879
)
-100
%
Income taxes
(912
)
(912
)
- 0
%

Total
$ 9,986

$ 21,321 $ (11,335
)
-53
%
$ 20 $ 10,898 $ (10,878
)
-100
%

Interest income for the period ended September 30, ~~2016~~2017 and September 30, ~~2015~~2016 consisted of bank interest.
~~Interest expense for the period ended September 30, 2015 represented the amortized portion of the original issue discount and the interest charge of the loan.~~

During the fourth quarters of 2013 and 2014, and third quarter of 2015, we issued various warrants that contained derivative liabilities. Such derivative liabilities are required to be marked-to-market each reporting period. In the ~~current~~third quarter of 2016, we determined the warrant liability recorded during the third quarter of 2015 did not meet the criteria to record a derivative liability and therefore, the related cumulative loss on the derivative was reversed.

LIQUIDITY AND CAPITAL RESOURCES

Cash Flows

Net cash used for operations during the nine months ended September 30, ~~2016~~2017 was approximately ~~$3,523,000.~~$1,804,000. The cash used in operating activities was primarily attributable to the following items:

●
~~Positive~~Net positive cash flows related to adjustments tofor non-cash expenses for allowances for doubtful accounts, depreciation, amortization, share-based compensation, and issuance of common stock to our non-employee directors ~~and Chief Executive Officer~~ of approximately ~~$329,000,~~$2,465,000, a decrease in accounts receivable of approximately ~~$957,000,~~$1,001,000, and a decrease in due from factor of approximately ~~$33,000.~~$25,000, an increase for payables and liabilities of approximately $134,000.

●
~~Negative~~
●
Net negative cash flows related to ~~an increase in~~ inventory, and reductions of deferred revenue of approximately $220,000, due to receipt of BIO-key brand fingerprint readers and fabricated assemblies with our Hong Kong subsidiary, and decreases in accrued expenses, deferred revenue, and accounts payable of approximately $900,000.$739,000.

~~Net cash~~Approximately $204,000 was used for investing activities during the nine months ended September 30, ~~2016 was approximately $53,000 and~~2017 related to capital expenditures.

~~Net cash used for~~Approximately $1,920,000 was provided by financing activities during the nine months ended September 30, ~~2016 was approximately $568,000,~~2017 consisting of approximately ~~$535,000 in payment of dividends on preferred stock and approximately $33,000 for~~$2,000,000 from the issuance of common stock net of approximately $80,000 of stock issuance costs.

~~Net~~We had a net working capital at September 30, ~~2016 was~~2017 of approximately ~~$1,921,000~~$3,281,000 as compared to net working capital of approximately ~~$10,930,000~~$3,074,000 at December 31, 2015. The decline in working capital is primarily due to the reclassification from current asset to long term of an account receivable from a foreign customer of approximately $2.1 million, and a revised estimate in the current portion of software licenses to be sold (decrease of $3 million) in the next twelve months, and cash used to fund operations during the nine months ended September 30, 2016.

Liquidity and Capital Resources

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~~$220,000 during the next twelve months. ~~We do not currently maintain a line of credit or term loan with any commercial bank or other financial institution.~~

The following sets forth our primary sources of capital during the previous two years:

As of December 2011, we entered into a 24-month accounts receivable factoring arrangement with a financial institution (the “Factor”) which ~~has since been~~was extended through October 31, ~~2017.~~2017. Pursuant to the terms of the arrangement, from time to time, we ~~sell~~sold to the Factor certain of our accounts receivable balances on a non-recourse basis for credit approved accounts. The Factor ~~remits~~remitted 35% of the foreign and 75% of the domestic accounts receivable balance to us (the “Advance Amount”), with the remaining balance, less fees, to be forwarded to us once the Factor collects the full accounts receivable balance from the customer. In addition, from time to time, we ~~receive~~received over advances from the Factor. Factoring fees ~~range~~ranged from 2.75% to 21% 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.~~

In November 2014, we issued an aggregate of 7,974,999 shares of our common stock and warrants to purchase an additional 11,962,501 shares of common stock for an aggregate purchase price of $1,595,000. The warrants have a term of five years and an exercise price of $0.30 per share.

On September 23, 2015, we issued a promissory note and a warrant to purchase ~~833,333~~69,445 shares of common stock for an aggregate principal sum of $250,000. The warrants have a term of five years and have an exercise price of $0.30 per share. The note was repaid in full in October 2015.

OnBetween October 22 and ~~29,~~November 11, 2015, we issued ~~84,500~~90,000 shares (the “Series A-1 Shares”) of Series A-1 Convertible Preferred Stock at a purchase price of $100.00 per share, for aggregate gross proceeds of ~~$8,450,000.~~$9,000,000. The Series A-1 Shares are convertible at any time at the option of the holder into shares of common stock at ~~an initial~~a conversion price of ~~$0.30~~$3.60 per share, subject to adjustment for stock dividends, stock splits, combinations, and reclassifications of our capital stock, and subject to a “blocker provision” which prohibits conversion if such conversion would result in the holder being the beneficial owner of in excess of 9.99% of our common stock. The Series A-1 Shares accrue dividends at the rate of 6% per annum payable quarterly on April 1, July, 1, October 1, and January 1 of each year payable in cash through October 1, 2017 and thereafter, in cash or kind through the issuance of additional shares of common stock having a value equal to the volume weighted average trading price of the Company’s common stock for the ten (10) days preceding the applicable dividend payment date.

On November 11, 2015, ~~the Company~~we issued 105,000 shares (the “Series B-1 Shares”) of Series B-1 Convertible Preferred Stock Series B-1 Shares at a purchase price of $100.00 per share, for gross proceeds of ~~$10,500,000, and 5,500 additional shares of Series A-1 Convertible Preferred Stock at a purchase price of $100.00 per share, for gross cash proceeds of $550,000.~~$10,500,000. The Series B-1 Shares are convertible at any time at the option of the holder into shares of common stock at ~~an initial~~a conversion price of ~~$0.30~~$3.60 per share, subject to adjustment for stock dividends, stock splits, combinations, and reclassifications of our capital stock, and subject to a “blocker provision” which prohibits conversion if such conversion would result in the holder being the beneficial owner of in excess of 9.99% of our common stock. The Series B-1 Shares accrue dividends at the rate of 2.5% per annum payable quarterly on April 1, July, 1, October 1, and January 1 of each year payable in cash.

On November 18, 2016, we issued to Wong Kwok Fong (Kelvin), a director and executive officer of the Company, 516,667 shares of common stock at a purchase price of $3.60 per share for gross cash proceeds of $1,860,000.
On April 28, 2017, we issued to Wong Kwok Fong (Kelvin), a director and executive officer of the Company, 277,778 shares of common stock at a purchase price $3.60 per share for gross cash proceeds of $1,000,000.
On May 2, 2017, we entered into a committed equity facility pursuant to which we may issue and sell up to $5.0 million worth of shares of common stock, subject to certain limitations and satisfaction of certain conditions, over a 36-month term following the effectiveness of a registration statement covering the public resale of the shares of common stock issued under the facility. From time to time over the term of the facility, we may in our sole discretion, issue requests to the investor to purchase a specified dollar amount of shares up to a maximum of $100,000 over a five trading day period based on the daily volume weighted average price of our common stock (VWAP) to the extent the VWAP equals or exceeds the greater of a formula amount or $3.83 per share. The per share purchase price for the shares issued under the facility will be equal to 94% of the lowest VWAP that equals or exceeds $3.83 per share. Aggregate sales under the facility are limited to 19.99% of the total outstanding shares of the Company’s common stock as of May 2, 2017, unless we obtain stockholder approval, and we are prohibited from making requests if the sale of shares pursuant to a request would result in beneficial ownership by the investor of more than 9.99% of our common stock.
On September 22, 2017, the Company issued to Wong Kwok Fong (Kelvin), a director and executive officer of the Company, 427,778 shares of common stock and warrants to purchase 138,889 shares of common stock for the aggregate purchase price of $1,540,000,or $3.60 per share. The purchase price was paid via a cash payment of $1,000,000 and the conversion of an accrued dividend payable in the amount of $540,000 on the Company’s Series A-1 Convertible Preferred Stock into 150,000 shares of common stock.
Liquidity outlook

At September 30, ~~2016,~~2017, our total cash and cash equivalents were approximately ~~$177,000,~~$972,000, as compared to approximately ~~$4,321,000~~$1,061,000 at December 31, ~~2015.~~ 2016.

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. In that regard, we recently entered into a securities purchase agreement with Wong Kwok Fong (Kelvin), who serves on our board of directors, to purchase 6,200,000 shares of our common stock at a purchase price of $1,860,000. We estimate that we currently require approximately ~~$579,000~~$592,000 per month to conduct our operations and pay dividend obligations, a monthly amount that we have been unable to consistently achieve through revenue generation. During the ~~first~~ nine months of ~~2016,~~2017, we generated approximately ~~$1,278,000~~$3,248,000 of revenue, which is below our average monthly requirements.

If we are unable to continue to generate sufficient revenue to meet our goals, we will need to obtain additional third-party financing to (i) conduct the sales, marketing and technical support necessary to execute our plan to substantially grow operations, increase revenue and serve a significant customer base; and (ii) provide working capital. We may, therefore, need to obtain additional financing through the issuance of debt or equity securities.

Due to several factors, including our history of losses and limited revenue, our independent auditors have included an explanatory paragraph in their opinion related to our annual financial statements as to the substantial doubt about our ability to continue as a going concern. 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, notcontinue as a going concern.

ITEM 4. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), evaluated the effectiveness of our disclosure controls and procedures ~~as of September 30, 2016. The term “disclosure controls and procedures,” as~~(as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of ~~1934,~~1934) as ~~amended (the “Exchange Act”), means controls and other procedures~~ of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.September 30, 2017. Based on the evaluation of our disclosure controls and procedures as of September 30, ~~2016,~~2017, our CEO and CFO concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

Changes in Internal Control Over Financial Reporting

No change in our internal control over financial reporting occurred during the fiscal quarter ended September 30, ~~2016,~~2017, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART~~PART~~ II — OTHER INFORMATION

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

On ~~November 7, 2016, we~~September 22, 2017, the Company issued ~~48,148~~to Wong Kwok Fong (Kelvin), a director and executive officer of the Company, 427,778 shares of common stock and warrants to ~~five non-employee directors in~~purchase 138,889 shares of common stock for the aggregate purchase price of $1,540,000, or $3.60 per share. The purchase price was paid via a cash payment of ~~directors’ fees.~~$1,000,000 and the conversion of an accrued dividend payable in the amount of $540,000 on the Company’s Series A-1 Convertible Preferred Stock into 150,000 shares of common stock. The foregoing securities were issued in a private placement transaction pursuant to ~~the~~an exemption from registration provided by Section 4(a)(2) of the Securities Act of 1933, as amended, without general solicitation or advertising of any kind and without payment of placement agent or brokerage ~~commissions~~fees to any person.
~~ITEM 5. OTHER INFORMATION.~~
~~The information set forth below is included herewith for the purpose of providing the disclosure required under “Item 1.01- Entry into a Material Definitive Agreement” of SEC Form 8-K.~~
~~On November 11, 2016, we entered into a Securities Purchase Agreement with~~Wong Kwok Fong (Kelvin) for the purchase and sale of 6,200,000 shares of our common stock at an aggregate purchase price of $1,860,000 or $0.30 per share. Mr. Wong is a director of the Company. We expect to close the transaction during the next ten days.

ITEM 6. EXHIBITS

The exhibits listed in the Exhibit Index immediately preceding such exhibits are filed as part of this Report.


SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.


BIO-key International,~~BIO-~~ Inc.k~~ey International, Inc.~~


Dated: November 14, ~~2016~~2017
/s/ Michael W. DePasquale

Michael W. DePasquale

Chief Executive Officer

(Principal Executive Officer)


Dated: November 14, ~~2016~~2017
/s/ Cecilia Welch

Cecilia Welch
Chief Financial Officer
(Principal Financial Officer)

EXHIBIT INDEX

Exhibit
No.

Description



~~10.1~~
~~Securities Purchase Agreement dated November 11, 2016, by and between the Registrant and Wong Kwok Fong (Kelvin)~~

31.1

Certificate of CEO of Registrant required under Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended

31.2

Certificate of CFO of Registrant required under Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended

32.1

Certificate of CEO of Registrant required under 18 U.S.C. Section 1350

32.2

Certificate of CFO of Registrant required under 18 U.S.C. Section 1350

101.INS

XBRL Instance

101.SCH

XBRL Taxonomy Extension Schema

101.CAL

XBRL Taxonomy Extension Calculation

101.DEF

XBRL Taxonomy Extension Definition

101.LAB

XBRL Taxonomy Extension Labels

101.PRE

XBRL Taxonomy Extension Presentation

30
27

DELAWARE	41-1741861
(State or other jurisdiction of incorporation of organization)	(IRS Employer Identification Number)

Large accelerated filer ☐	Accelerated filer ☐	Non-accelerated filer ☐	Smaller Reporting Company ☒


Emerging growth company ☐

PART I. FINANCIAL INFORMATION

Item 1	Financial Statements
	Condensed and consolidated balance sheets as of September 30, ~~2016~~2017 (unaudited) and December 31, ~~2015~~2016	3
	Condensed and consolidated statements of operations for the three and nine months ended September 30, 2017 and 2016 ~~and 2015~~ (unaudited)	4
	Condensed and consolidated statements of cash flows for the nine months ended September 30, 2017 and 2016 ~~and 2015~~ (unaudited)	5
	Notes to condensed consolidated financial statements	7
Item 2	~~Management’s~~Management’s Discussion and Analysis of Financial Conditions and Results of Operations	16 19
Item 4	Controls and Procedures	2427

PART II. OTHER INFORMATION

Item 1	~~Legal Proceedings~~
~~Item~~ 2	Unregistered Sales of Equity Securities and Use of Proceeds	25
~~Item 5~~	~~Other Information~~	2528
Item 6	Exhibits	2528

Signatures	2629

		September 30, 2016			December 31, 2015			September 30, 2017			December 31, 2016
		(Unaudited)						(Unaudited)
ASSETS
Cash and cash equivalents		$	177,388		$	4,321,078		$	971,857		$	1,061,307
Accounts receivable, current, net of allowance for doubtful accounts of $13,785 at September 30, 2016 and $20,526 December 31, 2015			364,381			3,391,405
Accounts receivable, net									562,296			1,563,246
Due from factor			4,041			37,421			28,750			53,638
Inventory			568,236			348,645			879,592			465,428
Software license rights			2,000,000			5,000,000			2,370,000			1,560,000
Prepaid expenses and other	��		136,408			97,203			175,955			206,677
Total current assets			3,250,454			13,195,752			4,988,450			4,910,296
Software license rights, less current portion			9,999,550			7,000,000
Software license rights, net of current portion									8,590,368			10,598,411
Accounts receivable, net of current portion			2,070,000			-			1,070,000			1,570,000
Equipment and leasehold improvements, net			79,088			63,877			186,917			67,814
Deposits and other assets			8,712			8,712			8,712			8,712
Intangible assets—less accumulated amortization			137,534			147,738
Intangible assets, net									175,896			134,132
Total non-current assets			12,294,884			7,220,327			10,031,893			12,379,069
TOTAL ASSETS		$	15,545,338		$	20,416,079		$	15,020,343		$	17,289,365

LIABILITIES
Accounts payable		$	550,807		$	1,158,555		$	507,886		$	466,842
Accrued liabilities			337,067			493,067			427,671			335,323
Dividends payable on preferred stock			200,625			133,851			463,125			401,250
Deferred revenue			240,154			376,405			308,622			633,062
Warrant liabilities			1,206			104,284
Total current liabilities			1,329,859			2,266,162			1,707,304			1,836,477
TOTAL LIABILITIES			1,329,859			2,266,162			1,707,304			1,836,477

Commitments and contingencies

STOCKHOLDERS’ EQUITY:
Series A-1 convertible preferred stock; authorized, 100,000 (liquidation preference of $100 per share): issued and outstanding 90,000 of $.0001 par value			9			9
Series B-1 convertible preferred stock; authorized, 105,000 (liquidation preference of $100 per share): issued and outstanding 105,000 of $.0001 par value			11			11
Common stock — authorized, 170,000,000 shares; $.0001 par value issued and outstanding; 66,377,157 at September 30, 2016, and 66,098,482 as of December 31, 2015			6,638			6,610
STOCKHOLDERS’ EQUITY:
Series A-1 convertible preferred stock; authorized, 100,000 (liquidation preference of $100 per share): issued and outstanding 90,000 of $.0001 par value at September 30, 2017 and December 31, 2016, respectively									9			9
Series B-1 convertible preferred stock; authorized, 105,000 (liquidation preference of $100 per share): issued and outstanding 105,000 of $.0001 par value at September 30, 2017 and December 31, 2016, respectively									11			11
Common stock — authorized, 170,000,000 shares; $.0001 par value issued and outstanding; 6,927,826 and 6,093,843 at September 30, 2017 and December 31, 2016, respectively									692			609
Additional paid-in capital			76,493,397			76,754,737			80,864,782			78,253,413
Accumulated deficit			(62,284,576	)		(58,611,450	)		(67,552,455	)		(62,801,154	)
TOTAL STOCKHOLDERS’ EQUITY			14,215,479			18,149,917
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	15,545,338		$	20,416,079
TOTAL STOCKHOLDERS’ EQUITY									13,313,039			15,452,888
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY								$	15,020,343		$	17,289,365

	Nine Months Ended September 30,
	2016			2015

CASH FLOW FROM OPERATING ACTIVITIES:
Net loss	$	(3,673,125	)	$	(1,250,539	)
Adjustments to reconcile net loss to cash used for operating activities:
Depreciation		37,764			32,049
Amortization of intangible assets		10,205			10,204
Gain on derivative liabilities		(10,879	)		(42,228	)
Share-based and warrant compensation for employees and consultants		231,983			258,297
Stock based directors fees		48,999			-
Amortization on note payable discount		-			20,000
Change in assets and liabilities:
Accounts receivable		957,024			(1,540,075	)
Due from factor		33,380			76,657
Inventory		(219,591	)		(138,895	)
Prepaid expenses and other		(39,205	)		198,841
Software license rights		450			-
Accounts payable		(607,748	)		960,673
Accrued liabilities		(156,000	)		(55,824	)
Due to factor		-			533,422
Deferred revenue		(136,251	)		(36,418	)
Net cash used for operating activities		(3,522,994	)		(973,836	)
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures		(52,976	)		(2,078	)
Net cash used for investing activities		(52,976	)		(2,078	)
CASH FLOW FROM FINANCING ACTIVITIES:
Preferred dividends paid		(535,100	)		-
Stock issued to directors		-			13,000
Proceeds from issuance of Note Payable		-			250,000
Costs to issue preferred and common stock		(32,620	)		(58,486	)
Net cash provided by (used for) financing activities		(567,720	)		204,514
NET DECREASE IN CASH AND CASH EQUIVALENTS		(4,143,690	)		(771,400	)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD		4,321,078			843,632
CASH AND CASH EQUIVALENTS, END OF PERIOD	$	177,388		$	72,232

	September 30,			December 31,
	2016			2015

Original invoice value	$	16,117		$	149,680
Factored amount		(12,076	)		(112,259	)
Balance due from factor	$	4,041		$	37,421

Risk-free interest rate	0.20	-	0.21%
Expected term	0.07	-	0.11
Expected dividends		0
Volatility of stock price	62.9	-	69.0%

Warrant issued under PI SPA
Fair value at January 1, 2016	$	7,478
Gain on derivative		(6,272	)
		1,206

Warrant issued under September 2015 SPA
Fair value at January 1, 2016		96,806
Gain on derivative		(4,607	)
Transfer to additional paid-in capital		(92,199	)
		-

Balance, September 30, 2016	$	1,206

	●	~~Negative~~
	●	Net negative cash flows related to ~~an increase in~~ inventory, and reductions of deferred revenue of approximately $220,000, due to receipt of BIO-key brand fingerprint readers and fabricated assemblies with our Hong Kong subsidiary, and decreases in accrued expenses, deferred revenue, and accounts payable of approximately $900,000.$739,000.

	BIO-key International,~~BIO-~~ Inc.k~~ey International, Inc.~~

Dated: November 14, ~~2016~~2017	/s/ Michael W. DePasquale
	Michael W. DePasquale
	Chief Executive Officer
	(Principal Executive Officer)

Dated: November 14, ~~2016~~2017	/s/ Cecilia Welch
	Cecilia Welch Chief Financial Officer
	(Principal Financial Officer)

Exhibit No.		Description

~~10.1~~		~~Securities Purchase Agreement dated November 11, 2016, by and between the Registrant and Wong Kwok Fong (Kelvin)~~


31.1		Certificate of CEO of Registrant required under Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended

31.2		Certificate of CFO of Registrant required under Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended

32.1		Certificate of CEO of Registrant required under 18 U.S.C. Section 1350

32.2		Certificate of CFO of Registrant required under 18 U.S.C. Section 1350

101.INS		XBRL Instance

101.SCH		XBRL Taxonomy Extension Schema

101.CAL		XBRL Taxonomy Extension Calculation

101.DEF		XBRL Taxonomy Extension Definition

101.LAB		XBRL Taxonomy Extension Labels

101.PRE		XBRL Taxonomy Extension Presentation