Aware, Inc. — FY 2013 Form 10-K
Business context and reporting period. Aware develops biometric software and provides related engineering services for government and commercial identity systems. This annual report covers the year ended December 31, 2013; the filing also reports fourth-quarter results. More than 80% of revenue is derived from government customers. Aware exited its DSL service-assurance product lines, presenting their results as discontinued operations.
Financial performance and position
- Revenue: FY 2013 revenue was $19.36 million, up from $17.30 million in 2012. Software licenses were $8.24 million, maintenance $3.87 million, services $3.15 million, hardware $3.18 million, and DSL royalties $0.92 million.
- Profit: Operating income before patent-related income was $4.54 million, versus $5.04 million in 2012. Income from continuing operations was $3.75 million and net income was $2.60 million, or $0.11 per diluted share. 2012 net income of $72.31 million included $86.39 million of gains on patent sales; the years are therefore not directly comparable on reported net income.
- Cash flow: Operating activities provided $2.83 million in 2013. Investing activities used $1.37 million and financing activities provided $0.12 million. In 2012, operating activities used $15.29 million, largely reflecting tax-related cash effects of the patent sales; investing activities provided $85.07 million from those sales.
- Margins and costs: Hardware gross margin was 26%; services gross margin was 52%, up from 40% in 2012. Research and development expense rose to $4.09 million from $3.49 million. The filing does not provide a single overall gross-margin figure.
- Liquidity and debt: Year-end cash and cash equivalents were $72.66 million, with investments of $2.75 million. Working capital was $75.76 million; current liabilities were $4.16 million and total liabilities $4.18 million. No borrowings are reported in the supplied financial statements. Management expects cash and investments to fund operations for at least the next 12 months.
- Fourth quarter: Revenue was $5.64 million and net income was $1.59 million. The quarter included $1.06 million of income from discontinued operations, following a $1.94 million discontinued-operations loss in Q3.
Material changes versus 2012
- Revenue increased by $2.05 million. New hardware shipments contributed $3.18 million, while software-license revenue fell 13% to $8.24 million and royalties fell 58% to $0.92 million.
- Maintenance revenue rose 27% to $3.87 million, and services revenue rose 22% to $3.15 million. Management attributed the services increase mainly to a new U.S. government project.
- Operating income before patent-related income declined by $0.51 million, primarily because of lower royalties, partly offset by reduced patent-monetization-related personnel costs. The large 2012 patent-sale gains did not recur.
- The DSL service-assurance software shutdown resulted in approximately $2.9 million of 2013 exit costs and a $1.16 million annual loss from discontinued operations. Royalties from legacy DSL intellectual property remain but are expected to decline.
- Cash rose by $1.59 million during 2013. Unlike 2012, the year had no special dividend payments; the company paid $66.02 million in dividends in 2012.
Outlook, commentary, and risks
- Year-end backlog was $5.0 million with two direct government customers, including $2.7 million of hardware and $2.3 million of services, scheduled for delivery in 2014. Backlog is atypical for the company and is not presented as a reliable indicator of future periods.
- Aware said it expected more hardware sales in 2014 but did not intend to deliberately grow hardware revenue. Hardware orders depend on customer purchase orders, and the government contract does not obligate purchases. A separate $4.7 million hardware order received in 2013 had $2.6 million remaining to ship in Q1 2014.
- Management expects continued investment in research and development and notes that growth initiatives may reduce near-term profitability. No specific revenue or earnings guidance is provided.
- Key risks include dependence on government budgets and contract timing, channel partners’ ability to win projects, customer concentration, intense competition and pricing pressure, uncertain biometrics-market adoption, technology and product-defect risks, reliance on single-source components for hardware, and potential intellectual-property claims.
- The U.S. Navy accounted for 21% of 2013 revenue, compared with 5% in 2012. Individual orders can materially affect quarterly results. The company also holds $2.8 million of high-yield corporate bonds and identifies issuer default risk.
- There were no material pending legal proceedings disclosed. The independent auditor and management concluded internal control over financial reporting was effective as of year-end.
Important facts for investors to verify
- Whether the $5.0 million backlog was delivered on schedule in 2014, and whether the remaining hardware order was shipped and collected.
- How much revenue and operating profit depended on the Navy and other government customers, and whether channel partners secured replacement projects.
- Whether declining DSL royalties and lower software-license sales continued, and whether maintenance growth offset those declines.
- The sustainability and margin contribution of hardware sales, given the customer-specific arrangement and 26% reported hardware gross margin.
- The final cash impact of DSL shutdown costs and the basis for the Q4 discontinued-operations income.
- Realizability of deferred tax assets and the outcome of the disclosed $2.945 million of uncertain tax positions.