Aware, Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; balance-sheet comparisons are with December 31, 2016. Aware develops and sells biometrics software and services, with additional imaging software and legacy DSL royalty revenue. Amounts below are in U.S. dollars; financial statement figures are in millions unless stated otherwise.
Financial results
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Revenue | $4.347 million | $4.834 million | Down 10% |
| Operating income | $0.386 million | $0.880 million | Down 56% |
| Net income | $0.405 million | $0.635 million | Down 36% |
| Diluted EPS | $0.02 | $0.03 | Lower |
| Operating margin | 8.9% | 18.2% | Down 9.3 percentage points |
| Operating cash flow | $0.018 million | $1.054 million | Down $1.036 million |
Calculated consolidated gross margin was approximately 89% versus 86% in Q1 2016, based on reported revenue less costs of software licenses, services, and hardware. Software license gross margin was 91% in both periods; services gross margin fell to 41% from 49%.
Revenue mix shifted: biometrics revenue rose to $4.003 million from $3.285 million, while imaging revenue fell to $0.310 million from $1.476 million. Software license revenue declined modestly overall to $2.686 million; maintenance was $1.253 million, services $0.374 million, hardware was nil, and royalties were $0.034 million.
Liquidity, balance sheet, and cash flow
- Cash and cash equivalents were $48.993 million at March 31, down $2.920 million from year-end. The company also held $0.996 million of available-for-sale corporate debt securities.
- Operating cash flow was nearly breakeven; investing cash use was $0.005 million. Financing cash use was $2.933 million, primarily due to $2.827 million of share repurchases and $0.119 million of employee tax withholding payments related to stock awards.
- Current assets were $52.683 million and current liabilities $3.761 million. No debt is reported on the balance sheet. Management said cash should fund operations for at least the next 12 months, while noting additional financing cannot be ruled out.
- Deferred tax assets increased to $5.802 million from $1.078 million at year-end. The company adopted ASU 2016-09 and recorded a $4.8 million deferred tax asset with an offsetting retained-earnings adjustment; no valuation allowance was recorded.
Material changes, outlook, and risks
- Management attributed lower revenue and operating income mainly to the absence of imaging revenue from a large prior-period license contract and no hardware sales, partly offset by higher biometrics licenses. Operating expenses also increased.
- Biometrics license growth was driven by government customers and channel partners. Q1 included a U.S. Marine Corps sale containing third-party software; Aware cannot predict whether the customer will buy it again. Commercial and Certisign revenue remained below expectations, and the Certisign rollout had not generated meaningful revenue.
- Services backlog was only $0.1 million. Management said services revenue is unlikely to return to 2014–2015 levels without new projects. It expects DSL royalties to continue declining and believes future Navy hardware orders may be minimal.
- Research and development expense rose 13% to $1.857 million. The company said remaining 2017 R&D expense may include an additional $0.550 million depending on contract milestones. Stock-based compensation related to a February award is expected to add approximately $0.098 million per quarter to G&A in each of the remaining three quarters.
- Q1 included $0.091 million of patent-related income under a third-party monetization arrangement; future proceeds are uncertain. The company also repurchased 593,719 shares for $2.827 million during the quarter, including 210,000 shares bought from a current director and former executive at a 10% discount to the prior-day closing price. Since the program began, it had repurchased 1,284,520 shares for $6.5 million; approximately $3.517 million remained authorized.
- Revenue standard ASC 606 was planned for adoption on January 1, 2018 using full retrospective application. Management’s preliminary assessment was that revenue would generally approximate current-GAAP results, but certain prior imaging-license revenue, royalty estimates, minimum-payment contracts, and sales acquisition costs could be affected; implementation was still in progress.
- Management identified interest-rate and default exposure in its investment portfolio, including $1.0 million in high-yield bonds with two corporate issuers maturing in 2017 and 2018. It reported no material change to the risk factors in its 2016 Form 10-K, no lawsuit believed likely to seriously harm the business, and effective disclosure controls.
Important facts for investors to verify
- Whether government biometrics license growth is repeatable and whether commercial customers, including Certisign, develop into meaningful revenue sources.
- New services-project wins, given the minimal backlog, and the expected trajectory of declining DSL royalties and Navy hardware demand.
- Execution and cost of the new product development work, including milestone-dependent R&D spending and the added stock-award expense.
- The final effects of ASC 606 adoption on historical revenue, royalties, minimum-payment contracts, and contract acquisition costs.
- Realizability of the $5.8 million deferred tax asset and the sustainability of cash generation after share repurchases.
- Future patent-monetization proceeds, remaining repurchase authorization, and the credit quality and maturity profile of the corporate bond investments.