Aware, Inc. — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014. Unaudited results; financial amounts below are in millions of dollars unless stated otherwise. Aware primarily develops and sells biometrics products and services, with smaller imaging and legacy DSL royalty streams. Its former DSL service assurance product line is reported as discontinued operations.
Financial results
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Revenue | $6.03 | $4.31 | $19.41 | $13.72 |
| Operating income | $4.16 | $1.04 | $6.85 | $4.56 |
| Income from continuing operations | $2.60 | $0.79 | $4.34 | $3.23 |
| Net income (loss) | $2.60 | ($1.15) | $4.34 | $1.01 |
| Diluted EPS | $0.11 | ($0.05) | $0.19 | $0.04 |
- Revenue rose about 40% year over year in Q3 and 41% for the nine-month period. Biometrics revenue was $5.51 million in Q3 and $17.72 million year to date.
- Q3 operating income included $2.13 million of patent-related income from a patent portfolio sale. The sale generated $2.6 million gross proceeds, less $0.5 million in transaction costs. Excluding that gain, operating income was approximately $2.03 million for Q3 and $4.72 million for the first nine months.
- Q3 service revenue increased 68% to $1.59 million; service gross margin rose to 61% from 48%. Nine-month service revenue increased 89% to $3.93 million, with gross margin of 57% versus 50%. Hardware gross margin was 32% in Q3 and 29% year to date.
- Cash provided by operations was $5.56 million for the first nine months, compared with $5.67 million in 2013. Investing activities provided $3.45 million; financing activities used $38.16 million, primarily due to a $39.91 million special dividend.
- Cash and cash equivalents were $43.51 million at September 30, down from $72.66 million at year-end 2013. Current assets were $48.11 million and current liabilities $3.71 million. The balance sheet reports no borrowings or other debt.
Changes and management commentary
- Q3 growth reflected higher software-license and service revenue, including a large U.S. government license sale and a significant government project continuing from 2013. Nine-month hardware sales rose to $4.81 million from $1.13 million, largely due to increased unit orders.
- Research and development expense increased 32% in Q3 and 33% year to date as Aware expanded engineering capacity and invested in new and existing products. Engineering headcount rose from 30 at June 30, 2013 to 46 at September 30, 2014.
- Q3 2013 and nine-month 2013 results included discontinued-operation losses of $1.94 million and $2.22 million, respectively; there were no such losses in 2014. This contributes to the reported year-over-year net-income change.
- Management believes existing cash is sufficient to fund operations for at least 12 months, while noting additional financing cannot be ruled out. No specific revenue or earnings guidance is provided.
Risks, contingencies, and notable items
- Hardware sales depend on purchase orders from a single U.S. government customer; the contract does not obligate purchases, and management says demand is difficult to forecast. Management expects legacy DSL royalties to decline.
- Aware may receive uncertain future proceeds under a patent monetization arrangement. A patent claim rejection was affirmed by the Patent Trial and Appeal Board and is under appeal to the Federal Circuit; future monetization is uncertain.
- The IRS began examining Aware’s 2012 tax return in Q3. Management reported no material change to the risk factors in its 2013 Form 10-K and said it was not party to a proceeding likely to seriously harm the business.
- The company is evaluating the impact of the new revenue-recognition standard, effective for annual periods beginning after December 15, 2016; early adoption is not permitted.
- Management concluded disclosure controls were effective and reported no materially affecting change in internal control over financial reporting.
Investor verification priorities
- Assess recurring operating performance separately from the $2.13 million patent gain and the prior-year discontinued-operation losses.
- Verify the sustainability and timing of biometrics license and services revenue, including dependence on government projects and the single hardware customer.
- Track cash use after the special dividend, future liquidity needs, and the expected decline in DSL royalties.
- Monitor engineering investment and new-product progress, the IRS examination, and the patent appeal and related monetization prospects.