AWARE INC /MA/ - Quarter Report: 2011 June (Form 10-Q)

Massachusetts	04-2911026
(State or Other Jurisdiction of	(I.R.S. Employer Identification No.)
Incorporation or Organization)

 

Class	Number of Shares Outstanding
Common Stock, par value $0.01 per share	20,573,688 shares

		June 30, 2011				December 31, 2010
ASSETS
Current assets:
Cash and cash equivalents		$	43,232			$	39,949
Accounts receivable, net			5,073				4,968
Inventories			1,413				1,863
Prepaid expenses and other current assets			240				235
Total current assets			49,958				47,015
Property and equipment, net			6,212				6,360
Other assets, net			17				25
Total assets		$	56,187			$	53,400
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	651			$	565
Accrued expenses			126				118
Accrued compensation			841				1,143
Accrued professional			278				427
Deferred revenue			1,208				944
Total current liabilities			3,104				3,197
Long-term deferred revenue			462				320
Stockholders’ equity:
Preferred stock, $1.00 par value; 1,000,000 shares authorized,              none outstanding			-				-
Common stock, $.01 par value; 70,000,000 shares authorized; issued              and outstanding 20,767,661 as of June 30, 2011 and 20,041,863              as of December 31, 2010			208				200
Additional paid-in capital			79,780				77,373
Accumulated deficit			(27,367	)			(27,690	)
Total stockholders’ equity			52,621				49,883
Total liabilities and stockholders’ equity		$	56,187			$	53,400

 

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2011				2010				2011				2010
Revenue:
Product sales		$	3,997			$	3,911			$	9,075			$	8,562
Services			1,375				346				2,204				555
Royalties			541				714				993				1,470
Total revenue			5,913				4,971				12,272				10,587
Costs and expenses:
Cost of product sales			1,087				840				2,308				1,877
Cost of services			450				74				807				145
Research and development			1,810				2,082				3,770				4,117
Selling and marketing			1,060				1,053				2,111				2,119
General and administrative			1,789				1,416				2,986				2,818
Total costs and expenses			6,196				5,465				11,982				11,076
Income (loss) from operations			(283	)			(494	)			290				(489	)
Other income			-				325				-				325
Interest income			16				21				35				39
Income (loss)  before provision for income taxes			(267	)			(148	)			325				(125	)
Provision for income taxes			-				-				2				1
Net income (loss)		$	(267	)		$	(148	)		$	323			$	(126	)
Net income (loss) per share – basic		$	(0.01	)		$	(0.01	)		$	0.02			$	(0.01	)
Net income (loss) per share – diluted		$	(0.01	)		$	(0.01	)		$	0.02			$	(0.01	)
Weighted average shares – basic			20,700				19,927				20,461				19,920
Weighted average shares - diluted			20,700				19,927				20,821				19,920

 

The accompanying notes are an integral part of the consolidated financial statements.

		Six Months Ended
		June 30,
		2011				2010
Cash flows from operating activities:
Net income (loss)		$	323			$	(126	)
Adjustments to reconcile net income (loss) to net cash    provided from (used) in operating activities:
Depreciation and amortization			244				260
Stock-based compensation			885				548
Increase (decrease) from changes in assets and liabilities:
Accounts receivable			(105	)			(968	)
Inventories			450				(220	)
Prepaid expenses and other current assets			(5	)			30
Accounts payable			86				337
Accrued expenses, compensation, and professional			(443	)			(107	)
Deferred revenue			406				92
Net cash provided from (used in) operating activities			1,841				(154	)
Cash flows from investing activities:
Purchases of property and equipment			(88	)			(67	)
Expenses from sale of assets			-				(100	)
Purchases of other assets			-				(60	)
Net cash used in investing activities			(88	)			(227	)
Cash flows from financing activities:
Proceeds from issuance of common stock			1,684				2
Shares surrendered by employees to pay taxes related to
unrestricted stock			(154	)			(161	)
Net cash provided by (used in) financing activities			1,530				(159	)
Increase (decrease)  in cash and cash equivalents			3,283				(540	)
Cash and cash equivalents, beginning of period			39,949				39,669
Cash and cash equivalents, end of period		$	43,232			$	39,129

 

A)

Basis of Presentation. The accompanying unaudited consolidated balance sheet, statements of operations, and statements of cash flows reflect all adjustments (consisting only of normal recurring items) which are, in the opinion of management, necessary for a fair presentation of financial position at June 30, 2011, and of operations and cash flows for the interim periods ended June 30, 2011 and 2010.

B)

Fair Value Measurements. The Financial Accounting Standards Board (“FASB”) issued authoritative guidance for fair value measurements, which defines fair value, establishes a framework for measuring fair value, and expands disclosures for assets and liabilities measured at fair value in financial statements. We adopted these provisions on January 1, 2008.

 

C)	Inventories. Inventories are stated at the lower of cost or net realizable value with cost being determined by the first-in, first-out (“FIFO”) method.  Inventory reserves are established for estimated excess and obsolete inventory. Inventories consist primarily of the following (in thousands):

		June 30, 2011			December 31, 2010
Raw materials		$	973		$	966
Finished goods			440			897
Total		$	1,413		$	1,863

D)

Computation of Earnings per Share. Basic earnings per share is computed by dividing net income or loss by the weighted average number of common shares outstanding.  Diluted earnings per share is computed by dividing net income or loss by the weighted average number of common shares outstanding plus additional common shares that would have been outstanding if dilutive potential common shares had been issued.  For the purposes of this calculation, stock options are considered common stock equivalents in periods in which they have a dilutive effect.  Stock options that are anti-dilutive are excluded from the calculation.

		Three Months Ended June 30,								Six Months Ended June 30,
		2011				2010				2011				2010
Net income (loss)		$	(267	)		$	(148	)		$	323			$	(126	)
Weighted average common shares outstanding			20,700				19,927				20,461				19,920
Additional dilutive common stock equivalents			-				-				360				-
Diluted shares outstanding			20,700				19,927				20,821				19,920
Net income (loss) per share – basic		$	(0.01	)		$	(0.01	)		$	0.02			$	(0.01	)
Net income (loss) per share – diluted		$	(0.01	)		$	(0.01	)		$	0.02			$	(0.01	)

E)	Stock-Based Compensation.  The following table presents stock-based employee compensation expenses included in our unaudited consolidated statements of operations (in thousands):

		Three Months Ended June 30,								Six Months Ended June 30,
		2011				2010				2011				2010
Cost of product sales		$	2			$	3			$	4			$	5
Cost of services			10				1				19				7
Research and development			64				54				131				169
Selling and marketing			22				13				44				51
General and administrative			484				132				687				316
Stock-based compensation expense		$	582			$	203			$	885			$	548

·	Stock options and SARS – No stock options or SARs were granted in the three or six month periods ended June 30, 2010 and 2011.

·

Unrestricted Stock Grants - In July 2010, we granted 575,443 shares of stock, including 102,040 shares to directors and 473,403 shares to officers and employees.  Shares granted to directors and one employee representing a total of 111,163 shares were issued to those individuals in August 2010, which resulted in a stock-based compensation charge of $281,000 during the three months ended September 30, 2010. All other shares granted to officers and employees representing a total of 464,280 shares were scheduled to be issued in four equal increments on December 31, 2010, June 30, 2011, December 31, 2011, and June 30, 2012; provided that grantees remain employed on each of those dates. The total stock-based compensation charge associated with this grant will be amortized into expense over the related two-year service period. We amortized $100,000 and $246,000 of stock-based compensation expense related to the officer and employee portion of the grant in the three and six month periods ended June 30, 2011, respectively. Based on a June 30, 2011 employee census, the total remaining stock-based compensation charge associated with this grant over the next four quarters is expected to be approximately $401,000.

·

Stock Option Exchange Program - In January 2010, we completed an employee option exchange program. Under the terms of the program, eligible rank and file employees had the right to exchange eligible vested and unvested stock options outstanding for shares of common stock. Exchange ratios for each eligible stock option were determined using the fair values of stock options and Aware’s common stock immediately prior to the initiation of the program. Employees exchanged 820,481 stock options for 178,314 shares of common stock.  Employees were also allowed to surrender a portion of their common stock in return for the Company paying their related withholding taxes. As a result of this provision, employees surrendered 60,659 shares of common stock and we paid approximately $161,000 of withholding taxes on their behalf. After the tax-related share surrender, 117,655 net shares of common stock were issued to participating employees.

F)	Business Segments. We manage the business as one segment and conduct our operations in the United States. We sell our products and technology to domestic and international customers.  Revenues were generated from the following geographic regions (in thousands):

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2011				2010				2011				2010
United States		$	2,969			$	2,959			$	6,614			$	6,411
Germany			583				799				942				1,443
Rest of World			2,361				1,213				4,716				2,733
		$	5,913			$	4,971			$	12,272			$	10,587

G)

Income Taxes. As of December 31, 2010, we had federal net operating loss (“NOLs”) and research and experimentation credit carryforwards of approximately $51.0 million and $13.5 million respectively, which may be available to offset future federal income tax liabilities and expire at various dates from 2011 through 2030.  In addition, at December 31, 2010, we had approximately $11.3 million and $7.3 million of state net operating losses and state research and development and investment tax carryforwards, respectively, which expire at various dates from 2011 through 2025.   We have recorded a full valuation allowance on all of our deferred tax assets.  We will release the valuation allowance when we are able to utilize NOLs and tax credit carryforwards by offsetting future taxable income.

Based on an analysis that we performed under Internal Revenue Code Section 382 on our NOLs generated for the period 1997 through 2010, we have not experienced a change in ownership as defined by Section 382, and, therefore, the NOLs are not currently under any Section 382 limitation.

H)	Recent Accounting Pronouncements.  As of the date of this report, new pronouncements issued, but not effective until after June 30, 2011, are not expected to have a material impact on our financial condition, results of operations, or disclosures.

 

I)

Spin-off Plans.  In September 2010, we announced plans to pursue a spin-off of our patent licensing operations. The spin-off would allow the spun-off entity to focus on patent licensing operations.  After the spin-off, Aware would continue as a supplier of test and diagnostics products and biometrics and imaging software.

 

 

 

Net income for the six months ended June 30, 2011 was $323,000, or $0.02 per share, which compares to a net loss of $126,000, or $0.01 per share, for the six months ended June 30, 2010.

For the six months ended June 30, 2011, product sales increased 6% from $8.6 million in 2010 to $9.1 million in 2011. As a percentage of total revenue, product sales decreased from 81% in the first six months of 2010 to 74% in the corresponding period of 2011. The dollar increase in product sales was primarily due to a $1.1 million increase in revenue from the sale of test and diagnostic hardware and software, which was partially offset by a $0.6 million decrease in revenue from the sale of biometrics software.  The $1.1 million increase in revenue from the sale of test and diagnostic products was mainly attributable to: 1) a $0.7 million increase in software revenue as a result of the sale of our LDP software to a European telephone company; and 2) a $0.4 million increase in hardware revenue. The $0.6 million decrease in revenue from the sale of biometrics software was primarily due to lower customer demand for these products in the current six month period.

For the three and six month periods, the dollar increase in services was primarily due to increases in revenue from the sale of biometrics engineering services. One of our strategic objectives over the last few years has been to increase revenue from biometrics engineering projects. Services revenue results in the current three and six month periods reflect initial success towards that goal. However, we are unable to predict whether services revenue will trend upward or downward in future periods as we continue to develop this business.

Our royalty revenue currently comes predominantly from DSL chipset sales by Ikanos Communications, Inc. (“Ikanos”) and Lantiq Deutschland GmbH (“Lantiq”). The sale of our DSL silicon IP assets in November 2009 did not alter the royalty obligations of Ikanos or Lantiq, which we expect to continue per the existing agreements with those parties. We remain uncertain as to whether these licensees will be able to maintain their market shares and chipset prices in the face of intense competition, and whether our relationships with them will contribute meaningful royalties to us in the future.  Accordingly, we are unable to predict whether royalties reported by our licensees will trend upward or downward in future periods.

For the six months ended June 30, 2011, cost of product sales increased 23% from $1.9 million in 2010 to $2.3 million in 2011. As a percentage of product sales, cost of product sales increased from 22% in the first six months of 2010 to 25% in the corresponding period of 2011, which means that product gross margins decreased from 78% to 75%. The cost of product sales dollar increase of $0.4 million was primarily due to: 1) $0.3 million of higher product costs driven by a $0.4 million increase in revenue from hardware product sales; and 2) $0.1 million of higher manufacturing period costs.  Product gross margins decreased from 78% to 75% primarily due to a greater proportion of hardware in the product sales mix in the current six month period.

Our research and development activities are focused primarily on developing: i) biometrics and imaging software; and ii) test and diagnostics hardware and software.

For the three and six month periods, unchanged sales and marketing expense reflected: 1) a stable sales and marketing organization; and 2) consistent levels of promotional activities.

For the three and six month periods, the dollar increase in general and administrative expense was primarily due to $0.6 million of severance related expenses that were incurred upon the resignation of our former President and CEO in April 2011.  Severance related expenses were partially offset by lower legal fees and compensation expenses for directors and officers.

Other Income.  Other income was $325,000 in the second quarter of 2010. This amount represents proceeds from a legal settlement with a former customer.

For the three and six month periods, the dollar decrease was primarily due to a decline in money market interest rates.

Due to the uncertainty surrounding the realization of our deferred tax assets, based principally on our historical operating losses, we have provided a full valuation allowance against our various tax attributes. We will assess the level of valuation allowance required in future periods. Should more positive than negative evidence regarding the realizability of tax attributes exist at a future point in time, the valuation allowance may be reduced or eliminated altogether. Reduction of the valuation allowance, in whole or in part, would result in a non-cash reduction in income tax expense during the period of reduction.

·	Cash and cash equivalents, which consist of financial instruments with original maturities of three months or less;

·	Short-term investments, which consist of financial instruments with remaining maturities of twelve months or less; and

·	Investments, which consist of financial instruments that mature in three years or less.

Exhibit 10.1*

Separation Agreement dated April 1, 2011 between Aware, Inc. and Edmund C. Reiter (filed as Exhibit 10.1 to the Company’s Form 8-K filed with the Securities and Exchange Commission on April 1, 2011 and incorporated herein by reference).

Exhibit 10.2*

Consulting Agreement dated April 1, 2011 between Aware, Inc. and Edmund C. Reiter (filed as Exhibit 10.2 to the Company’s Form 8-K filed with the Securities and Exchange Commission on April 1, 2011 and incorporated herein by reference).

Exhibit 31.1

Certification of co-Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

Exhibit 31.2

Certification of co-Chief Executive Officer and Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

Exhibit 32.1

Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

	AWARE, INC.
Date: July 27, 2011	By:		/s/ Kevin T. Russell
			Kevin T. Russell
			co-Chief Executive Officer & co-President
			General Counsel
Date: July 27, 2011	By:		/s/ Richard P. Moberg
			Richard P. Moberg,
			co-Chief Executive Officer & co-President
			Chief Financial Officer (Principal Financial and Accounting Officer)

 

 

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