AWARE INC annual report, FY2012

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Aware, Inc. — FY 2012 Form 10-K

Reporting period: Fiscal year ended December 31, 2012. The filing also reports unaudited fourth-quarter results; it is an annual report, not a standalone Q4 filing. Dollar amounts below are in U.S. dollars.

Business context

Aware sells biometrics and imaging software and services, DSL service-assurance software and services, and receives legacy DSL chipset royalties. Biometrics and imaging generated 76% of 2012 revenue; DSL service assurance 13%; and royalties 11%. The company shut down its DSL service-assurance hardware product line during 2012 and reports it as discontinued operations.

Financial performance and liquidity

  • Revenue: $19.9 million, up 1.9% from $19.5 million in 2011. Software licenses were $11.3 million (+9%); maintenance $3.4 million (+25%); services $3.0 million (-30%); and royalties $2.2 million, essentially unchanged.
  • Operating results: Operating income before patent-related income was $4.3 million, versus $3.3 million in 2011, a margin of approximately 21.6% versus 17.0%. Biometrics and imaging operating income was $6.8 million; DSL service assurance reported an operating loss of $1.4 million.
  • Patent-related items and net income: The company recorded $86.4 million of net gains from two patent sales and $1.1 million of income from a separate patent arrangement. Net income was $72.3 million, or $3.28 diluted EPS, compared with $2.6 million, or $0.12, in 2011. The 2012 result was driven primarily by the patent transactions, not recurring operations.
  • Fourth quarter: Revenue was $5.66 million; operating income before patent-related income was $1.68 million; net income was $5.97 million, or $0.27 per diluted share. The quarter included $1.12 million of patent-arrangement income and no patent-sale gain.
  • Cash flow: Operating activities used $15.3 million, including $22.0 million of patent-sale-related tax items, partly offset by $6.7 million of cash from ongoing operations. Investing activities provided $85.1 million, principally from patent-sale proceeds. Financing activities used $45.3 million, including $66.0 million of special dividends.
  • Balance sheet and liquidity: Year-end cash and cash equivalents were $71.1 million, investments $2.0 million, working capital $73.4 million, and total assets $85.9 million. Total liabilities were $4.0 million; the filing does not report borrowings. Management said available cash and investments should fund operations for at least 12 months. Contractual obligations listed were $118,000 in purchase orders, all due within one year.
  • Other notable metrics: Total tax expense was $20.4 million; management reported actual 2012 tax liability of $7.8 million after an equity tax benefit related to excess stock-based compensation. Service gross margin declined to 44% from 59%. The company paid special dividends totaling $2.95 per share.

Changes versus 2011

  • Revenue grew modestly, as higher biometrics and imaging license and maintenance sales were partly offset by lower services revenue and DSL software sales.
  • Operating income before patent-related items increased by $1.0 million, reflecting stronger biometrics and imaging results and lower general and administrative expense, partly offset by greater DSL software losses.
  • Reported net income rose sharply because of patent monetization; it should not be read as a measure of ongoing earnings.
  • Operating cash flow turned negative, largely because of tax-related cash effects from the patent sales. Cash and short-term investments nonetheless increased to $73.1 million after patent proceeds and dividend payments.

Outlook, risks, and unusual items

  • The filing provides no numerical revenue or earnings guidance. Management expects to continue substantial R&D investment and says available liquidity is adequate for at least the next 12 months.
  • Management said royalties from the two legacy DSL IP licensees are more likely to decline than increase. Biometrics services revenue is difficult to forecast because contract timing and project delivery vary.
  • Key risks include unpredictable license, services, and royalty revenue; competition from larger companies; dependence on government and systems-integrator opportunities; rapid technology change; intellectual-property disputes; and possible customer or project losses. DSL service assurance sales are exposed to a limited customer base and stronger competitors.
  • The DSL hardware shutdown produced $373,000 of discontinued-operations income in 2012, after losses in 2011 and 2010, and involved approximately $282,000 of one-time shutdown costs.
  • A separate patent arrangement may generate an estimated $400,000–$800,000 in additional income in Q1 2013; subsequent proceeds are uncertain. The filing reports no material pending litigation and no material off-balance-sheet financing arrangements.
  • Independent auditors issued an unqualified opinion on the financial statements and concluded internal control over financial reporting was effective as of year-end.

Investor verification priorities

  • Separate recurring operating performance from the $86.4 million patent-sale gains and $1.1 million patent-arrangement income.
  • Review the sustainability of biometrics and imaging growth, the decline in services, and ongoing losses in DSL service assurance.
  • Verify the timing and cash impact of patent-related taxes, deferred tax assets, and the reported $7.8 million actual tax liability.
  • Assess future DSL royalties, customer and project concentration, and any proceeds from the remaining patent arrangement.
  • Confirm post-dividend cash, investment holdings and associated issuer credit risk, and whether management’s 12-month liquidity assessment remains applicable.