PSB Monthly Issue July 2013

Eventually, new technology or new competition creeps into the picture.  That’s why a good management team is always looking for new ways to grow and expand.

Take telecommunications technology for example…

Not all that long ago, DSL (Digital Subscriber Line) technology was all the rage.  It allowed digital data to pass through the wires of a local telephone network.

Basically, it opened up Internet access to a multitude of people who previously couldn’t surf the web.

In fact, many people still connect to the internet using DSL.  However, DSL technology is no longer innovative – and it’s certainly not the best way to get Internet access.

But, one company was able to leverage their knowledge and expertise of DSL technology and expand into new, exciting areas.

These days, AWARE (NASDAQ: AWRE) is using its innovative technology for all sorts of profitable applications.

THE COMMUNICATION EQUIPMENT BUSINESS

AWRE is a leading provider of advanced signal processing technologies.  In a nutshell, processing and analysis of digital data and signals has important applications across a diverse set of industries.  The company develops products for telecommunications, biometrics, and medical imaging.

Back in the day, AWRE was known for its DSL related products. In fact, the company still offers test and diagnostic software and hardware products which enable service providers to manage their DSL networks.

However, as the popularity of DSL has declined, the 20-year old company has shifted its focus to more modern pursuits.

These days, AWRE’s primary products are in the biometrics field.  It may seem odd, but the technology behind biometrics is the same signal processing technology behind DSL analysis.

The company’s biometrics products are used for a host of functions including fingerprint, face, and iris recognition, quality assurance, standards compliance, and more.  The primary customer is governmental in nature as the technology is used for border management, law enforcement, defense, credentialing, and access control.

As you may have guessed, the demand for biometrics is expanding rapidly.  Areas such as border management and law enforcement are rapidly increasing their reliance on technology as efficiency has taken on prime importance.

But it doesn’t stop there…

AWRE is also able to use its expertise in signal processing for medical imaging.  The company’s medical imaging software products allow the transport and viewing of diagnostic medical images such as x-rays and CAT scans.

Basically, the company has transitioned to providing key technology to sensitive industries.  Areas such as law enforcement and medicine are always looking for cutting edge products to make their jobs easier and safer.

Aware has tapped into this demand.  And, judging by the company’s financials, the strategy is working as intended.

THE NUMBERS

Aware has solid financials across the board.  There really isn’t a single area where the company is lagging from a financial perspective.  Rarely do you see a small company able to boast such breadth of financial strength.

The most recent quarter’s revenues came in at $5.6 million, an increase of 15% over the same period last year.  Over the same time, operating income doubled to $2 million.

Meanwhile, net income jumped to $1.9 million, or $0.08 per share, compared to $1.1 million, or $0.05 per share a year ago.  That’s a 66% year over year increase. Although, a portion of the profits are from patent royalties from a third party – which are difficult to forecast.

The revenue and income gains (not including the patent income) are due to increased profitability in the biometrics and imaging businesses.  Plus, the company is seeing lower administrative and general expenses.

And that’s not all…

AWRE also has a rock-solid balance sheet.

The company’s sitting on a cash hoard of over $72 million.  And, they have zero debt. Plus, current assets are an impressive 23x current liabilities.  Not only is this a healthy company, but the excess cash gives them a lot of flexibility moving forward.

It’s certainly difficult to argue with a company growing revenues, operating income, and net income while having a ton of cash and no debt!

INVESTMENT RISKS

As with any investment, AWRE does have a few risks.

An unexpected slowdown in the economy could reduce demand for AWRE’s products as companies would likely cut back on discretionary spending.

New entrants into the biometrics market could put pricing pressure on AWRE and hurt revenues or margins.

Finally, new technology could render AWRE’s technology obsolete or significantly decrease demand for its products.

POTENTIAL RETURN OF 100% OR MORE

AWRE develops innovative technology in a growing market.  And, the company has excellent financial numbers across the board.

However, although there’s a lot to like about Aware, the shares are trading at a miniscule 1.6x earnings.  That’s extremely low for any industry.  And, it’s particularly tiny compared to the competition’s 13x price to earnings ratio.

Not to mention, the company’s cash position is worth $3.22 per share alone.  That means the market’s valuing the rest of the company at only around $2 per share. That’s a crazy bargain for the kind of technology AWRE develops.

With the shares trading at such a discount to its competitors (and the industry in general), we believe the price could easily double.

Based on our analysis, we see AWRE climbing to $10.50 a share or more.  Buy the shares now for potential gains of 100% or higher!

ACTION RECOMMENDATION

BUY Aware (NASDAQ: AWRE) up to $5.90 per share.

Don’t forget your position sizing and stop-loss rules.