AWARE INC /MA/ - Quarter Report: 2012 June (Form 10-Q)

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PART I	FINANCIAL INFORMATION
Item 1.	Unaudited Consolidated Financial Statements
	Consolidated Balance Sheets as of June 30, 2012 and December 31, 2011	3
	Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2012 and June 30, 2011	4
	Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2012 and June 30, 2011	5
	Notes to Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	13
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	20
Item 4.	Controls and Procedures	20
PART II	OTHER INFORMATION
Item 1.	Legal Proceedings	21
Item 1A.	Risk Factors	21
Item 4.	Mine Safety Disclosures	21
Item 6.	Exhibits	22
	Signatures	22

 

		June 30, 2012				December 31, 2011
ASSETS
Current assets:
Cash and cash equivalents		$	101,058			$	46,577
Accounts receivable, net			4,317				3,546
Inventories			265				547
Prepaid expenses and other current assets			238				213
Total current assets			105,878				50,883
Property and equipment, net			6,064				6,232
Investments			-				727
Other assets, net			1				9
Total assets		$	111,943			$	57,851
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	543			$	399
Accrued expenses			114				121
Accrued compensation			1,049				868
Accrued professional			226				109
Accrued income taxes			4,083				-
Deferred revenue			1,715				1,317
Total current liabilities			7,730				2,814
Long-term deferred revenue			358				462
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 22,260,377 as of June 30, 2012 and 20,622,889 as of December 31, 2011			223				206
Additional paid-in capital			98,218				79,512
Accumulated other comprehensive loss			-				(20	)
Retained earnings (accumulated deficit)			5,414				(25,123	)
Total stockholders’ equity			103,855				54,575
Total liabilities and stockholders’ equity		$	111,943			$	57,851

 

 

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2012				2011				2012				2011
Revenue:
Product sales		$	4,027			$	3,997			$	8,578			$	9,075
Services			683				1,375				1,375				2,204
Royalties			624				541				1,115				993
Total revenue			5,334				5,913				11,068				12,272
Costs and expenses:
Cost of product sales			830				1,087				1,290				2,308
Cost of services			361				450				717				807
Research and development			1,653				1,810				3,406				3,770
Selling and marketing			1,046				1,060				2,184				2,111
General and administrative			1,075				1,789				2,060				2,986
Total costs and expenses			4,965				6,196				9,657				11,982
Income (loss) from operations			369				(283	)			1,411				290
Gain on sale of patent assets			71,226				-				71,226				-
Other income			59				-				85				-
Interest income			40				16				92				35
Income (loss)  before provision for income taxes			71,694				(267	)			72,814				325
Provision for income taxes			16,768				-				16,770				2
Net income (loss)		$	54,926			($	267	)		$	56,044			$	323
Other comprehensive income, net of $0 tax:
Unrealized gains (loss) on available for sale securities			(39	)			-				20				-
Comprehensive income (loss)		$	54,887			($	267	)		$	56,064			$	323
Net income (loss) per share – basic		$	2.52			($	0.01	)		$	2.64			$	0.02
Net income (loss) per share – diluted		$	2.49			($	0.01	)		$	2.60			$	0.02
Weighted average shares – basic			21,757				20,700				21,241				20,461
Weighted average shares - diluted			22,099				20,700				21,583				20,821

 

 

 

		Six Months Ended
		June 30,
		2012				2011
Cash flows from operating activities:
Net income		$	56,044			$	323
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			235				244
Stock-based compensation			278				885
Gain on sale of patent assets			(71,226	)			-
Excess tax benefits from stock-based compensation			12,684				-
Amortization of discount on investments			(24	)			-
Gain on sale of investments			(85	)			-
Provision for doubtful accounts			4				-
Changes in assets and liabilities:
Accounts receivable			(775	)			(105	)
Inventories			282				450
Prepaid expenses and other current assets			(25	)			(5	)
Accounts payable			144				86
Accrued expenses, compensation, and professional			291				(443	)
Accrued income taxes			4,083				-
Deferred revenue			294				406
Net cash provided by operating activities			2,204				1,841
Cash flows from investing activities:
Purchases of property and equipment			(59	)			(88	)
Sales of investments			855				-
Proceeds from sale of patent assets, net			71,226				-
Net cash provided by (used in) investing activities			72,022				(88	)
Cash flows from financing activities:
Proceeds from issuance of common stock			5,798				1,684
Payment of dividends			(25,506	)			-
Shares surrendered by employees to pay taxes related to unrestricted stock			(37	)			(154	)
Net cash provided by (used in) financing activities			(19,745	)			1,530
Increase in cash and cash equivalents			54,481				3,283
Cash and cash equivalents, beginning of period			46,577				39,949
Cash and cash equivalents, end of period		$	101,058			$	43,232

 

 

 

 

A)

Basis of Presentation. The accompanying unaudited consolidated balance sheet, statements of comprehensive income, 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, 2012, and of operations and cash flows for the interim periods ended June 30, 2012 and 2011.

 

 

 

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. The fair value guidance establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value.  These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.

 

 

 

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, 2012				December 31, 2011
Raw materials		$	127			$	339
Finished goods			138				208
Total		$	265			$	547

 

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,
		2012				2011				2012				2011
Net income (loss)		$	54,926			($	267	)		$	56,044			$	323
Weighted-average common shares outstanding			21,757				20,700				21,241				20,461
Additional dilutive common stock equivalents			342				-				342				360
Diluted shares outstanding			22,099				20,700				21,583				20,821
Net income (loss) per share – basic		$	2.52			($	0.01	)		$	2.64			$	0.02
Net income (loss) per share – diluted		$	2.49			($	0.01	)		$	2.60			$	0.02

 

 

 

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

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2012				2011				2012				2011
Cost of product sales		$	1			$	2			$	1			$	4
Cost of services			6				10				12				19
Research and development			36				64				73				131
Selling and marketing			57				22				135				44
General and administrative			31				484				57				687
Stock-based compensation expense		$	131			$	582			$	278			$	885

 

 

 

 

●

Stock options and SARS – We granted stock options for 25,000 and 0 shares in the three months ended June 30, 2012 and 2011, respectively. We granted stock options for 50,000 and 0 shares in the six months ended June 30, 2012 and 2011, respectively. No SARs were granted in the three and six month periods ended June 30, 2012 and 2011.

 

●

Unrestricted Stock Grants - In July 2010, we granted 575,443 shares of stock to directors, officers and employees of which 111,163 shares were issued immediately and 464,280 shares were 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.  We expensed $94,000 and $100,000 of stock-based compensation expense related to this grant in the three months ended June 30, 2012 and 2011, respectively. We expensed $189,000 and $246,000 of stock-based compensation expense related to this grant in the six months ended June 30, 2012 and 2011, respectively.

 

 

●

Six months ended June 30, 2012 - We issued 76,906 shares on January 3, 2012 to officers and employees who were employed on December 31, 2011. Grantees were allowed to surrender a portion of their stock in return for the Company paying their related withholding taxes. As a result of this provision, grantees surrendered 12,153 shares of common stock and the Company paid approximately $36,000 of withholding taxes on their behalf. After the share surrender, 64,753 net shares of common stock were issued.

 

 

●

Six months ended June 30, 2011 - We issued 115,682 shares on January 4, 2011 to officers and employees who were employed on December 31, 2010. Grantees surrendered 13,721 shares of common stock and the Company paid approximately $39,000 of withholding taxes on their behalf. After the share surrender, 101,961 net shares of common stock were issued.

 

 

F)	Business Segments. We organize ourselves into multiple segments reporting to the chief operating decision makers.  Results of operations for our reportable segments were (in thousands):

 

		Segments
		Biometrics				DSL Service								Total
		& Imaging				Assurance				Corporate				Company
Three Months Ended June 30, 2012
Revenue		$	2,890			$	1,820			$	624			$	5,334
Income (loss) from operations			897				(262	)			(266	)			369
Gain on sale of patent assets											71,226				71,226
Other income											59				59
Interest income											40				40
Income before provision for income taxes															71,694
Provisions for income taxes											(16,768	)			(16,768	)
Net income														$	54,926
Three Months Ended June 30, 2011
Revenue		$	2,950			$	2,422			$	541			$	5,913
Income (loss) from operations			1,038				(420	)			(901	)			(283	)
Interest income											16				16
Loss before provision for income taxes															(267	)
Provisions for income taxes															-
Net loss														($	267	)

 

		Segments
		Biometrics				DSL Service								Total
		& Imaging				Assurance				Corporate				Company
Six Months Ended June 30, 2012
Revenue		$	6,560			$	3,393			$	1,115			$	11,068
Income (loss) from operations			2,614				(570	)			(633	)			1,411
Gain on sale of patent assets											71,226				71,226
Other income											85				85
Interest income											92				92
Income before provision for income taxes															72,814
Provisions for income taxes											(16,770	)			(16,770	)
Net income														$	56,044
Six Months Ended June 30, 2011
Revenue		$	5,855			$	5,425			$	992			$	12,272
Income (loss) from operations			2,065				(468	)			(1,307	)			290
Interest income											35				35
Income before provision for income taxes															325
Provisions for income taxes											(2	)			(2	)
Net income														$	323

 

 

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2012				2011				2012				2011
United States		$	3,571			$	2,969			$	7,030			$	6,614
Rest of World			1,763				2,944				4,038				5,658
		$	5,334			$	5,913			$	11,068			$	12,272

 

 

G)	Statement of Stockholders’ Equity. A statement of changes in stockholders’ equity for the six month period ended June 30, 2012 is as follows:

 

														Accumulated				Retained
										Additional				Other				Earnings/				Total
		Common Stock								Paid-In				Comprehensive				(Accumulated				Stockholders’
		Shares				Amount				Capital				Loss				Deficit)				Equity
Balance at December 31, 2011			20,623			$	206			$	79,512			($	20	)		($	25,123	)		$	54,575
Exercise of common stock options			1,570				16				5,770												5,786
Issuance of unrestricted stock			77				1				(1	)											-
Shares surrendered by employees to       pay taxes related to unrestricted stock			(12	)							(37	)											(37	)
Issuance of common stock under        employee stock purchase plan			2								12												12
Stock-based compensation expense											278												278
Tax benefits from stock-based awards											12,684												12,684
Dividend payment																			(25,507	)			(25,507	)
Accumulated other comprehensive loss															20								20
Net income																			56,044				56,044
Balance at June 30, 2012			22,260			$	223			$	98,218			$	-			$	5,414			$	103,855

 

H)

Recent Accounting Pronouncements.  We describe below recent pronouncements that have had or may have a significant effect on our financial statements. We do not discuss recent pronouncements that are not anticipated to have an impact on or are unrelated to our financial condition, results of operations, or disclosures.

 

As of the date of this report, new pronouncements issued, but not effective until after June 30, 2012, are not expected to have a material impact on our financial condition, results of operations, or disclosures.

 

I)

Sale of Patent Assets.  On April 26, 2012, we entered into an agreement to sell the portion of our patent portfolio pertaining to wireless technology for $75 million. The transaction closed on June 21, 2012.  The proceeds from the sale were reduced by $3.8 million of transaction costs, which consisted primarily of fees from the law firm that assisted us in the sale.

 

 

We intend to continue to pursue patent monetization alternatives for certain other patents remaining in our patent portfolio. We are unable to predict the size or the timing of any future potential transactions involving such patents or whether such transactions will be completed. We believe that the sale of wireless patents will have no material impact on our biometrics and imaging and DSL service assurance product lines, which we will continue after the patent sale.

 

J)

Income Taxes.  The gain on sale of patent assets was primarily responsible for producing $72.8 million of income before taxes in the six month period ended June 30, 2012. We used a significant portion our deferred tax assets available as of June 30, 2012 to reduce income taxes on year-to-date pre-tax earnings. Consequently, we recorded a $4.1 million income tax liability as of June 30, 2012, which consisted of $3.1 million of federal income taxes and $1.0 million of state income taxes.

 

A substantial portion of the deferred tax assets we utilized comprised cumulative deductions for stock options in excess of book expense. Under income tax accounting rules, that portion of tax benefits attributable to such deductions must be recorded as an adjustment to equity versus a reduction of income tax expense. In the three months ended June 30, 2012, the tax benefits from such stock-based awards were $12.7 million, which we recorded as an equity adjustment to additional paid-in capital. After the equity adjustment, we recorded $16.8 million of income tax expense in the statement of comprehensive income during the three months ended June 30, 2012.  The $16.8 million income tax expense consists of the $4.1 million current income tax liability plus the $12.7 million non-cash adjustment that was recorded to equity.

 

We continue to record a full valuation allowance against our remaining deferred tax assets because based on all the available evidence, we continue to believe that it is more likely than not that our deferred tax assets are not currently realizable.  In reaching this determination, we evaluated our three-year cumulative results as well as the impact that current economic conditions may have on our future results.

 

We will continue to assess the level of valuation allowance required in future periods. Should more positive than negative evidence regarding the realizability of tax assets exist at a future point in time, the valuation allowance may be reduced or eliminated altogether.

 

K)	Dividends.  In April 2012, our board of directors declared a special cash dividend of $1.15 per share. The dividend was paid on May 25, 2012 to shareholders of record as of May 11, 2012.  The total amount of the dividend paid was $25.5 million.

 

L)

Variable Interest Entity. We have a patent arrangement with a third party that we classify as a variable interest entity. We have no equity interest and are not contractually obligated to fund this entity; therefore our maximum exposure to loss as a result of our involvement with this entity is zero. We may receive royalties in the future if certain conditions are met.

 

 

M)

DSL Service Assurance Hardware Exit.  In January 2012, our Board of Directors approved the shutdown of our DSL service assurance hardware product line. We will continue to build and ship DSL service assurance hardware products to fulfill customer orders that were received as of the date of the shutdown notice. DSL hardware revenue and expenses will continue in 2012 until we complete the shutdown, which we currently anticipate will be during the third quarter of 2012.

 

 

 

 

		Balance												Balance												Balance
		December												March												June
		31, 2011				Expense				Utilization				31, 2012				Expense				Utilization				30, 2012
Exit costs		$	0			$	181			$	104			$	77			$	101				-			$	178

 

 

 

 

 

 

 

 

 

 

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2012				2011				2012				2011
Hardware revenue		$	1,255			$	1,603			$	2,084			$	3,353
Direct expenses			1,005				1,656				1,835				3,545
Income (loss) from operations		$	250			($	53	)		$	249			($	192	)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2012				2011				2012				2011
Research and development expense		$	1,654			$	1,809			$	3,406			$	3,770
Cost of services			361				450				717				807
Total engineering costs		$	2,015			$	2,259			$	4,123			$	4,577