Aware, Inc. — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017; unaudited. Aware develops and sells biometrics software and services, with additional imaging software and legacy DSL royalty revenue. It reports as one operating segment.
Financial results
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Revenue | $2.745m | $6.904m | $7.092m | $11.738m |
| Operating income | $0.238m | $2.074m | $0.624m | $2.954m |
| Net income | $0.228m | $1.436m | $0.634m | $2.070m |
| Diluted EPS | $0.01 | $0.06 | $0.03 | $0.09 |
Unless stated otherwise, amounts below are in U.S. dollars. Q2 revenue fell 60% year over year and six-month revenue fell 40%. Operating margins were approximately 9% in Q2 and 9% for the six months, compared with 30% and 25%, respectively, in 2016. Patent-related income of $1.313m in Q2 and $1.403m for the six months supported 2017 operating income; there was none in the comparable 2016 periods.
Q2 software-license revenue declined 77% to $1.214m; maintenance revenue increased 9% to $1.282m. For the six months, software licenses fell 52% to $3.900m, while maintenance rose 3% to $2.534m. Biometrics and imaging revenue both declined. Six-month software-license gross margin was 94%, versus 86% a year earlier. Services revenue was $0.206m for Q2 and $0.580m for the six months; services backlog was only $0.2m. Hardware revenue was zero in 2017, and DSL royalties declined to $0.077m for the six months.
Six-month operating cash flow was $0.268m, compared with $1.010m in 2016. Investing activities provided $0.966m, principally from selling investments; financing used $3.722m, mainly for share repurchases. Cash and cash equivalents were $49.425m at June 30, down $2.488m from year-end. Current assets were $53.018m and current liabilities $3.460m. The balance sheet reports no debt. Deferred tax assets were $5.843m, with no valuation allowance.
Material changes and management commentary
- Lower license revenue was the main driver of weaker results. The prior-year quarter included a U.S. Marine Corps sale and imaging-license revenue from a 2015 contract; no further revenue remained under that imaging agreement in 2017. Management says future Navy or Marine Corps purchases are unpredictable.
- R&D expense increased to $3.733m for the six months, principally due to a third-party developer working on a new product. Management said remaining-2017 fees could include an additional $450,000, depending on milestones.
- Aware repurchased 762,644 shares for $3.6m in the first half under its $10m buyback authorization, which expires December 31, 2017. The company had repurchased 1,453,445 shares for $7.3m since the program began.
- Management believes existing cash will fund operations for at least the next 12 months, while noting it cannot assure that additional financing would be unnecessary or available. No formal revenue or earnings guidance is provided; interim results may not indicate full-year performance.
- Aware adopted ASU 2016-09 in Q1 2017 and recorded a $4.8m deferred tax asset with an offsetting retained-earnings adjustment. It plans to adopt the new revenue standard on January 1, 2018 using full retrospective adoption. Management’s preliminary assessment identifies possible timing changes for an older imaging contract, DSL royalties, minimum license/royalty payments, and contract acquisition costs; implementation was not complete.
Risks, contingencies and other notable items
Revenue depends on winning project-based software licenses and is subject to large customer and contract fluctuations; management describes commercial biometrics markets as emerging and difficult to forecast. Hardware is not part of the growth strategy, and DSL royalties are expected to continue declining. The IRS began examining the 2015 tax return in Q2. The filing reports no lawsuit expected by management to seriously harm the business and no material change to the risk factors in the 2016 Form 10-K. Management assessed disclosure controls as effective and reported no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether subsequent biometrics license awards, particularly from government customers, offset the absence of prior-year large contracts.
- Whether the new-product development milestones are achieved and whether the potential additional $450,000 R&D cost is incurred.
- How much additional income, if any, is generated by the patent monetization arrangement; management says it cannot predict future receipts.
- The effect of full-retrospective adoption of the revenue standard, including the ultimate impact on reported historical periods and contract acquisition costs.
- The outcome of the IRS examination and whether future evidence changes the conclusion that the $5.8m deferred tax asset is realizable.
- Cash use, repurchases under the remaining authorization, and the limited services backlog.