Aware, Inc. — Q3 2017 Form 10-Q
Business context and period. Aware develops and sells biometrics software and services, with additional imaging software revenue and declining DSL royalties. This unaudited report covers the quarter and nine months ended September 30, 2017; amounts below are in millions unless noted. The company reports one operating segment.
Financial performance and position
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $5.905 | $5.899 | $12.997 | $17.637 |
| Operating income | $1.665 | $2.313 | $2.288 | $5.267 |
| Net income | $1.229 | $1.573 | $1.863 | $3.643 |
| Diluted EPS | $0.06 | $0.07 | $0.08 | $0.16 |
| Operating margin | 28.2% | 39.2% | 17.6% | 29.9% |
- Revenue mix: Q3 software license revenue rose 7% to $4.433 million, driven by imaging licenses (+$1.2 million), partly offset by lower biometrics licenses (-$0.9 million). Maintenance declined 15% to $1.088 million and services fell 19% to $0.343 million. YTD license revenue declined 32% to $8.332 million; maintenance was down 3% to $3.623 million, services down 13% to $0.924 million, and hardware and royalties were lower.
- Costs and margins: Q3 total costs and expenses increased to $4.259 million from $3.824 million, chiefly as research and development rose 23% to $2.151 million. YTD R&D increased 13% to $5.884 million. For the first nine months, software license gross margin rose to 97% from 91%; services gross margin declined to 46% from 51%.
- Cash flow and liquidity: Operating cash flow was $0.611 million for the first nine months, versus $2.694 million a year earlier. Investing activities provided $0.958 million, mainly from investment sales; financing used $4.357 million, including $4.213 million for share repurchases. Cash and cash equivalents were $49.125 million at September 30, down $2.788 million from year-end. Current assets were $55.056 million and current liabilities $4.392 million. No debt is reported on the balance sheet.
- Capital and equity: The company repurchased 879,216 shares for $4.2 million during the first nine months. Since the program began in April 2016, it had repurchased 1,570,017 shares for $7.9 million; $2.132 million remained authorized at September 30. Shares outstanding were 21,612,591 as of October 23, 2017.
Material changes and notable items
- Q3 revenue was essentially flat year over year, but operating income fell 28% and net income fell 22%, reflecting higher operating expenses and lower patent-related income.
- For the first nine months, revenue fell 26% and operating income fell 57%. Management attributed the decline mainly to lower imaging and biometrics license sales, maintenance, services, hardware, and DSL royalties, plus higher operating expenses. Prior-year comparisons included larger government/system-integrator sales and revenue from a 2015 imaging license contract.
- Patent-related income was $1.422 million for the first nine months of 2017 versus $0.238 million a year earlier, but only $19,000 in Q3 2017 versus $238,000 in Q3 2016. Further proceeds are uncertain.
- Adoption of share-based-payment guidance in Q1 2017 added a $4.8 million deferred tax asset with an offset to retained earnings. Deferred tax assets were $5.648 million at September 30, with no valuation allowance recorded.
Outlook, risks, and contingencies
- Management said cash should be sufficient to fund operations for at least the next 12 months, while noting it cannot assure that additional financing will not be needed or available.
- Services backlog was minimal, and management said services revenue was unlikely to return to 2014–2015 levels without new projects. No hardware orders were in backlog; future Navy hardware orders may be minimal. DSL royalties are expected to continue declining.
- The company is pursuing legacy government biometrics markets and expansion into commercial biometrics, but cannot predict future commercial-market revenue or whether the Navy or Marine Corps will repeat prior software purchases.
- Management planned to complete implementation of ASC 606 in Q4 2017 and adopt it January 1, 2018 using full retrospective application. Preliminary expected differences include timing of recognition for certain license, royalty, and minimum-payment contracts, and capitalization of some contract-acquisition costs; the assessment was not complete.
- The IRS began examining the company’s 2015 tax return in Q2 2017. The company reported no material change to the risk factors in its 2016 Form 10-K and no litigation it believed likely to seriously harm the business.
- Disclosure controls were assessed as effective, with no material changes in internal control over financial reporting reported during the quarter.
Investor verification priorities
- Assess the sustainability and timing of biometrics and imaging license sales, given project concentration and volatile customer orders.
- Verify whether the new product development investment and commercial-market expansion generate new revenue, particularly after third-party development work ended in Q3.
- Track operating cash conversion and working-capital movements, especially the $2.601 million increase in accounts receivable in the nine-month cash flow statement.
- Review the outcome of the 2015 tax examination and the realizability of the $5.648 million deferred tax asset.
- Confirm final ASC 606 transition impacts and retrospective restatements, which management said were still under evaluation.
- Monitor remaining repurchase authorization and cash use, alongside the end-of-2017 expiration of the repurchase program.