Aware, Inc. — Q3 2012 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2012. Aware develops biometrics and imaging software and services, DSL service-assurance software, and manages patent assets. Financial amounts below are in millions of dollars unless otherwise stated.
Financial performance
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Revenue | $5.26 | $5.42 | $14.24 | $14.34 |
| Operating income before patent-sale gains | $1.45 | $1.59 | $2.61 | $2.09 |
| Patent-sale gains | $15.17 | — | $86.39 | — |
| Income from continuing operations | $10.08 | $1.60 | $65.98 | $2.13 |
| Net income | $10.30 | $1.28 | $66.34 | $1.61 |
| Diluted EPS | $0.46 | $0.06 | $3.03 | $0.08 |
| Operating cash flow | Not separately reported by quarter | $4.04 | $4.95 |
- Q3 revenue declined 3% year over year; nine-month revenue declined about 1%. Product sales rose 4% in Q3 and 10% year to date, while services fell 25% and 34%, respectively. Royalties fell 12% in Q3 but increased 4% year to date.
- Operating income before patent-sale gains was broadly comparable year over year. As a share of revenue, it was approximately 28% in Q3 2012 versus 29% a year earlier, and 18% for the first nine months versus 15%.
- Services gross margin declined to 42% in Q3 from 57%, and to 46% year to date from 62%, primarily due to project mix and lower services revenue. The filing does not provide an overall gross margin.
- Discontinued DSL hardware operations contributed $0.22 of income in Q3 and $0.36 for the first nine months, versus losses of $0.32 and $0.52 in the comparable 2011 periods.
Financial position and liquidity
- At September 30, 2012, cash and cash equivalents were $114.6 million, up from $46.6 million at year-end 2011; current assets were $118.8 million and current liabilities $8.3 million. Investments were $1.0 million.
- The balance sheet reports no borrowings or other debt. Stockholders’ equity was $117.2 million.
- Nine-month operating cash flow was $4.0 million. Investing cash flow was $83.8 million, mainly reflecting $86.4 million of net patent-sale proceeds; financing cash flow was negative $19.8 million, including a $25.5 million special dividend.
- Management said available cash should fund operations for at least the next 12 months, while noting it cannot assure that additional financing will not be needed or available.
Material developments, outlook, and risks
- Two patent transactions drove reported earnings: wireless patents sold for $75.0 million gross, with $3.8 million of transaction costs; DSL patents sold for $16.0 million gross, with $0.8 million of costs. The remaining portfolio mainly supports existing product lines; management said it did not currently intend to monetize those patents, though that could change.
- The board declared and paid a special dividend of $1.15 per share, totaling $25.5 million. Cash also benefited from $5.9 million of stock-option exercise proceeds.
- Q3 and nine-month earnings growth largely reflects patent gains, not a comparable increase in underlying operations. Management said operating income before patent gains was comparable across periods.
- The DSL service-assurance hardware product line was substantially shut down in Q3 and reclassified as discontinued operations. The filing reports approximately $0.28 million of one-time shutdown costs for the first nine months, mostly severance and employee costs.
- Taxes include substantial use of deferred tax assets and $15.8 million of tax benefits from stock-based awards recorded in equity. The company maintained a full valuation allowance on remaining deferred tax assets; it identified up to $7.7 million of research-credit carryforwards as an uncertain tax position. Accrued income taxes were $5.3 million at quarter-end.
- Management gave no specific revenue or earnings guidance. It cautioned that biometrics services revenue and legacy DSL royalties may fluctuate; royalties depend on two licensees facing intense competition. The company also noted default exposure on $1.0 million of high-yield bonds held from one issuer.
- Management reported effective disclosure controls and no material change in internal control over financial reporting. It reported no material change to the risk factors in its 2011 Form 10-K and no legal proceeding it believed likely to seriously harm the business.
Important facts for investors to verify
- How much of future earnings and cash generation can be sustained without further patent sales.
- Whether biometrics software growth can offset weaker services and DSL-related revenue, and whether service margins recover.
- Future royalty receipts from Ikanos and Lantiq and the ongoing relevance of the existing agreements.
- Realizability of deferred tax assets, the status of the research-credit uncertainty, and the final cash tax burden related to patent gains.
- Collection and settlement of the remaining DSL hardware receivable and warranty obligations following the shutdown.
- Cash deployment after the special dividend, including any future distributions, investments, or financing needs.