ITEM 1: CONSOLIDATED
FINANCIAL STATEMENTS
AWARE, INC.
CONSOLIDATED BALANCE
SHEETS
(in thousands,
except share data)
(unaudited)
|
|
June 30,
2017
|
|
|
December 31,
2016
|
|
ASSETS
|
|
|
|
|
|
|
|
|
Current assets:
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
49,425
|
|
|
$
|
51,913
|
|
Accounts receivable, net
|
|
|
3,321
|
|
|
|
3,016
|
|
Prepaid expenses and other current assets
|
|
|
272
|
|
|
|
268
|
|
Total current assets
|
|
|
53,018
|
|
|
|
55,197
|
|
|
|
|
|
|
|
|
|
|
Property and equipment, net
|
|
|
4,479
|
|
|
|
4,634
|
|
Investments
|
|
|
-
|
|
|
|
951
|
|
Deferred tax assets
|
|
|
5,843
|
|
|
|
1,078
|
|
Other assets
|
|
|
71
|
|
|
|
124
|
|
Total assets
|
|
$
|
63,411
|
|
|
$
|
61,984
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS’ EQUITY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$
|
200
|
|
|
$
|
135
|
|
Accrued expenses
|
|
|
1,124
|
|
|
|
1,075
|
|
Deferred revenue
|
|
|
2,136
|
|
|
|
2,722
|
|
Total current liabilities
|
|
|
3,460
|
|
|
|
3,932
|
|
|
|
|
|
|
|
|
|
|
Long-term deferred revenue
|
|
|
155
|
|
|
|
211
|
|
|
|
|
|
|
|
|
|
|
Commitments and contingent liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 21,675,149 as of June 30, 2017 and 22,370,713 as of December 31, 2016
|
|
|
217
|
|
|
|
224
|
|
Additional paid-in capital
|
|
|
97,037
|
|
|
|
100,485
|
|
Accumulated other comprehensive loss
|
|
|
-
|
|
|
|
(19
|
)
|
Accumulated deficit
|
|
|
(37,458
|
)
|
|
|
(42,849
|
)
|
Total stockholders’ equity
|
|
|
59,796
|
|
|
|
57,841
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and stockholders’ equity
|
|
$
|
63,411
|
|
|
$
|
61,984
|
|
The accompanying notes are an integral
part of the consolidated financial statements.
AWARE, INC.
CONSOLIDATED STATEMENTS OF INCOME AND
COMPREHENSIVE INCOME
(in thousands, except
per share data)
(unaudited)
|
|
Three Months Ended
June 30,
|
|
|
Six Months Ended
June 30,
|
|
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
Revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Software licenses
|
|
$
|
1,214
|
|
|
$
|
5,347
|
|
|
$
|
3,900
|
|
|
$
|
8,121
|
|
Software maintenance
|
|
|
1,282
|
|
|
|
1,181
|
|
|
|
2,534
|
|
|
|
2,462
|
|
Services
|
|
|
206
|
|
|
|
216
|
|
|
|
580
|
|
|
|
635
|
|
Hardware
|
|
|
-
|
|
|
|
31
|
|
|
|
-
|
|
|
|
317
|
|
Royalties
|
|
|
43
|
|
|
|
129
|
|
|
|
78
|
|
|
|
203
|
|
Total revenue
|
|
|
2,745
|
|
|
|
6,904
|
|
|
|
7,092
|
|
|
|
11,738
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Costs and expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of software licenses
|
|
|
-
|
|
|
|
858
|
|
|
|
247
|
|
|
|
1,101
|
|
Cost of services
|
|
|
104
|
|
|
|
158
|
|
|
|
320
|
|
|
|
372
|
|
Cost of hardware
|
|
|
-
|
|
|
|
29
|
|
|
|
-
|
|
|
|
234
|
|
Research and development
|
|
|
1,876
|
|
|
|
1,802
|
|
|
|
3,733
|
|
|
|
3,451
|
|
Selling and marketing
|
|
|
1,024
|
|
|
|
1,111
|
|
|
|
1,966
|
|
|
|
2,031
|
|
General and administrative
|
|
|
816
|
|
|
|
872
|
|
|
|
1,605
|
|
|
|
1,595
|
|
Total costs and expenses
|
|
|
3,820
|
|
|
|
4,830
|
|
|
|
7,871
|
|
|
|
8,784
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Patent related income
|
|
|
1,313
|
|
|
|
-
|
|
|
|
1,403
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
|
238
|
|
|
|
2,074
|
|
|
|
624
|
|
|
|
2,954
|
|
Other income
|
|
|
36
|
|
|
|
-
|
|
|
|
36
|
|
|
|
-
|
|
Interest income
|
|
|
88
|
|
|
|
72
|
|
|
|
172
|
|
|
|
138
|
|
Income before provision for income taxes
|
|
|
362
|
|
|
|
2,146
|
|
|
|
832
|
|
|
|
3,092
|
|
Provision for income taxes
|
|
|
134
|
|
|
|
710
|
|
|
|
198
|
|
|
|
1,022
|
|
Net income
|
|
$
|
228
|
|
|
$
|
1,436
|
|
|
$
|
634
|
|
|
$
|
2,070
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per share – basic
|
|
$
|
0.01
|
|
|
$
|
0.06
|
|
|
$
|
0.03
|
|
|
$
|
0.09
|
|
Net income per share – diluted
|
|
$
|
0.01
|
|
|
$
|
0.06
|
|
|
$
|
0.03
|
|
|
$
|
0.09
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average shares – basic
|
|
|
21,774
|
|
|
|
22,964
|
|
|
|
22,013
|
|
|
|
22,978
|
|
Weighted-average shares - diluted
|
|
|
21,919
|
|
|
|
23,124
|
|
|
|
22,119
|
|
|
|
23,064
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
228
|
|
|
$
|
1,436
|
|
|
$
|
634
|
|
|
$
|
2,070
|
|
Other comprehensive income (net of tax):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized gains (losses) on available for sale securities
|
|
|
(9
|
)
|
|
|
(9
|
)
|
|
|
19
|
|
|
|
(12
|
)
|
Comprehensive income
|
|
$
|
219
|
|
|
$
|
1,427
|
|
|
$
|
653
|
|
|
$
|
2,058
|
|
The accompanying notes are an integral
part of the consolidated financial statements.
AWARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
|
|
Six Months Ended
|
|
|
|
June 30,
|
|
|
|
2017
|
|
|
2016
|
|
Cash flows from operating activities:
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
634
|
|
|
$
|
2,070
|
|
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
260
|
|
|
|
324
|
|
Stock-based compensation
|
|
|
267
|
|
|
|
190
|
|
Deferred tax provision (benefit) on other comprehensive income
|
|
|
(9
|
)
|
|
|
6
|
|
Amortization of discount on investments
|
|
|
(4
|
)
|
|
|
(6
|
)
|
Gain on sale of investments
|
|
|
(36
|
)
|
|
|
-
|
|
Changes in assets and liabilities:
|
|
|
|
|
|
|
|
|
Accounts receivable
|
|
|
(305
|
)
|
|
|
(815
|
)
|
Prepaid expenses and other current assets
|
|
|
(4
|
)
|
|
|
14
|
|
Deferred tax assets
|
|
|
(7
|
)
|
|
|
1
|
|
Accounts payable
|
|
|
65
|
|
|
|
821
|
|
Accrued expenses
|
|
|
49
|
|
|
|
39
|
|
Accrued income taxes
|
|
|
-
|
|
|
|
(236
|
)
|
Deferred revenue
|
|
|
(642
|
)
|
|
|
(1,398
|
)
|
Net cash provided by operating activities
|
|
|
268
|
|
|
|
1,010
|
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities:
|
|
|
|
|
|
|
|
|
Purchases of property and equipment
|
|
|
(53
|
)
|
|
|
(54
|
)
|
Sales of investments
|
|
|
1,019
|
|
|
|
-
|
|
Net cash provided from (used) in investing activities
|
|
|
966
|
|
|
|
(54
|
)
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities:
|
|
|
|
|
|
|
|
|
Proceeds from issuance of common stock
|
|
|
43
|
|
|
|
21
|
|
Excess tax benefits from stock-based compensation
|
|
|
-
|
|
|
|
457
|
|
Payments made for taxes of employees who surrendered shares related to unrestricted stock
|
|
|
(119
|
)
|
|
|
(61
|
)
|
Repurchase of common stock
|
|
|
(3,646
|
)
|
|
|
(349
|
)
|
Net cash provided by (used in) financing activities
|
|
|
(3,722
|
)
|
|
|
68
|
|
|
|
|
|
|
|
|
|
|
Increase (decrease) in cash and cash equivalents
|
|
|
(2,488
|
)
|
|
|
1,024
|
|
Cash and cash equivalents, beginning of period
|
|
|
51,913
|
|
|
|
51,232
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents, end of period
|
|
$
|
49,425
|
|
|
$
|
52,256
|
|
|
|
|
|
|
|
|
|
|
Supplemental disclosure:
|
|
|
|
|
|
|
|
|
Cash paid for income taxes
|
|
$
|
275
|
|
|
$
|
833
|
|
The accompanying notes are an integral
part of the consolidated financial statements.
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
|
A)
|
Nature of Business.
We
are a leading provider of software and services to the biometrics industry. Our software
products are used in government and commercial biometrics systems, which are capable
of determining or verifying an individual’s identity. We also offer engineering
services related to software customization, integration, and installation, as well as
complete systems development. We sell our biometrics software products and services globally
through systems integrators, OEMs, and directly to end user customers. We also derive
a portion of our revenue from the sale of imaging software.
|
|
B)
|
Basis of Presentation.
The accompanying unaudited consolidated financial statements have been prepared in accordance
with the instructions for Form 10-Q and therefore do not include all information and
notes necessary for a complete presentation of our financial position, results of operations
and cash flows, in conformity with generally accepted accounting principles. We filed
audited financial statements which included all information and notes necessary for such
presentation for the three years ended December 31, 2016 in conjunction with our 2016
Annual Report on Form 10-K. This Form 10-Q should be read in conjunction with that Form
10-K.
|
The accompanying unaudited
consolidated balance sheets, statements of income and 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, 2017, and of operations and cash flows for the interim periods ended June 30, 2017 and 2016.
The results of operations for
the interim period ended June 30, 2017 are not necessarily indicative of the results to be expected for the year.
|
C)
|
Fair Value Measurements.
The
Financial Accounting Standards Board (“FASB”) Codification defines fair value,
and establishes a fair value hierarchy that prioritizes the inputs to valuation techniques
used to measure fair value. The hierarchy gives the highest priority to the unadjusted
quoted prices in active markets for identical assets or liabilities (level 1 measurements)
and the lowest priority to unobservable inputs (level 3 measurements). The three levels
of the fair value hierarchy under the FASB Codification are: i) Level 1 – valuations
that are based on quoted prices (unadjusted) in active markets for identical assets or
liabilities that the reporting entity has the ability to access at the measurement date;
ii) Level 2 – valuations that are based on quoted prices in markets that are not
active or for which all significant inputs are observable, either directly or indirectly;
and iii) Level 3 – valuations that require inputs that are both significant to
the fair value measurement and unobservable.
|
Cash and cash equivalents,
which primarily include money market mutual funds, were $49.4 million and $51.9 million as of June 30, 2017 and December 31, 2016,
respectively. We classified our cash equivalents of $47.4 million and $49.8 million as of June 30, 2017 and December 31, 2016
within Level 1 of the fair value hierarchy because they are valued using quoted market prices.
Our investments, which consist
of high yield corporate debt securities, are also classified within Level 1 of the fair value hierarchy because they are valued
using quoted market prices. We categorize our investments as available-for-sale securities, and carry them at fair value in our
financial statements. We had $1.0 million of available-for-sale investments as of December 31, 2016.
As of June 30, 2017, our assets
that are measured at fair value on a recurring basis and whose carrying values approximate their respective fair values include
the following (in thousands):
|
|
Fair Value Measurement at June 30, 2017 Using:
|
|
|
|
Quoted Prices in
Active Markets for
Identical Assets
|
|
|
Significant Other
Observable Inputs
|
|
|
Significant
Unobservable
Inputs
|
|
|
|
(Level 1)
|
|
|
(Level 2)
|
|
|
(Level 3)
|
|
Corporate debt securities
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
Money market funds (included in cash and cash equivalents)
|
|
|
47,411
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
47,411
|
|
|
$
|
-
|
|
|
$
|
-
|
|
As of December 31, 2016, our
assets that are measured at fair value on a recurring basis and whose carrying values approximate their respective fair values
include the following (in thousands):
|
|
Fair Value Measurement at December 31, 2016 Using:
|
|
|
|
Quoted Prices in
Active Markets for
Identical Assets
|
|
|
Significant Other
Observable Inputs
|
|
|
Significant
Unobservable
Inputs
|
|
|
|
(Level 1)
|
|
|
(Level 2)
|
|
|
(Level 3)
|
|
Corporate debt securities
|
|
$
|
951
|
|
|
$
|
-
|
|
|
$
|
-
|
|
Money market funds (included in cash and cash equivalents)
|
|
|
49,839
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
50,790
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
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.
|
Net income per share is calculated as follows (in
thousands, except per share data):
|
|
Three Months Ended
June 30,
|
|
|
Six Months Ended
June 30,
|
|
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
228
|
|
|
$
|
1,436
|
|
|
$
|
634
|
|
|
$
|
2,070
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average common shares outstanding
|
|
|
21,774
|
|
|
|
22,964
|
|
|
|
22,013
|
|
|
|
22,978
|
|
Additional dilutive common stock equivalents
|
|
|
145
|
|
|
|
160
|
|
|
|
106
|
|
|
|
86
|
|
Diluted shares outstanding
|
|
|
21,919
|
|
|
|
23,124
|
|
|
|
22,119
|
|
|
|
23,064
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per share – basic
|
|
$
|
0.01
|
|
|
$
|
0.06
|
|
|
$
|
0.03
|
|
|
$
|
0.09
|
|
Net income per share - diluted
|
|
$
|
0.01
|
|
|
$
|
0.06
|
|
|
$
|
0.03
|
|
|
$
|
0.09
|
|
For the three and six month
periods ended June 30, 2016, options to purchase 54,034 shares of common stock were outstanding, but were not included in the
computation of diluted EPS because the options’ exercise prices were greater than the average market price of the common
stock and thus would be anti-dilutive.
|
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,
|
|
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of services
|
|
$
|
2
|
|
|
$
|
3
|
|
|
$
|
4
|
|
|
$
|
3
|
|
Research and development
|
|
|
36
|
|
|
|
28
|
|
|
|
48
|
|
|
|
30
|
|
Selling and marketing
|
|
|
4
|
|
|
|
4
|
|
|
|
6
|
|
|
|
4
|
|
General and administrative
|
|
|
154
|
|
|
|
147
|
|
|
|
209
|
|
|
|
153
|
|
Stock-based compensation expense
|
|
$
|
196
|
|
|
$
|
182
|
|
|
$
|
267
|
|
|
$
|
190
|
|
Stock Option Grants
.
We may grant stock options under our 2001 Nonqualified Stock Plan although we have not granted any stock options since the first
quarter of 2012. When we grant stock options, we estimate their fair value using the Black-Scholes valuation model. This valuation
model takes into account the exercise price of the award, as well as a variety of significant assumptions. The assumptions used
to estimate the fair value of stock options include the expected term, the expected volatility of our stock over the expected
term, the risk-free interest rate over the expected term, and our expected annual dividend yield. We believe that the valuation
technique and the approach utilized to develop the underlying assumptions are appropriate in calculating the fair values of our
stock options. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by persons
who receive equity awards.
Unrestricted Stock Grants
.
We also grant unrestricted shares of stock under our 2001 Nonqualified Stock Plan. Stock-based compensation expense for stock
grants is determined based on the fair market value of our stock on the date of grant, provided the number of shares in the grant
is fixed on the grant date.
We granted shares of unrestricted
stock in 2017 and 2016 that affected financial results for the three and six month periods ended June 30, 2017 and 2016. These
grants are described below.
2017 Grant.
On February
27, 2017, we granted 134,000 shares of unrestricted stock to directors, officers and employees. The shares will be issued in two
equal installments shortly after June 30, 2017 and December 31, 2017, provided each grantee is serving as a director, officer
or employee on those dates. The total stock-based compensation expense related to this grant is $663,000, of which $196,000 and
$267,000 was charged to expense in the three and six months ended June 30, 2017 and we anticipate the remaining $396,000 will
be charged to expense ratably over the remaining two quarters of 2017.
2016 Grant
. In March 2016,
we granted 152,000 shares of unrestricted stock to directors, officers and employees. The shares were issued in two equal installments
shortly after June 30, 2016 and December 31, 2016. We expensed the entire $558,000 stock-based compensation expense related to
this grant in 2016. We issued shares of common stock related to this grant as follows: i) 58,902 net shares of common stock were
issued in early July 2016 after employees surrendered 17,098 shares for which we paid $74,000 of withholding taxes on their behalf;
and ii) 56,443 net shares of common stock were issued in early January 2017 after employees surrendered 19,557 shares for which
we paid $119,000 of withholding taxes on their behalf.
|
F)
|
Business Segments
. We
organize ourselves into a single segment that reports to the chief operating decision
maker.
|
We conduct our operations in
the United States and sell our products and services to domestic and international customers. Revenues were generated from the
following geographic regions for the three and six months ended June 30, 2017 and 2016 (in thousands):
|
|
Three Months Ended
|
|
|
Six Months Ended
|
|
|
|
June 30,
|
|
|
June 30,
|
|
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States
|
|
$
|
1,870
|
|
|
$
|
6,180
|
|
|
$
|
5,113
|
|
|
$
|
9,920
|
|
Rest of World
|
|
|
875
|
|
|
|
724
|
|
|
|
1,979
|
|
|
|
1,818
|
|
|
|
$
|
2,745
|
|
|
$
|
6,904
|
|
|
$
|
7,092
|
|
|
$
|
11,738
|
|
Revenue by product group for
the three months ended June 30, 2017 and 2016 was (in thousands):
|
|
Three Months Ended
|
|
|
Six Months Ended
|
|
|
|
June 30,
|
|
|
June 30,
|
|
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Biometrics
|
|
$
|
2,488
|
|
|
$
|
5,443
|
|
|
$
|
6,491
|
|
|
$
|
8,727
|
|
Imaging
|
|
|
214
|
|
|
|
1,332
|
|
|
|
524
|
|
|
|
2,808
|
|
DSL royalties
|
|
|
43
|
|
|
|
129
|
|
|
|
77
|
|
|
|
203
|
|
|
|
$
|
2,745
|
|
|
$
|
6,904
|
|
|
$
|
7,092
|
|
|
$
|
11,738
|
|
|
G)
|
Recent Accounting Pronouncements.
|
|
|
FASB ASU No. 2014-09. In May 2014, the
FASB issued Accounting Standard Update No. 2014-09, Revenue from Contracts with Customers
(Topic 606). The ASU is the result of a joint project by the FASB and the International
Accounting Standards Board (“IASB”) to clarify the principles for recognizing
revenue and to develop a common revenue standard for GAAP and International Financial
Reporting Standards (“IFRS”) that would: remove inconsistencies and weaknesses,
provide a more robust framework for addressing revenue issues, improve comparability
of revenue recognition practices across entities, jurisdictions, industries, and capital
markets, improve disclosure requirements and resulting financial statements, and simplify
the presentation of financial statements. The core principle of the new guidance is that
an entity should recognize revenue to depict the transfer of promised goods or services
to customers in an amount that reflects the consideration to which the entity expects
to be entitled in exchange for those goods or services. The ASU is effective for annual
reporting periods beginning after December 15, 2016. Early adoption is not permitted.
On July 9, 2015, the FASB voted to delay the effective date of the new revenue standard
by one year, but to permit entities to choose to adopt the standard as of the original
effective date.
|
|
|
We have begun to evaluate the effect
the new revenue standard will have on our consolidated financial statements and related
disclosures, but have not completed our evaluation and implementation process. We intend
to complete that process during 2017 and adopt the new standard on January 1, 2018 using
the full retrospective adoption transition method. Based on our preliminary evaluations
to date, we believe that revenue recognized under the new standard will generally approximate
revenue recognized under current GAAP with the exception of the following expected significant
differences:
|
|
i)
|
2015 imaging software license
contract
. We consummated a $4.625 million license contract in October 2015 that included
a $4.5 million license fee plus a $125,000 software maintenance fee. We delivered the
licensed software and the customer paid us in the fourth quarter of 2015. Under current
GAAP, we were unable to establish vendor specific objective evidence ("VSOE")
for the maintenance element and, as a result we recognized the total fee ratably over
the twelve-month period that ran from October 2015 to October 2016. Under the new standard,
license revenue from that contract will be recognized in 2015 when control over the software
was transferred to the customer. That change will have a material impact on our 2015
and 2016 financial statements.
|
|
ii)
|
DSL
royalty contracts
. Under our current revenue recognition policy, we recognize DSL
royalty revenue in the period in which we receive royalty reports, which is typically
in the quarter immediately following the quarter in which sales of royalty-bearing products
occurred. Under the new standard, we will be required to make estimates of royalties
earned in the current period and record royalty revenue based on those estimates.
|
|
iii)
|
Minimum license/royalty payment
contracts
. Some of our revenue contracts require customers to make minimum license/royalty
payments. Under current GAAP, we recognize that revenue when those minimum payments become
due. Under the new standard, we may have to recognize the expected minimum payments in
the period in which such contracts are signed.
|
|
iv)
|
Sales commissions and other
third party acquisition costs.
Under current GAAP, sales commissions and other third
party acquisition costs resulting directly from securing contracts with customers are
currently expensed as incurred. ASC 606 will require these costs to be recognized as
an asset when incurred and expensed over an amortization period. As a practical expedient,
if the term of the contract is one year or less, the Company will expense the costs as
incurred. The Company is currently assessing the impact of the cost guidance.
|
|
|
The foregoing observations are subject
to change as we complete our implementation process.
|
|
|
FASB ASU No. 2016-09.
In March
2016, the FASB issued Accounting Standard Update No. 2016-09, “Improvements to
Employee Share-Based Payment Accounting,” which is intended to simplify various
aspects of how share-based payments are accounted for and presented in financial statements.
The standard is effective prospectively for fiscal years, and interim periods within
those fiscal years, beginning after December 15, 2016, with early adoption permitted.
|
|
|
The new standard contains several amendments
that will simplify the accounting for employee share-based payment transactions, including
the accounting for income taxes, forfeitures, statutory tax withholding requirements,
classification of awards as either equity or liabilities, and classification on the statement
of cash flows. The changes in the new standard eliminate the accounting for excess tax
benefits to be recognized in additional paid-in capital and tax deficiencies recognized
either in the income tax provision or in additional paid-in capital. In addition, the
new standard eliminates the limitation on recognition of excess stock compensation benefits
until such benefits are actually realized, and instead applies the general recognition
standard to these deferred tax assets. We adopted ASU 2016-09 in the first quarter of
2017 which will be applied using a modified retrospective approach. Upon adoption, we
recorded a deferred tax asset of $4.8 million with an offsetting adjustment to retained
earnings related to excess stock compensation deductions that were not previously recorded
as tax assets. For the six month period ended June 30, 2017, we recognized all excess
tax benefits and tax deficiencies as income tax expense or benefit as a discrete event.
We have elected to present the cash flow statement on a prospective transition method
and no prior periods have been adjusted.
|
|
|
FASB ASU No. 2016-13.
In June
2016, the FASB issued Accounting Standard Update No. 2016-13, “Financial Instruments
- Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.”
This new standard replaces the incurred loss impairment methodology in current GAAP with
a methodology that reflects expected credit losses and requires consideration of a broader
range of reasonable and supportable information to inform credit loss estimates. For
trade and other receivables, loans, and other financial instruments, entities will be
required to use a forward-looking expected loss model rather than the incurred loss model
for recognizing credit losses which reflects losses that are probable. Credit losses
relating to available-for-sale debt securities will also be recorded through an allowance
for credit losses rather than as a reduction in the amortized cost basis of the securities.
This standard is effective for fiscal years beginning after December 15, 2019 with early
adoption permitted in fiscal years beginning after December 15, 2018. We are currently
evaluating the effect this standard will have on our consolidated financial statements
and related disclosures.
|
With the exception of the standards
discussed above, there have been no other recently issued accounting pronouncements that are of significance or potential significance
to us that we have not adopted as of June 30, 2017.
|
H)
|
Income
Taxes
.
Income
tax expense was $0.1 million and $0.7 million for the three months ended June 30, 2017
and 2016, respectively. Income tax expense was $0.2 and $1.0 million for the six months
ended June 30, 2017 and 2016, respectively. Income tax expense in the three and six month
periods of 2017 and 2016 was based on the U.S. statutory rate of 34%, increased by state
income taxes, and reduced by permanent adjustments and research tax credits.
|
In
the six month period ended June 30, 2016, we utilized deferred tax assets to reduce our tax liability payable to the government.
A portion of the deferred tax assets we used comprised cumulative deductions for stock options in excess of book expense. Under
income tax accounting rules at that time, that portion of tax benefits attributable to such deductions must be recorded as an
adjustment to equity versus a reduction of income tax expense. The tax benefits from such stock-based awards were $0.5 million
in the six month period ended June 30, 2016. These tax benefits were recorded as an equity adjustment to additional paid-in capital.
For the six month period ended June 30, 2017, we
recognized all excess tax benefits and tax deficiencies as income tax expense or benefit as a discrete event.
As
of June 30, 2017, we had a total of $5.8 million of deferred tax assets for which we had recorded no valuation allowance. We have
assessed the need for a valuation allowance on our deferred tax assets. Based on our assessment of future sources of income,
including reversing deferred tax liabilities, and future earnings, we have determined that it is more likely than not that the
deferred tax assets will be realized, and therefore there is no valuation allowance required for the deferred tax assets. We will
continue to assess the level of valuation allowance in future periods. Should evidence regarding the realizability of tax assets
change at a future point in time, the valuation allowance will be adjusted accordingly.
In the second quarter of 2017,
the Internal Revenue Service commenced an examination of our tax return for the year ended December 31, 2015.
I)
Accumulated Other Comprehensive Loss.
The components of accumulated other comprehensive loss and activity were as follows
(in thousands):
|
|
December 31,
|
|
|
Increase/
|
|
|
Reclassification
|
|
|
June 30,
|
|
|
|
2016
|
|
|
Decrease
|
|
|
Adjustments
|
|
|
2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized losses on available for sale securities
|
|
$
|
(45
|
)
|
|
$
|
21
|
|
|
$
|
24
|
|
|
$
|
-
|
|
Unrealized gains on available for sale securities
|
|
|
17
|
|
|
|
21
|
|
|
|
(38
|
)
|
|
|
-
|
|
Net unrealized gains (losses) on available for sale securities
|
|
|
(28
|
)
|
|
|
42
|
|
|
|
(14
|
)
|
|
|
-
|
|
Income tax benefit (expense) on other comprehensive loss
|
|
|
9
|
|
|
|
(14
|
)
|
|
|
5
|
|
|
|
-
|
|
Total accumulated other comprehensive income (loss), net of taxes
|
|
$
|
(19
|
)
|
|
$
|
28
|
|
|
$
|
(
9
|
)
|
|
|
-
|
|
All amounts reclassified from
accumulated other comprehensive income were related to realized gains on available-for-sale securities. These reclassifications
impacted "other income" on the Consolidated Statements of Income and Other Comprehensive Income.
J)
Share Repurchase Program.
On April 26, 2016, we announced that our Board of Directors had approved a program authorizing
the Company to purchase up to $10 million of our common stock. The shares may be purchased from time to time in the open market
or through privately negotiated transactions at management’s discretion, depending upon market conditions and other factors.
The authorization to repurchase our stock expires on December 31, 2017.
|
|
We repurchased 168,925 shares of common
stock under this program for a total cost of $0.8 million during the three months ended
June 30, 2017. We repurchased 762,644 shares of common stock under this program for a
total cost of $3.6 million during the six months ended June 30, 2017. Included in the
shares repurchased during the first six months of 2017 were 210,000 shares repurchased
through a privately negotiated transaction. On March 9, 2017, after approval by the Company's
Audit Committee and Board of Directors, the Company repurchased 210,000 shares from Richard
P. Moberg, the Company's former co-Chief Executive Officer, co-President and Chief Financial
Officer and current member of the Board of Directors at a 10% discount off of the market
closing price of the Company's stock on March 8, 2017. The closing price of our common
stock on March 8, 2017 was $4.85. The resulting sale price, after calculating the ten
percent (10%) discount was $4.36 and the total transaction cost was $915,600.
|
|
|
Since the program commenced in April
2016, we have repurchased 1,453,445 shares for a total cost of $7.3 million.
|
|
K)
|
Income from patent arrangement.
We entered into an arrangement with an unaffiliated third party in 2010 under
which we assigned certain patents in return for royalties on proceeds from patent monetization
efforts by the third party. The third party has engaged in various patent monetization
activities, including enforcement, litigation and licensing. In the three and six months
ended June 30, 2017, the third party reported and we recorded $1.3 million and $1.4 million,
respectively, of income from this arrangement.
|
ITEM 2:
Management’s Discussion and Analysis
of
Financial Condition and Results of Operations
Cautionary Statement for Purposes of the “Safe Harbor”
Provisions of the Private Securities Litigation Reform Act of 1995
Some of the information in this Form
10-Q contains forward-looking statements that involve substantial risks and uncertainties. You can identify these statements by
forward-looking words such as “may,” “will,” “expect,” “anticipate,” “believe,”
“estimate,” “continue” and similar words. You should read statements that contain these words carefully
because they: (1) discuss our future expectations; (2) contain projections of our future operating results or financial condition;
or (3) state other “forward-looking” information. However, we may not be able to predict future events accurately.
The risk factors listed in our Annual Report on Form 10-K for the year ended December 31, 2016, as well as any cautionary language
in this Form 10-Q, provide examples of risks, uncertainties and events that may cause our actual results to differ materially
from the expectations we describe in our forward-looking statements. You should be aware that the occurrence of any of the events
described in these risk factors and elsewhere in this Form 10-Q could materially and adversely affect our business.
Summary of Operations
We are primarily engaged in the development
and sale of biometrics products and services. Our software products are used in government and commercial biometrics systems to
identify or authenticate people. Principal government applications of biometrics systems include border control, visitor screening,
law enforcement, national defense, intelligence, secure credentialing, access control, and background checks. Principal commercial
applications include: i) user authentication for login and access to mobile devices, computers, networks, and software programs;
ii) user authentication for financial transactions and purchases (online and in-person); iii) physical access control to buildings,
and iv) screening and background checks of prospective employees and customers. We sell our software and services globally through
systems integrators and OEMs, and directly to end user customers. We also derive a portion of our revenue from the sale of imaging
software licenses to OEMs and systems integrators that incorporate our software into medical imaging products and medical systems.
Summary of Financial Results
We use revenue and operating income to
summarize financial results as we believe these measurements are the most meaningful way to understand our operating performance.
Revenue and operating income for the three
months ended June 30, 2017 were $2.7 million and $0.2 million, respectively. These results compared to revenue of $6.9 million
and operating income of $2.1 million in the three months ended June 30, 2016. Lower revenue and operating income in the current
quarter versus the year ago quarter were primarily due to lower imaging and biometrics software license sales. This was partially
offset by: i) income from a patent arrangement, ii) lower cost of software licenses; and iii) lower operating expenses.
Revenue and operating income for the six
months ended June 30, 2017 were $7.1 million and $0.6 million, respectively. These results compared to revenue of $11.7 million
and operating income of $3.0 million in the three months ended June 30, 2016. Lower revenue and operating income in the current
six month period were primarily due to: i) lower imaging and biometrics software license sales, ii) no hardware sales; and iii)
lower DSL royalties. This was partially offset by: i) income from a patent arrangement, ii) lower cost of software licenses; and
iii) lower cost of hardware.
These and all other financial results
are discussed in more detail in the results of operations section that follows.
Results of Operations
Software licenses.
Software
licenses consist of revenue from the sale of biometrics and imaging software products. Sales of software products depend on our
ability to win proposals to supply software for biometrics systems projects either directly to end user customers or indirectly
through channel partners.
Software license revenue decreased 77%
from $5.3 million in the three months ended June 30, 2016 to $1.2 million in the same three month period in 2017. As a percentage
of total revenue, software license revenue decreased from 77% in the second quarter of 2016 to 44% in the current year quarter.
The $4.1 million decrease in software license revenue was primarily due to: i) a $3.0 million decrease in biometrics software
license sales, and ii) a $1.1 million decrease in imaging software license sales. The reasons for the changes in biometrics and
imaging software licenses were:
|
i)
|
Biometrics software licenses –
Biometrics software license sales were $1.0 million in the second quarter of 2017 versus
$4.1 million in the same quarter last year. The dollar decrease was primarily due to
a software license sale to the U.S. Marine Corps ("USMC") in the second quarter
of 2016 whereas we had no such sale in the second quarter of 2017. This was slightly
offset by higher license sales to our channel partners that serve government customers.
|
|
ii)
|
Imaging software licenses –
Imaging software license sales were $0.2 million in the second quarter of 2017 versus
$1.3 million in the same quarter last year. The decrease was primarily due to a software
license agreement we entered into in October 2015 with a systems integrator. The $4.5
million license fee from that arrangement was recognized over a twelve-month period that
ran from October 2015 to October 2016. We recognized $1.1 million from that sale in the
second quarter of 2016. There is no remaining license revenue to be recognized from this
agreement in 2017.
|
Software license revenue decreased 52%
from $8.1 million in the six months ended June 30, 2016 to $3.9 million in the same six month period in 2017. As a percentage
of total revenue, software license revenue decreased from 69% in the first six months of 2016 to 55% in the current year quarter.
The $4.2 million decrease in software license revenue was primarily due to: i) a $1.9 million decrease in biometrics software
license sales, and ii) a $2.3 million decrease in imaging software license sales. The reasons for the changes in imaging and biometrics
software licenses were:
|
i)
|
Biometrics software licenses –
Biometrics software license sales were $3.5 million in the six months ended June 30,
2017 versus $5.4 million in the same quarter last year. The decrease was primarily due
to: i) a $0.6 million software sales to the U.S. Navy (the "Navy") in the first
six months of 2016 whereas the was no such sale in the corresponding period of 2017;
and ii) software sales of $3.2 million to the USMC in the second quarter of 2016 versus
$0.9 million in the corresponding period of 2017. This was partially offset by higher
license revenue from our other biometrics customers. We are unable to predict whether
the USMC or the Navy will purchase this software again in the future.
|
|
ii)
|
Imaging software licenses –
Imaging software license sales were $0.5 million in the six months ended June 30, 2017
versus $2.7 million in the corresponding period a year ago. The decrease was primarily
due to a software license agreement we entered into in October 2015 with a systems integrator.
The $4.5 million license fee from that arrangement was recognized over a twelve-month
period that ran from October 2015 to October 2016. We recognized $2.2 million from that
sale in the first six months of 2016. There is no remaining license revenue to be recognized
from this agreement in 2017.
|
As described in the strategy section of
our Form 10-K for the year ended December 31, 2016, our market strategy is to continue to focus on our legacy government biometrics
markets and expand into new commercial biometrics markets. We are unable to predict future revenue from commercial markets as
these are emerging markets.
Software maintenance
. Software
maintenance consists of revenue from the sale of software maintenance contracts. Software maintenance contracts entitle customers
to receive software support and software updates, if and when they become available, during the term of the contract.
Software maintenance revenue increased
9% from $1.2 million in the three months ended June 30, 2016 to $1.3 million in the same three month period in 2017. As a percentage
of total revenue, software maintenance revenue increased from 17% in the second quarter of 2016 to 47% in the current year quarter.
Software maintenance revenue increased
3% from $2.46 million in the six months ended June 30, 2016 to $2.53 million in the same six month period in 2017. As a percentage
of total revenue, software maintenance revenue increased from 21% in the first six months of 2016 to 36% in the corresponding
period of 2017.
For the three and six month periods ended
June 30, 2017, the dollar increase in software maintenance revenue was primarily due to a base of maintenance revenue from prior
periods that grows as we sell maintenance contracts with new licenses in current periods.
Services
.
Services
consist of fees we charge to perform software development, integration, installation, and customization services. Similar to software
license revenue, services revenue depends on our ability to win biometrics systems projects either directly with end user customers
or in conjunction with channel partners. Services revenue will fluctuate when we commence new projects and/or when we complete
projects that were started in previous periods.
Services decreased 5% from $216,000 in
the three months ended June 30, 2016 to $206,000 in the same three month period in 2017. As a percentage of total revenue, services
increased from 3% in the second quarter of 2016 to 8% in the current year quarter.
Services decreased 9% from $635,000 in
the six months ended June 30, 2016 to $580,000 in the same six month period in 2017. As a percentage of total revenue, services
increased from 5% in the first six months of 2016 to 8% in the corresponding period of 2017.
For the three and six month periods ended
June 30, 2017, the dollar decrease in services revenue was primarily due to lower revenue from our non-U.S. government customers
and the Navy that was partially offset by higher revenue from the USMC.
Services backlog of $0.2 million was minimal
as of June 30, 2017, which means that services revenue in 2017 is unlikely to return to the levels we achieved in 2014 and 2015
unless we are able to obtain new service projects.
Hardware.
Hardware revenue
consists of sales of biometrics equipment to the Navy for whom we developed biometrics software. Hardware products sold to this
customer integrate hardware purchased from third parties with software from other third parties as well as software from Aware.
We evaluated the classification of gross versus net revenue recognition and determined gross recognition was appropriate.
Hardware revenue decreased 100% from $31,000
in the three months ended June 30, 2016 to zero in the same three month period in 2017. The dollar decrease in hardware revenue
was due to the delivery of an order in the second quarter of 2016 whereas we had no such order in the current year quarter.
Hardware revenue decreased 100% from $317,000
in the six months ended June 30, 2016 to zero in the same six month period in 2017. As a percentage of total revenue, hardware
revenue decreased from 3% in the first six months of 2016 to 0% in the corresponding period of 2017. The dollar decrease in hardware
revenue was due to the delivery of orders in the first six months of 2016 whereas we had no such orders in the corresponding period
of 2017.
We believe that future hardware orders
from the Navy may be minimal as we believe it has completed the bulk of its purchasing. We had no hardware orders in backlog as
of June 30, 2017. It is worth noting that our strategy does not include maintaining or growing biometrics hardware revenue. We
agreed to provide hardware products as an accommodation to this important customer.
Royalties.
Royalties consist
primarily of royalty payments we receive under DSL silicon contracts with two customers that incorporate our silicon intellectual
property (“IP”) in their DSL chipsets. We sold our DSL IP business in 2009, but we continue to receive royalty payments
from these customers. Royalties are reported in continuing operations in accordance with ASC 205-20, Reporting Discontinued Operations,
because we have continuing ongoing cash flows from this business.
Royalties decreased 66% from $129,000
in the three months ended June 30, 2016 to $43,000 in the same three month period in 2017. As a percentage of total revenue, royalties
were 2% for both periods.
Royalties decreased 62% from $203,000
in the six months ended June 30, 2016 to $77,000 in the same six month period in 2017. As a percentage of total revenue, royalties
decreased from 2% in the first six months of 2016 to 1% in the corresponding period of 2017.
We do not consider DSL royalties to be
a key element of our strategy and we expect that this revenue will continue to decline in future periods.
Cost of software licenses.
Cost
of software licenses consists primarily of the cost of third party software included in certain software products delivered to
the Navy and USMC.
Cost of software licenses decreased 100%
from $0.9 million in the three months ended June 30, 2016 to zero in the same three month period in 2017. The dollar decrease
in cost of software licenses was primarily due to the delivery of software to the USMC that included third party software in the
second quarter of 2016 whereas we had no such order in the second quarter of 2017.
Cost of software licenses decreased 78%
from $1.1 million in the six months ended June 30, 2016 to $0.2 million in the same six month period in 2017. Cost of software
licenses as a percentage of software license sales decreased from 14% in the first six months of 2016 to 6% in the corresponding
of 2017, which means that gross margins increased from 86% to 94%. The dollar decrease in cost of software licenses was primarily
due to lower sales of software to the Navy and USMC that included third party software.
Cost of Services.
Cost of
services consists of engineering costs to perform customer services projects. Such costs primarily include: i) engineering salaries,
stock-based compensation, fringe benefits, and facilities; and ii) engineering consultants and contractors.
Cost of services decreased 34% from $158,000
in the three months ended June 30, 2016 to $104,000 in the same three month period in 2017. Cost of services as a percentage of
services decreased from 73% in the second quarter of 2016 to 51% in the current year quarter, which means that gross margins increased
from 27% to 49%.
Cost of services decreased 14% from $372,000
in the six months ended June 30, 2016 to $320,000 in the same six month period in 2017. Cost of services as a percentage of services
decreased from 58% in the first six months of 2016 to 55% in the corresponding period of 2017, which means that gross margins
increased from 42% to 45%.
For the three and six month periods ended
June 30, 2017, the dollar decrease in cost of services was due to: the profitably profile of the projects comprising services
revenue; and ii) a decrease in services revenue.
Cost of hardware.
Cost of
hardware consists primarily of the cost of third party equipment and software included in hardware shipments.
Cost of hardware sales decreased 100%
from $29,000 in the three months ended June 30, 2016 to zero in the same three month period in 2017. Cost of hardware sales decreased
100% from $234,000 in the six months ended June 30, 2016 to zero in the same six month period in 2017.
For the three and six month periods ended
June 30, 2017, the dollar decrease in cost of hardware was due to the delivery of replacement parts to the Navy in 2016, whereas
we had no hardware shipments in the corresponding periods of 2017.
Research and development expense.
Research and development expense consists of costs for: i) engineering personnel, including salaries, stock-based compensation,
fringe benefits, and facilities; ii) engineering consultants and contractors, and iii) other engineering expenses such as supplies,
equipment depreciation, dues and memberships and travel. Engineering costs incurred to develop our technology and products are
classified as research and development expense. As described in the cost of services section, engineering costs incurred to provide
engineering services for customer projects are classified as cost of services, and are not included in research and development
expense.
The classification of total engineering
costs to research and development expense and cost of services was (in thousands):
|
|
Three Months Ended
June 30,
|
|
|
Six Months Ended
June 30,
|
|
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and development expense
|
|
$
|
1,876
|
|
|
$
|
1,802
|
|
|
$
|
3,733
|
|
|
$
|
3,451
|
|
Cost of services
|
|
|
104
|
|
|
|
158
|
|
|
|
320
|
|
|
|
372
|
|
Total engineering costs
|
|
$
|
1,980
|
|
|
$
|
1,960
|
|
|
$
|
4,053
|
|
|
$
|
3,823
|
|
Research and development expense increased
4% from $1.8 million in the three months ended June 30, 2016 to $1.9 million in the same three month period in 2017. As a percentage
of total revenue, research and development expense increased from 26% in the second quarter of 2016 to 68% in the corresponding
period of 2017.
Research and development expense increased
8% from $3.5 million in the six months ended June 30, 2016 to $3.7 million in the same six month period in 2017. As a percentage
of total revenue, research and development expense increased from 29% in the first six months of 2016 to 53% in the corresponding
period of 2017.
For the three and six month periods ended
June 30, 2017, the increase in research and development expense was primarily due to the engagement of a third party software
development company to assist us in the development of an important new product. Work with the development company commenced in
the fourth quarter of 2016 and we expect that research and development expenses in the remainder of 2017 may include an additional
$450,000 in fees to the development company depending on the achievement of contract milestones. This expense was partially offset
by lower employee costs due to lower headcount.
We anticipate that we will continue to
focus our future research and development activities on enhancing our existing products and developing new products.
Selling and marketing expense.
Selling and marketing expense primarily consists of costs for: i) sales and marketing personnel, including salaries, sales
commissions, stock-based compensation, fringe benefits, travel, and facilities; and ii) advertising and promotion expenses.
Sales and marketing expense decreased
8% from $1.1 million in the three months ended June 30, 2016 to $1.0 million in the same three month period of 2017. As a percentage
of total revenue, sales and marketing expense increased from 16% in the second quarter of 2016 to 37% in the corresponding period
of 2017. The dollar decrease in sales and marketing expense was primarily due to lower sales commissions, which was partially
offset by higher advertising and tradeshows expenses.
Sales and marketing expense decreased
3% from $2.03 million in the six months ended June 30, 2016 to $1.97 million in the same six month period of 2017. As a percentage
of total revenue, sales and marketing expense increased from 17% in the first six months of 2016 to 28% in the corresponding period
of 2017. The dollar decrease in sales and marketing expense was primarily due to lower sales commission, which was partially offset
by higher spending on sales agents and higher advertising and tradeshows expenses.
General and administrative expense.
General and administrative expense consists primarily of costs for: i) officers, directors and administrative personnel,
including salaries, bonuses, director compensation, stock-based compensation, fringe benefits, and facilities; ii) professional
fees, including legal and audit fees; iii) public company expenses; and iv) other administrative expenses, such as insurance costs
and bad debt provisions.
General and administrative expense decreased
6% from $0.9 million in the three months ended June 30, 2016 to $0.8 million in the same three month period in 2017. As a percentage
of total revenue, general and administrative expense increased from 13% in the second quarter of 2016 to 30% in the corresponding
period in 2017. The decrease in general and administrative expense was primarily due to lower employee costs.
General and administrative expense was
essentially unchanged at $1.6 million in the six months ended June 30, 2017 and 2016. As a percentage of total revenue, general
and administrative expense increased from 14% in the first six months of 2016 to 23% in the corresponding period in 2017. Unchanged
general and administrative expense in the first six months of 2017 was primarily due to lower employee costs that were offset
by higher stock-based compensation and higher legal fees related to corporate matters and patents.
Patent related income.
We
entered into an arrangement with an unaffiliated third party in 2010 under which we assigned certain patents in return for royalties
on proceeds from patent monetization efforts by the third party. The third party has engaged in various patent monetization activities,
including enforcement, litigation and licensing. In the three and six months ended June 30, 2017, the third party reported and
we recorded $1.3 million and $1.4 million, respectively, of income from this arrangement. There was no such income in the three
and six month periods ended June 30, 2016. We continue to have a contractual relationship with this third party. However, we are
unable to predict how much more income we might receive from this arrangement, if any, because we do not know whether any patent
monetization efforts by the third party will be successful.
Other income.
We recorded
$36,000 of other income in the three and six months ended June 30, 2017. This amount represented a $37,000 realized gain offset
by a $1,000 realized loss on the sale of two high yield bonds.
Interest income.
Interest
income increased 23% from $72,000 in the three months ended June 30, 2016 to $89,000 in the same three month period in 2017. Interest
income increased 25% from $138,000 in the six months ended June 30, 2016 to $172,000 in the same six month period in 2017. For
the three and six month periods, the dollar increase in interest income was primarily due to higher interest rates.
Income taxes.
Income
tax expense was $0.1 million and $0.7 million for the three months ended June 30, 2017 and 2016, respectively. Income tax expense
was $0.2 and $1.0 million for the six months ended June 30, 2017 and 2016, respectively. Income tax expense in the three and six
month periods of 2017 and 2016 was based on the U.S. statutory rate of 34%, increased by state income taxes, and reduced by permanent
adjustments and research tax credits.
In
the six month period ended June 30, 2016, we utilized deferred tax assets to reduce our tax liability payable to the government.
A portion of the deferred tax assets we used comprised cumulative deductions for stock options in excess of book expense. Under
income tax accounting rules at that time, that portion of tax benefits attributable to such deductions must be recorded as an
adjustment to equity versus a reduction of income tax expense. The tax benefits from such stock-based awards were $0.5 million
in the six month period ended June 30, 2016. These tax benefits were recorded as an equity adjustment to additional paid-in capital.
For the six month period ended June 30, 2017, we recognized
all excess tax benefits and tax deficiencies as income tax expense or benefit as a discrete event.
As
of June 30, 2017, we had a total of $5.8 million of deferred tax assets for which we had recorded no valuation allowance. We have
assessed the need for a valuation allowance on our deferred tax assets. Based on our assessment of future sources of income,
including reversing deferred tax liabilities, and future earnings, we have determined that it is more likely than not that the
deferred tax assets will be realized, and therefore there is no valuation allowance required for the deferred tax assets. We will
continue to assess the level of valuation allowance in future periods. Should evidence regarding the realizability of tax assets
change at a future point in time, the valuation allowance will be adjusted accordingly.
In
the second quarter of 2017, the Internal Revenue Service commenced an examination of our tax return for the year ended December
31, 2015.
Liquidity and Capital Resources
At June 30, 2017, we had cash and cash
equivalents of $49.4 million, which represented a decrease of $2.5 million from December 31, 2016. The decrease in cash and cash
equivalents was primarily due to the following factors:
Cash provided by operations was $0.3 million
in the first six months of 2017. Cash provided from operations was primarily the result of $0.6 million of net income and the
add back of $0.5 million of non-cash items primarily for depreciation, amortization, and stock-based compensation. Cash from these
sources was partially offset by $0.8 million of changes in assets and liabilities.
Cash provided by investing activities
was $966,000 in the first six months of 2017. Cash provided from investing activities consisted of $1,019,000 from sales of investments
less $53,000 of purchases of property and equipment.
Cash used in financing activities was
$3.7 million in the first six months of 2017. Financing activity cash usage was primarily the result of $3.6 million used to buy
back stock under our stock repurchase program and $119,000 used to pay income taxes for employees who surrendered shares in connection
with stock grants. Cash used for these purposes was partially offset by $43,000 of proceeds from our employee stock purchase plan
and stock option exercises.
While we cannot assure you that we will
not require additional financing, or that such financing will be available to us, we believe that our cash and cash equivalents
will be sufficient to fund our operations for at least the next twelve months.
Recent Accounting Pronouncements
See Note G to our Consolidated Financial Statements in Item
1.
ITEM 3: