AWARE INC /MA/ 10-Q

ITEM 2: Management’s Discussion and Analysis o f 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 Quarterly Report on 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 this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K for the year ended December 31, 2024, as well as any cautionary language in this Quarterly Report on 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 Quarterly Report on 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, solutions and services. Our software products are used in government and commercial systems and applications and fulfill a broad range of functions critical to secure biometric enrollment, authentication, identification and transactions. Principal government applications of biometrics systems include border control, visa applicant screening, law enforcement, national defense, intelligence, secure credentialing, access control, and background checks. Principal commercial applications include: i) user enrollment and authentication used for login 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) identity proofing of prospective employees and customers. We sell our biometrics software products and services globally through a multifaceted distribution strategy using systems integrators, OEMs, VARs, partners, 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. On October 30, 2024, we announced that Robert Eckel, our Chief Executive Officer and a member of our Board of Directors, would resign from these positions effective December 31, 2024. Following this announcement, we retained an executive search firm and conducted an extensive search for his successor. As a result of that process, on February 3, 2025, Ajay Amlani was appointed Chief Executive Officer and a member of our Board of Directors. Summary of Financial Results We use revenue and results of operations to summarize financial results as we believe these measurements are the most meaningful way to understand our operating performance. Revenue and operating loss for the three months ended March 31, 2025 were $3.6 million and $1.9 million, respectively. These results compared to revenue of $4.4 million and operating loss of $1.3 million for the three months ended March 31, 2024. The decrease in revenue and operating loss in the current three month period was primarily due to a $0.8 million decrease in software license revenue. The impact of the decrease in revenue on our operating loss was partially offset by $0.2 million decrease in operating expenses resulting from temporary cost reductions related to reduced headcount in the first quarter of 2025. 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. 16 Software license revenue decreased 39% from $2.1 million in the three months ended March 31, 2024 to $1.3 million for the three months ended March 31, 2025. As a percentage of total revenue, software license revenue decreased from 49% in the first quarter of 2024 to 36% in the current year quarter. The $0.8 million decrease in software license revenue was due primarily to a decrease in perpetual licenses sales of $0.3 million due to fewer one-time license deals in the current quarter and a $0.4 million decrease in license revenue related to subscription contracts as a result of timing of renewal of licenses. Software license sales have historically fluctuated, and we expect software license revenue to continue to fluctuate since these sales are based on the timing of projects with our customers and partners. 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 was $2.2 million in the three months ended March 31, 2025 and 2024. As a percentage of total revenue, software maintenance revenue increased from 49% in the first quarter of 2024 to 60% in the current year first quarter. Services and other revenue . Services revenue consists 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. Other revenue consists of hardware fees that are included with some of our software licenses. Services and other revenue was $0.1 million in the three months ended March 31, 2025 and 2024. As a percentage of total revenue, services and other revenue increased from 3% in the first quarter of 2024 to 4% in the current year quarter. Services and other revenue fluctuate dependent on when we commence new projects and when we complete projects that were started in previous periods. Cost of revenue. Cost of revenue consists primarily of engineering costs to perform customer services projects, amortization of intangible assets related to acquisitions, and other third-party costs that are included with some of our software licenses. Such costs primarily include: i) engineering salaries, stock-based compensation, fringe benefits, and facilities; ii) engineering consultants and contractors; iii) software license fees; and iv) hardware costs. Cost of revenue decreased 11% from $0.3 million in the three months ended March 31, 2024 to $0.2 million the three months ended March 31, 2025. Cost revenue as a percentage of total revenue increased from 6% in the first quarter of 2024 to 7% in the current year first quarter. For first quarter of 2025, cost of revenue of $0.2 million was composed of $0.1 million of engineering costs to perform customer services, $0.1 million of amortization of intangible assets, and $50 thousand for software license and hardware costs. For first quarter of 2024, cost of revenue of $0.3 million was composed of $0.1 million of engineering costs to perform customer services, $0.1 million of amortization of intangible assets, and $67 thousand for software license and hardware costs. Gross margins on revenue are a function of: i) the nature of the projects; ii) the level of engineering difficulty and labor hours required to complete project tasks; iii) how much we were able to charge; and iv) product mix. We expect that gross margins on services and other revenue will continue to fluctuate in future periods based on the nature, complexity, and pricing of future projects and product mix. 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 17 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 other revenue, and are not included in research and development expense. The classification of total engineering costs to research and development expense and engineering costs to perform customer services included in cost of revenue was (in thousands): Three Months Ended March 31, 2025 2024 Research and development expense $ 1,922 $ 2,182 Engineering costs allocated to cost of revenue 91 105 Total engineering costs $ 2,013 $ 2,287 Total engineering costs decreased 12% from $2.3 million in the three months ended March 31, 2024 to $2.0 million in the three months ended March 31, 2025. As a percentage of total revenue, total engineering costs increased from 52% in the three months ended March 31, 2024 to 56% in the same current year quarter. The spending decreases for the three months ended March 31, 2025 compared to the same prior year period was primarily due to decreased headcount. While costs declined in the first quarter, we anticipate engineering expenses may increase during the remainder of 2025 as we ramp up investment to support strategic product development initiatives. 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. Selling and marketing expense decreased 12% from $1.9 million in the three months ended March 31, 2024 to $1.7 million in the same three month period of 2025. As a percentage of total revenue, selling and marketing expense increased from 43% in the first quarter of 2024 to 46% in the corresponding period in 2025. The spending decreases for the three months ended March 31, 2025, compared to the same prior year periods was primarily due to the departure of our chief revenue officer in 2024 who was not replaced until March 2025 and the departure of our chief product officer in 2024. We expect selling and marketing expense to increase in future periods as we continue to invest in revenue-generating activities. This includes plans to backfill the chief product officer position and make additional hires across our sales organization to support pipeline growth and capitalize on market opportunities. 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 increased 22% from $1.3 million for the three months ended March 31, 2024 to $1.6 million for the three months ended March 31, 2025. As a percentage of total revenue, general and administrative expense was 30% in the first quarter of 2024 and 45% in the corresponding period of 2025. The expense increase for the three months ended March 31, 2025 compared to the same prior year period was primarily due to the impact of a $0.1 million signing bonus paid to Mr. Amlani in connection with his appointment as our chief executive officer and a $0.2 million increase in professional services related to strategic advisor hired as part of our chief executive officer transition. Fluctuations of general and administrative expenses are expected depending on specific activities in a period. We expect that general and administrative costs will decrease for the next few quarters now that we have completed our CEO transition. Interest Income. Interest income was $0.3 million in the three months ended March 31, 2025 and 2024. 18 We expect interest income to decrease slightly over the remainder of 2025 due to a lower projected average cash balance. Income taxes . Total income tax expense was $7 thousand and $0 for the three months ended March 31, 2025 and 2024, respectively. The income tax expense relates to limitations on the usage of net operating loss carryforwards generated in years beginning after December 31, 2017. We are subject to income taxes in the United States, and we use estimates in determining our provisions for income taxes. We account for income taxes using the asset and liability method for accounting and reporting income taxes. Deferred tax assets and liabilities are recognized based on temporary differences between the financial reporting and income tax bases of assets and liabilities using statutory rates. We have evaluated the positive and negative evidence bearing upon our ability to realize our deferred tax assets, which primarily consist of net operating loss carryforwards and research and development tax credits. We considered the history of cumulative net losses, estimated future taxable income and prudent and feasible tax planning strategies and we have concluded that it is more likely than not that we will not realize the benefits of our deferred tax assets. As a result, as of March 31, 2025 and December 31, 2024, we recorded a full valuation allowance against our net deferred tax assets. Liquidity and Capital Resources At March 31, 2025, we had cash, cash equivalents and marketable securities of $24.8 million, which represented a decrease of $3.0 million from December 31, 2024. The decrease in cash, cash equivalents and marketable securities was primarily due to the impact of $2.9 million of cash used in operating activities. Cash used in investing activities was $1.5 million in the first three months of 2025, which primarily consisted of $1.5 million of net sales of marketable securities and $45,000 thousand of purchase of fixed assets. Cash used by financing activities was $53 thousand in the first three months of 2025, which consisted of cash used to repurchase shares of our common stock. 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 from the date of this filing and to meet our known long-term cash requirements. Whether these resources are adequate to meet our liquidity needs beyond that period will depend on our future growth, operating results, and the investments needed to support our operations. If we require additional capital resources, we may utilize available funds or seek external financing, which may not be available on terms we find attractive or at all. To date, inflation has not had a material impact on our financial results. There can be no assurance, however, that inflation will not adversely affect our financial results in the future. Recent Accounting Pronouncements See Note 1 to our Consolidated Financial Statements in Item 1.