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, 2025, 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. 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. The comparisons below reflect certain reclassifications described in more detail in Note 1 to the consolidated financial statements. Revenue and operating loss for the three months ended June 30, 2026 were $3.3 million and $2.7 million, respectively. These results compared to revenue of $3.9 million and operating loss of $2.0 million for the three months ended June 30, 2025. The decrease in revenue and increase in operating loss was primarily due to lower software license revenue. Revenue and operating loss for the six months ended June 30, 2026 were $6.6 million and $6.4 million, respectively. These results compared to revenue of $7.5 million and operating loss of $3.8 million for the six months ended June 30, 2025. The decrease in revenue was primarily due to lower software license revenue. The increase in operating loss was primarily due to lower revenue, one-time severance costs in the current period of $0.7 million and a $0.6 million increase in salary-related expenses resulting from additional headcount hired in 2025. These severance costs relate to workforce reduction actions taken during the period as part of our efforts to align our cost structure with current business conditions. We expect to realize incremental cost savings from these actions throughout the remainder of 2026. 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. 17 Software license revenue decreased 33% from $1.4 million in the three months ended June 30, 2025 to $1.0 million for the three months ended June 30, 2026. As a percentage of total revenue, software license revenue decreased from 36% in the second quarter of 2025 to 29% in the current year quarter. The $0.4 million decrease in software license revenue was due primarily to a decrease in perpetual licenses sales due to a decrease in one-time license deals in the current quarter. Software license revenue decreased 27% from $2.7 million in the six months ended June 30, 2025 to $2.0 million for the six months ended June 30, 2026. As a percentage of total revenue, software license revenue decreased from 36% in the first six months of 2025 to 30% in the current period. The $0.7 million decrease in software license revenue was due primarily to a decrease in perpetual licenses sales due to a decrease in one-time license deals in the current year period. 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 decreased 7% from $2.1 million in the three months ended June 30, 2025 to $2.0 million for the three months ended June 30, 2026. As a percentage of total revenue, software maintenance revenue increased from 55% in the second quarter of 2025 to 61% in the current year period. Software maintenance decreased 4% from $4.3 million in the six months ended June 30, 2025 to $4.1 million for the six months ended June 30, 2026. As a percentage of total revenue, software maintenance revenue increased from 57% in the six months ended June 30, 2025 to 61% in the current year period. The slight decrease in software maintenance was primarily due to the non-renewal of maintenance contracts by certain customers. Prior period amounts have been reclassified to conform to the current period presentation. See Note 1 to the consolidated financial statements for additional information regarding these reclassifications. Services and other revenue . Services and other revenue consists of fees we charge to perform software development, integration, installation, customization, and other professional services, as well as subscription-based SaaS offerings and hardware included with certain software licenses. 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. SaaS revenue reflects recurring subscription fees for access to our biometric software solutions. Services and other revenue may fluctuate based on the timing of commencement and completion of customer projects, the mix of professional services and subscription-based arrangements, and the timing of hardware delivered in connection with software licenses. Services and other revenue was $0.3 million in the three months ended June 30, 2025 and 2026. As a percentage of total revenue, services and other revenue increased from 8% in the three months ended June 30, 2025 to 9% in the current year period. Services and other revenue increased from $0.5 million in the six months ended June 30, 2025 to $0.6 million in the six months ended June 30, 2026. As a percentage of total revenue, services and other revenue increased from 7% in the six months ended June 30, 2025 to 9% in the current year period. The increase was primarily due to growth in SaaS revenue, which increased from $0.1 million in the six months ended June 30, 2025 to $0.3 million in the current year period and was partially offset by lower services revenue. The increase in SaaS revenue reflects expansion of subscription-based customer arrangements. Prior period amounts have been reclassified to conform to the current period presentation. See Note 1 to the consolidated financial statements for additional information regarding these reclassifications. 18 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 increased 95% from $0.3 million in the three months ended June 30, 2025 to $0.5 million in the three months ended June 30, 2026. Cost of revenue as a percentage of total revenue increased from 7% in the second quarter of 2025 to 16% in the current year second quarter. The $0.2 million increase was the result of increased software license costs. Cost of revenue increased 97% from $0.4 million in the six months ended June 30, 2025 to $0.9 million in the six months ended June 30, 2026. Cost of revenue as a percentage of total revenue increased from 6% in the six months ended June 30, 2025 to 13% in the current year period. The $0.5 million increase was the result of increased software license costs. Prior period amounts have been reclassified to conform to the current period presentation. See Note 1 to the consolidated financial statements for additional information regarding these reclassifications. 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 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 revenue section, engineering costs incurred to provide engineering services for customer projects are classified as cost of 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 June 30, Six Months Ended June 30, 2026 2025 2026 2025 Research and development expense $ 2,533 $ 1,960 $ 5,755 $ 3,881 Engineering costs allocated to cost of revenue 100 91 150 189 Total engineering costs $ 2,633 $ 2,051 $ 5,905 $ 4,070 Total engineering costs increased 28% from $2.1 million in the three months ended June 30, 2025 to $2.6 million in the three months ended June 30, 2026. As a percentage of total revenue, total engineering costs increased from 53% in the three months ended June 30, 2025 to 81% in the same current year quarter. The spending increase for the three months ended June 30, 2026 compared to the same prior year period was primarily due to salary related costs in relation to additional headcount hired in 2025. Total engineering costs increased 45% from $4.0 million in the six months ended June 30, 2025 to $5.9 million in the six months ended June 30, 2026. As a percentage of total revenue, total engineering costs increased from 54% in the six months ended June 30, 2025 to 89% in the same current year period. The spending increase for the six months ended June 30, 2026 compared to the same prior year period was primarily due to one-time severance costs of $0.6 million including the termination of our chief technology officer and a $1.3 million increase in salary related costs in relation to additional headcount hired in 2025. We anticipate engineering expenses to decrease during the remainder of 2026 as we focus on strategic product development initiatives. 19 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 29% from $2.0 million in the three months ended June 30, 2025 to $1.4 million in the same three month period of 2026. As a percentage of total revenue, selling and marketing expense decreased from 50% in the second quarter of 2025 to 42% in the corresponding period in 2026. Selling and marketing expense decreased 11% from $3.6 million in the six months ended June 30, 2025 to $3.2 million in the same six month period of 2026. As a percentage of total revenue, selling and marketing expense was 48% in the six months ended June 30, 2025 and 2026. The decrease in selling and marketing expense for the three and six months ended June 30, 2026, compared to the same periods in the prior year, was primarily due to lower personnel-related costs resulting from the cost saving plan implemented in March 2026 to better align the Company's cost structure with current business needs. 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 7% from $1.7 million in the three months ended June 30, 2025 to $1.6 million in the three months ended June 30, 2026. As a percentage of total revenue, general and administrative expense increased from 43% in the three months ended June 30, 2025 to 47% in the corresponding period of 2026. General and administrative expense decreased 5% from $3.4 million in the six months ended June 30, 2025 to $3.2 million in the same six month period of 2026. As a percentage of total revenue, general and administrative expense increased from 45% in six months ended June 30, 2025 to 48% in the corresponding period of 2026. The decrease in general and administrative expense for the three and six months ended June 30, 2026, compared to the same periods in the prior year, was primarily due to lower personnel-related costs resulting from the cost saving plan implemented in March 2026 to better align the Company's cost structure with current business needs. Prior period amounts have been reclassified to conform to the current period presentation. See Note 1 to the consolidated financial statements for additional information regarding these reclassifications. Fluctuations in general and administrative expenses are expected depending on specific activities in a period. Interest Income. Interest income was $0.2 million in the three months ended June 30, 2026 and 2025. Interest income was $0.4 million and $0.5 million in the six months ended June 30, 2026 and 2025, respectively. The decrease in interest income in the six months ended June 30, 2026 was primarily the result of lower average cash balances during the current year period. We expect interest income to decrease slightly over the remainder of 2026 due to a lower projected average cash balance. Income taxes . Total income tax expense was $1 thousand and $26 thousand for the three months ended June 30, 2026 and 2025, respectively. The income tax expense relates to state income taxes. Total income tax expense was $9 thousand and $34 thousand for the six months ended June 30, 2026 and 2025, respectively. The income tax expense relates to state income taxes. 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. 20 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 June 30, 2026 and December 31, 2025, we recorded a full valuation allowance against our net deferred tax assets. Liquidity and Capital Resources At June 30, 2026, we had cash, cash equivalents and marketable securities of $16.8 million, which represented a decrease of $5.5 million from December 31, 2025. The decrease in cash, cash equivalents and marketable securities was primarily due to the impact of $5.4 million of cash used in operating activities. Cash provided by investing activities was $1.0 million in the first six months of 2026, which primarily consisted of net sales of marketable securities. Cash provided by financing activities was $47 thousand in the first six months of 2026, which primarily consisted of proceeds from issuances of 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.