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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED SEPTEMBER 30, 1999
COMMISSION FILE NUMBER 000-21129
AWARE, INC.
------------------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
MASSACHUSETTS 04-2911026
- ------------------------------- ------------------------------------
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
40 MIDDLESEX TURNPIKE, BEDFORD, MASSACHUSETTS, 01730
----------------------------------------------------
(Address of Principal Executive Offices)
(Zip Code)
(781) 276-4000
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(Registrant's Telephone Number, Including Area Code)
Indicate by check whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES [X] NO [ ]
Indicate the number of shares outstanding of the issuer's common stock as of
October 29, 1999:
CLASS NUMBER OF SHARES OUTSTANDING
- --------------------------------------- ----------------------------
Common Stock, par value $0.01 per share 21,784,779 shares
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AWARE, INC.
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 1999
TABLE OF CONTENTS
Page
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PART I FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets as of
September 30, 1999 and December 31, 1998......................... 3
Consolidated Statements of Operations for the
Three and Nine Months Ended September 30, 1999
and 1998......................................................... 4
Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 1999 and 1998.................... 5
Notes to Consolidated Financial Statements....................... 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.............................. 8
Item 3. Quantitative and Qualitative Disclosures about
Market Risk...................................................... 19
PART II OTHER INFORMATION
Item 1. Legal Proceedings................................................ 20
Item 6. Exhibits and Reports on Form 8-K................................. 21
Signatures....................................................... 21
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PART I. FINANCIAL INFORMATION
ITEM 1: CONSOLIDATED FINANCIAL STATEMENTS
AWARE, INC.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
------------- ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ................................................. $ 28,019,729 $ 23,512,242
Short-term investments .................................................... 5,947,458 3,054,717
Accounts receivable (less allowance for doubtful
accounts of $200,000 in 1999 and $100,000 in 1998) ..................... 5,191,913 2,901,724
Inventories ............................................................... 120,427 120,911
Prepaid expenses and other assets ......................................... 820,312 252,050
------------ ------------
Total current assets ................................................ 40,099,839 29,841,644
Property and equipment, net of accumulated depreciation and
amortization of $4,160,335 in 1999 and $2,860,516 in 1998 ................. 10,307,753 10,320,581
------------ ------------
Total assets ................................................................... $ 50,407,592 $ 40,162,225
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable .......................................................... $ 648,224 $ 479,705
Accrued expenses .......................................................... 161,500 127,525
Accrued compensation ...................................................... 295,347 324,669
Accrued professional ...................................................... 150,121 84,000
Deferred revenue .......................................................... -- 12,500
------------ ------------
Total current liabilities ........................................... 1,255,192 1,028,399
Stockholders' equity:
Preferred stock, $1.00 par value; 1,000,000 shares authorized,
none outstanding .................................................... -- --
Common stock, $.01 par value; 30,000,000 shares authorized; issued
and outstanding, 21,715,280 in 1999 and 20,911,388 in 1998 .......... 217,153 209,114
Additional paid-in capital ................................................ 62,928,402 55,938,189
Accumulated deficit ....................................................... (13,993,155) (17,013,477)
------------ ------------
Total stockholders' equity .......................................... 49,152,400 39,133,826
------------ ------------
Total liabilities and stockholders' equity ..................................... $ 50,407,592 $ 40,162,225
============ ============
</TABLE>
The accompanying notes are an integral part of the financial statements.
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AWARE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------- -----------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Revenue:
Product sales ...................................... $ 1,241,098 $ 704,308 $ 3,896,929 $ 2,171,579
Contract revenue ................................... 2,947,000 2,543,792 8,007,211 5,394,991
Royalties .......................................... 1,218,961 98,593 2,519,986 215,643
----------- ----------- ----------- -----------
Total revenue ................................. 5,407,059 3,346,693 14,424,126 7,782,213
Costs and expenses:
Cost of product sales .............................. 367,981 301,849 957,231 1,135,611
Cost of contract revenue ........................... 1,827,969 1,421,259 5,212,061 3,627,793
Research and development ........................... 814,061 955,358 2,371,846 3,240,842
Selling and marketing .............................. 677,649 620,222 1,976,389 2,249,693
General and administrative ......................... 686,769 551,416 1,961,291 1,640,350
----------- ----------- ----------- -----------
Total costs and expenses ...................... 4,374,429 3,850,104 12,478,818 11,894,289
Income (loss) from operations .......................... 1,032,630 (503,411) 1,945,308 (4,112,076)
Other income and expense ............................... -- 102,750 18,300 300,750
Interest income ........................................ 391,752 322,889 1,056,714 987,139
----------- ----------- ----------- -----------
Income (loss) before provision for income taxes ........ 1,424,382 (77,772) 3,020,322 (2,824,187)
Provision for income taxes ............................. -- -- -- --
----------- ----------- ----------- -----------
Net income (loss) ...................................... $ 1,424,382 $ (77,772) $ 3,020,322 $(2,824,187)
=========== =========== =========== ===========
Net income (loss) per share - basic .................... $ 0.07 $ (0.00) $ 0.14 $ (0.14)
Net income (loss) per share - diluted .................. $ 0.06 $ (0.00) $ 0.13 $ (0.14)
Weighted average shares - basic ........................ 21,643,728 20,636,604 21,385,157 20,192,611
Weighted average shares - diluted ...................... 23,601,190 20,636,604 23,598,381 20,192,611
</TABLE>
The accompanying notes are an integral part of the financial statements.
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AWARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------------
1999 1998
----------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) ...................................................... $ 3,020,322 $(2,824,187)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization ........................................ 1,299,819 1,121,882
Increase (decrease) from changes in assets and liabilities:
Accounts receivable ................................................ (2,290,189) (184,805)
Inventories ........................................................ 484 (8,765)
Prepaid expenses ................................................... (68,262) 27,181
Accounts payable ................................................... 168,519 (508,166)
Accrued expenses ................................................... 70,774 (36,057)
Deferred revenue ................................................... (12,500) 18,750
----------- -----------
Net cash provided by (used in) operating activities ....................... 2,188,967 (2,394,167)
Cash flows from investing activities:
Purchases of property and equipment .................................... (1,286,991) (858,996)
Other assets ........................................................... (500,000) --
Net purchases of short-term investments ................................ (2,892,741) (7,440,151)
----------- -----------
Net cash used in investing activities ..................................... (4,679,732) (8,299,147)
Cash flows from financing activities:
Proceeds from issuance of common stock ................................. 6,998,252 1,974,670
----------- -----------
Increase (decrease) in cash and cash equivalents .......................... 4,507,487 (8,718,644)
Cash and cash equivalents, beginning of period ............................ 23,512,242 23,496,508
----------- -----------
Cash and cash equivalents, end of period .................................. $28,019,729 $14,777,864
=========== ===========
</TABLE>
The accompanying notes are an integral part of the financial statements.
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AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
A) BASIS OF PRESENTATION
The accompanying unaudited consolidated balance sheets, statements of
operations, 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 September 30, 1999, and of operations and cash flows for
interim periods ended September 30, 1999 and 1998.
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 footnotes necessary for
a complete presentation of operations, the financial position, and
cash flows of the Company, in conformity with generally accepted
accounting principles. The Company filed audited financial statements
which included all information and footnotes necessary for such
presentation for the three years ended December 31, 1998 in
conjunction with its 1998 Annual Report on Form 10-K.
The results of operations for the interim period ended September 30,
1999 are not necessarily indicative of the results to be expected for
the year.
B) INVENTORY
Inventory consists primarily of the following:
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
Raw materials................... $ 91,295 $ 13,091
Finished goods.................. 29,132 107,820
-------- --------
Total.................... $120,427 $120,911
======== ========
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C) EARNINGS PER SHARE
Basic earnings per share (EPS) is calculated by dividing net income
(loss) by the weighted average number of shares outstanding during
the period. Diluted EPS is calculated by dividing net income (loss)
by the weighted average number of shares outstanding plus the
dilutive effect of outstanding stock options using the "treasury
stock" method. The following table presents the calculation for both
basic and diluted EPS:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- ---------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Net income (loss) .............................. $ 1,424,382 $ (77,772) $ 3,020,322 $(2,824,187)
=========== =========== =========== ===========
Weighted average shares outstanding:
Common stock ............................... 21,643,728 20,636,604 21,385,157 20,192,611
Employee stock options ..................... 1,957,462 -- 2,213,224 --
----------- ----------- ----------- -----------
Common stock and common stock equivalents ...... 23,601,190 20,636,604 23,598,381 20,192,611
=========== =========== =========== ===========
Net income (loss) per share:
Basic ...................................... $ 0.07 $ (0.00) $ 0.14 $ (0.14)
Diluted .................................... $ 0.06 $ (0.00) $ 0.13 $ (0.14)
</TABLE>
For the three and nine month periods ended September 30, 1998,
potential common shares related to stock options of 308,906 and
981,574 respectively, were not included in the per share calculations
for diluted EPS, because the effect of their inclusion would be
anti-dilutive.
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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
Certain statements contained in the following Management's Discussion
and Analysis of Financial Condition and Results of Operations, including
statements regarding the anticipated development and expansion of the Company's
business, the intent, belief or current expectations of the Company, its
directors or its officers, primarily with respect to the future operating
performance of the Company, and other statements contained herein regarding
matters that are not historical facts, are "forward-looking" statements. These
forward-looking statements represent the Company's present expectations or
beliefs concerning future events, however the Company cautions that such
statements are qualified by important factors. Such factors, which include, but
are not limited to, the risk factors identified below, could cause actual
results to differ materially from those indicated in Management's Discussion and
Analysis of Financial Condition and Results of Operations.
RESULTS OF OPERATIONS
Product Sales. Product sales consist primarily of revenue from the
sale of compression software products and digital subscriber line ("DSL")
equipment. DSL equipment sales include customer premise equipment, such as
modems and access routers, and engineering tools, such as DSL test and
development systems.
Product sales increased 76% from $704,000 in the third quarter of 1998 to
$1,241,000 in the current year quarter. As a percentage of total revenue,
product sales increased from 21% in the third quarter of 1998 to 23% in the
current year quarter. The dollar increase is primarily due to a substantial
increase in hardware product revenue from the sale of Veritas DSL test and
development systems and to a lesser degree higher revenue from the sale of x200
Access Routers. DSL test and development system revenue increased primarily due
to: (i) increased sales to equipment suppliers using chipsets based upon the
Company's DSL technology and (ii) the availability of the Company's Veritas992
product, which began shipping in the fourth quarter of 1998, and therefore was
not available in the third quarter of 1998. x200 Access Router revenue increased
primarily due to shipments to an equipment supplier who is using the x200 in an
end-to-end deployment.
For the nine months ended September 30, product sales increased 80% from
$2,172,000 in 1998 to $3,897,000 in 1999. As a percentage of total revenue,
product sales decreased from 28% in the first nine months of 1998 to 27% in the
corresponding period of 1999. The dollar increase is primarily due to a
substantial increase in hardware product revenue from the sale of DSL test and
development systems, and higher revenue from the sale of compression software.
DSL test and development system revenue increased primarily due to: (i)
increased sales to equipment suppliers using chipsets based upon the Company's
DSL technology and (ii) the availability of the Company's new Veritas992 product
during the first nine months of 1999. Compression software revenue increased
primarily due to increased demand by a number of OEM customers
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who shipped the Company's compression software in higher volumes during the
first three quarters of 1999.
Contract Revenue. Contract revenue consists primarily of license,
engineering development, and customer support fees that Aware is paid under
development and license agreements with semiconductor and equipment
manufacturers. The majority of contract revenue is due upon the transfer of
pre-existing intellectual property, the completion of development milestones, or
the provision of customer support by Aware. Contract revenue also includes an
insignificant amount of revenue from U.S. government research contracts.
Contract revenue increased 16% from $2,544,000 in the third quarter of 1998 to
$2,947,000 in the current year quarter. As a percentage of total revenue,
contract revenue decreased from 76% in the third quarter of 1998 to 55% in the
current year quarter. The dollar increase was primarily due to an increase in
contract revenue from the Company's semiconductor customers. Higher contract
revenue from these customers was primarily attributable to new projects with
existing and new customers.
For the nine months ended September 30, contract revenue increased 48% from
$5,395,000 in 1998 to $8,007,000 in 1999. As a percentage of total revenue,
contract revenue decreased from 69% in the first nine months of 1998 to 56% in
the corresponding period of 1999. The dollar increase is primarily due to a
substantial increase in contract revenue from the Company's semiconductor
customers. Higher contract revenue from these customers was primarily
attributable to new projects with existing and new customers. The dollar
increase in telecommunications contract revenue was partially offset by a
decline in U.S. government research revenue. The Company completed its last U.S.
government research project in the first quarter of 1999, and anticipates that
revenue from such projects will not continue in future periods.
Royalties. Royalties consist of royalty payments to Aware under
development and license agreements. Aware receives royalties when customers
utilize Aware technology in chipsets or equipment.
Royalties increased from $99,000 in the third quarter of 1998 to $1,219,000 in
the current year quarter. As a percentage of total revenue, royalties increased
from 3% in the third quarter of 1998 to 23% in the current year quarter. For the
nine months ended September 30, royalties increased from $216,000 in 1998 to
$2,520,000 in 1999. As a percentage of total revenue, royalties increased from
3% in the first nine months of 1998 to 18% in the corresponding period of 1999.
The Company believes that the increase in royalties was primarily the result of
higher utilization of the Company's technology in DSL chipsets for central
office equipment and customer premise equipment. The increase in customer DSL
chipset shipments was driven by initial deployments of DSL services by the
telecommunications industry.
Cost of Product Sales. Cost of product sales consists primarily of
the cost of goods for equipment sales.
Cost of product sales increased 22% from $302,000 in the third quarter of 1998
to $368,000 in the current year quarter. As a percentage of product sales, cost
of product sales decreased from 43% in the third quarter of 1998 to 30% in the
current year quarter. DSL equipment cost of product sales as a percentage of DSL
equipment product sales was 83% in the third quarter of 1998 as compared to 44%
in the third quarter of 1999. The improvement in equipment gross
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margin is primarily due to a larger percentage of higher margin test and
development system revenue in the sales mix, and no obsolescence provision in
the current year period.
For the nine months ended September 30, cost of product sales decreased 16% from
$1,136,000 in 1998 to $957,000 in 1999. As a percentage of product sales, cost
of product sales decreased from 52% in the first nine months of 1998 to 25% in
the corresponding period of 1999. Some of the percentage decrease is
attributable to a higher percentage of compression software in the product sales
mix, which has minimal related costs. DSL equipment cost of product sales as a
percentage of DSL equipment product sales was 75% in the first nine months of
1998 as compared to 48% in the corresponding period of 1999. The improvement in
equipment gross margin is primarily due to a larger percentage of higher margin
test and development system revenue in the sales mix, and a substantial
reduction of obsolescence provisions in the current year period.
Cost of Contract Revenue. Cost of contract revenue consists primarily
of salaries for engineers and expenses for consultants, recruiting, supplies,
equipment, depreciation and facilities associated with Aware's license and
development agreements and U.S. government contracts. Cost of contract revenue
increased 29% from $1,421,000 in the third quarter of 1998 to $1,828,000 in the
current year quarter. As a percentage of contract revenue, cost of contract
revenue increased from 56% in the third quarter of 1998 to 62% in the current
year quarter. For the nine months ended September 30, cost of contract revenue
increased 44% from $3,628,000 in 1998 to $5,212,000 in 1999. As a percentage of
contract revenue, cost of contract revenue decreased from 67% in the first nine
months of 1998 to 65% in the corresponding period of 1999. For the three and
nine month periods, the dollar increase is primarily due to projects with
existing and new customers. Increased spending related to these new projects and
customers was partially offset by almost no spending on U.S. government research
projects.
Research and Development Expense. Research and development expense
consists primarily of salaries for engineers and expenses for consultants,
recruiting, supplies, equipment, depreciation and facilities related to research
and development of Aware DSL equipment and core DSL and compression technologies
not associated with semiconductor customer contracts. Research and development
expense decreased by 15% from $955,000 in the third quarter of 1998 to $814,000
in the current year quarter. As a percentage of total revenue, research and
development expense decreased from 29% in the third quarter of 1998 to 15% in
the current year quarter. For the nine months ended September 30, research and
development expense decreased 27% from $3,241,000 in 1998 to $2,372,000 in 1999.
As a percentage of total revenue, research and development expense decreased
from 42% in the first nine months of 1998 to 16% in the corresponding period of
1999. For the three and nine month periods, the dollar decrease was primarily
due to: (i) lower spending related to the development of the Company's x200
Access Router, (ii) lower spending due to the replacement of a number of
relatively expensive outside contractors with new full-time Aware engineering
employees, and (iii) the redeployment of research and development engineering
resources to semiconductor customer contracts. Lower spending was partially
offset by higher expenses related to the development of the Company's Veritas992
product.
Selling and Marketing Expense. Selling and marketing expense consists
primarily of salaries for sales and marketing personnel, travel, advertising and
promotion, recruiting, and facilities expense. Selling and marketing expense
increased 9% from $620,000 in the third quarter of 1998 to $678,000 in the
current year quarter. As a percentage of total revenue, sales and marketing
expense decreased from 19% in the third quarter of 1998 to 13% in the current
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year quarter. The dollar increase was primarily due to sales expenses associated
with identifying and completing development and licensing agreements, which was
partially offset by lower marketing and advertising expenses.
For the nine months ended September 30, selling and marketing expense decreased
by 12% from $2,250,000 in 1998 to $1,976,000 in 1999. As a percentage of total
revenue, selling and marketing expense decreased from 29% in the first nine
months of 1998 to 14% in the corresponding period of 1999. The dollar decrease
was primarily due to lower sales and marketing costs to execute the Company's
intellectual property and software licensing strategy, which was implemented
during the second and third quarters of 1998. Previously, the Company was
primarily pursuing an end-user modem distribution and sales strategy.
General and Administrative Expense. General and administrative
expense consists primarily of salaries for administrative personnel, facilities
costs, public company expenses and professional services, such as legal and
audit expenses. General and administrative expense increased 25% from $551,000
in the third quarter of 1998 to $687,000 in the current year quarter. As a
percentage of total revenue, general and administrative expense decreased from
17% in the third quarter of 1998 to 13% in the current year quarter. For the
nine months ended September 30, general and administrative expense increased 20%
from $1,640,000 in 1998 to $1,961,000 in 1999. As a percentage of total revenue,
general and administrative expense decreased from 21% in the first nine months
of 1998 to 14% in the corresponding period of 1999. For the three and nine month
periods, the dollar increase is primarily due to higher public company expenses
and additions to the Company's legal and administrative staff.
Other Income and Expense. Other income consists of rental income from
real estate leases. Other income and expense decreased from $103,000 in the
third quarter of 1998 to zero in the current year quarter. For the nine months
ended September 30, other income decreased from $301,000 in 1998 to $18,000 in
1999. When the Company completed the purchase of its headquarters building in
July 1997, the terms of the purchase agreement required Aware to sublet 24,000
square feet to the seller for a period of 18 months. The sublease agreement
terminated in January 1999 and the Company does not anticipate any further
sublease income in future periods. The Company plans to occupy the additional
24,000 square feet commencing in the fourth quarter of 1999.
Interest Income. Interest income increased 21% from $323,000 in the
third quarter of 1998 to $392,000 in the current year quarter. For the nine
months ended September 30, interest income increased 7% from $987,000 in 1998 to
$1,057,000 in 1999. The dollar increase in both periods is primarily due to
increased interest income from higher cash balances, which was partially offset
by lower interest rates.
Income Taxes. Aware has made no provision for income taxes as its
historical net losses have resulted in tax loss carryforwards. At December 31,
1998, Aware had available federal net operating loss carryforwards of
approximately $29,514,000, which expire in 2003 through 2018, and federal
research and development credit carryforwards of approximately $1,628,000, which
expire in 2003 through 2013. At December 31, 1998, Aware also had available
state net operating loss carryforwards of approximately $25,379,000, which
expire in 1999 through 2003, and state research and development and investment
tax credit carryforwards of approximately $1,094,000, which expire in 2006
through 2013. Of the total net operating loss carryforwards, approximately
$14,561,000 are attributable to the exercise of stock options, and the tax
benefit from these losses, when utilized, will be credited to additional paid-in
capital.
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LIQUIDITY AND CAPITAL RESOURCES
At September 30, 1999, the Company had cash, cash equivalents and short-term
investments of $33,967,000, an increase of $7,400,000 from December 31, 1998.
The increase is primarily due to $2,189,000 of cash provided from operations and
$6,998,000 of proceeds from the issuance of common stock under the Company's
employee stock plans. Cash provided from these sources was partially offset by
$1,787,000 of cash invested in capital and other assets.
Cash provided from operations in the first nine months of 1999 was the result of
net income less working capital requirements. Property and equipment spending
was primarily related to: (i) the renovation of the third floor of the Company's
office building, and (ii) the purchase of laboratory equipment, computer
equipment, and purchased software acquired primarily for engineering activities.
While there can be no assurance that the Company will not require additional
financing, or that such financing will be available to the Company, the Company
believes that its financial resources are adequate to meet its liquidity
requirements over the next twelve months.
YEAR 2000 COMPLIANCE
The following information constitutes a "Year 2000 Readiness Disclosure" under
the Year 2000 Information and Readiness Disclosure Act. Many currently installed
software products and computer systems are coded to accept only two digit
entries in the date code field. These date code fields will need to accept four
digit entries to distinguish 21st century dates from twentieth century dates.
The use of software and computer systems that are not Year 2000 compliant could
result in system failures or miscalculations causing disruptions of operations,
including a temporary inability to process transactions, send invoices or engage
in similar normal business activities. As a result, many companies' software and
computer systems may need to be upgraded or replaced in order to comply with
Year 2000 requirements.
The Company has implemented a program to consider and address Year 2000 issues.
A project team led by members of the Company's management has made a detailed
assessment of (1) software that the Company licenses to third parties and (2)
software that the Company uses internally. The assessment is complete and the
Company has nearly completed implementing solutions to address Year 2000 issues
that it has identified.
Most of the software that the Company licenses to third parties is aimed at
transmitting or compressing data and is not date sensitive. The Company does
license some software that is date sensitive, which it believes is now Year 2000
compliant. Although the Company believes the software it licenses is either Year
2000 compliant or not affected by Year 2000 issues, the Company's software is
typically used in conjunction with other software and computer systems supplied
by third parties. The failure of other software or computer systems to be Year
2000 compliant when used in conjunction with the Company's software could cause
the entire application to perform improperly. Failure of applications that
contain the Company's software to be Year 2000 compliant could result in fewer
or no sales of those applications, which could have a material adverse effect on
the Company's business, financial condition and results of operations.
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The Company has reviewed the software it uses internally to determine whether it
is Year 2000 compliant. In those instances in which installed software was not
already Year 2000 compliant, the Company has either replaced all non-compliant
software with Year 2000 compliant software or obtained patches that has made
such software Year 2000 compliant. Based on the foregoing, the Company currently
has no reason to believe that its internal software systems will not be Year
2000 compliant.
To date, the Company has not incurred significant incremental costs in order to
comply with Year 2000 requirements and does not believe it will incur
significant incremental costs in the foreseeable future. However, there can be
no assurance that Year 2000 errors or defects will not be discovered in software
that the Company licenses or in its own internal software systems and, if such
errors or defects are discovered, there can be no assurance that the costs of
making such software Year 2000 compliant will not have a material adverse effect
on the Company's business, financial condition and results of operations.
Although the Company has assessed whether its internal software systems are Year
2000 compliant, it has not conducted a Year 2000 review of all of its vendors
and suppliers. Failure of systems maintained by the Company's vendors and
suppliers to operate properly with regard to the Year 2000 and thereafter could
require the Company to incur significant unanticipated expenses to remedy any
problems or replace affected vendors and suppliers that could have a material
adverse effect on the Company's business, financial condition and results of
operations.
RISK FACTORS
The Company believes that the occurrence of any one or some combination of the
following risk factors could have a material adverse effect on the Company's
business, financial condition and results of operations.
History of Operating Losses
The Company may not achieve profitable operations in any future period. The
Company has incurred operating losses in every fiscal year from inception
through 1998. As of September 30, 1999, the Company had an accumulated deficit
of $14.0 million. Substantial additional research and development spending will
be required to enhance the Company's core technology before market acceptance
can be determined. Although revenue has grown in recent quarters and the Company
has begun to achieve profitability, there can be no assurance that it will
continue to grow in future quarters or that it will grow enough to enable
sustained profitability.
Unpredictable and Fluctuating Operating Results
Because many of the Company's revenue components fluctuate and are difficult to
predict, and its expenses are largely independent of revenues in any particular
period, it is difficult for the Company to accurately forecast revenues and
profits or losses. If quarterly revenue or operating results fall below the
expectations of investors or public market analysts, the price of the Company's
common stock could fall significantly.
Other factors, many of which are outside of the Company's control, also could
cause variations in quarterly revenue and operating results. Some of these
factors are: (i) the rate of market
13
<PAGE> 14
acceptance of DSL broadband access, generally, and of Aware's G.Lite and
full-rate ADSL technology in particular; (ii) demand for the Company's
licensees' chipsets and products that incorporate Aware technology, particularly
G.Lite; (iii) development by Aware or its competitors of enhanced or alternative
high-speed network access technologies; (iv) changes in industry standards
governing DSL technology solutions; (v) the extent and timing of new customer
license transactions; (vi) changes in the Company's and system companies'
development schedules and levels of expenditure on research and development;
(vii) personnel changes, particularly those involving engineering and technical
personnel; (viii) costs associated with protecting the Company's intellectual
property; (ix) regulatory developments; and (x) general economic trends.
New and Unproven Business Model
In the second quarter of 1998, the Company shifted its business strategy to
focus on licensing its DSL technology to semiconductor and equipment
manufacturers that incorporate the Company's technology into DSL chipsets and
products, and away from sales of DSL-based products such as modems. Other than
the Company's six-year relationship with Analog Devices, Aware does not have
extensive experience licensing its technology to third parties. Moreover,
obtaining suitable licensees for the Company's technology is difficult because
of the following features of its strategy: (i) the Company must typically
undergo a lengthy and expensive process of building a relationship with a
potential licensee before entering into an agreement; (ii) the Company must
persuade semiconductor and equipment manufacturers with significant resources to
rely on the Company for critical technology on an ongoing basis rather than
trying to develop similar technology internally; and (iii) the Company must
persuade potential licensees to bear development costs associated with
utilization of the Company's technology and to make the necessary investment to
successfully produce chipsets and products utilizing Aware's technology. The
Company's success also depends on its ability to generate significant royalties
from its customer licensing arrangements. If the Company cannot obtain suitable
licensees or otherwise fails to implement its business strategy successfully,
there could be a material adverse effect on the Company's business, financial
condition and results of operations.
Dependence Upon Limited Number of Licensees
There are a relatively limited number of larger semiconductor and equipment
companies to which the Company can license its DSL technology in a manner
consistent with its business model. There can be no assurance that customers
will not use their superior size and bargaining power to demand license terms
that are unfavorable to the Company.
Aware's royalties from its licensees are often based on the selling prices of
its licensees' chipsets and products, and the Company has little or no control
over such selling prices. The Company also has little or no control over its
licensees' promotional and marketing efforts. The Company's licensees are not
obligated to use Aware's technology, and generally are not required to pay
royalties to Aware unless they utilize the Company's technology. The failure of
the Company's licensees to achieve significant sales of chipsets and products
utilizing Aware's technology could materially and adversely affect the Company's
business.
14
<PAGE> 15
Dependence on Equipment Companies To Incorporate Aware's Technology
Equipment companies, particularly those that develop and market high-volume
business and consumer products such as central office line cards, modems and
personal computers, must purchase chipsets containing Aware's DSL technology
from Aware's licensees for the Company to be successful. There are other chipset
solutions available for equipment companies seeking to offer high-speed network
access products. Therefore, the Company faces the risk that equipment
manufacturers will choose chipset solutions that do not incorporate Aware's
technology. Also, the Company's ability to influence equipment manufacturers'
decision whether to adopt its technology is limited.
The Company also faces the risk that equipment companies that elect to
incorporate Aware's DSL technology into their products will not compete
successfully against other equipment companies. Many factors beyond Aware's
control could influence the success or failure of a particular equipment company
that adopts Aware's technology, such as: (i) competition from other businesses
in the same industry; (ii) market acceptance of the equipment company's
products; (iii) engineering, sales and marketing, and management capabilities of
the equipment company; (iv) technical challenges that an equipment company faces
during its product development cycle that are unrelated to Aware's technology;
and (v) the financial and other resources of the equipment company.
Therefore, even if equipment companies incorporate Aware's DSL technology into
their products, there can be no assurance that their products will achieve
commercial acceptance or result in significant royalties to Aware.
Dependence on Service Providers and End Users To Purchase Products and Services
That Incorporate Aware's Technology
The markets for products incorporating DSL technology and for DSL services are
new and rapidly evolving. As is typical of new and rapidly evolving markets,
demand for recently introduced DSL products and services is highly uncertain.
The market for products and services incorporating Aware's DSL technology may
not develop successfully.
The Company's future success depends substantially upon whether its DSL
technology gains widespread commercial acceptance by providers of high-speed
network access services. Although global standards for DSL technology have been
adopted, including the G.lite standard, service providers continue to evaluate
DSL and alternative technology solutions as options for "last-mile" data
transmission. There can be no assurance that service providers will use Aware's
DSL technology in their service offerings.
Even if numerous service providers buy equipment that incorporates Aware's DSL
technology, the Company is also dependent on the acceptance of those high-speed
DSL service offerings by end user customers. There can be no assurance that end
user customers will accept DSL service offerings and products in sufficient
volumes to support the Company's business model.
15
<PAGE> 16
Dependence on Acceptance of DSL Technology For Broadband Access
In addition to DSL technology for telephone networks, high-speed network access
solutions have been developed for cable networks and wireless systems.
Furthermore, other alternative high-speed access technologies may be developed
in the future as well. Cable modem installations have begun and are expected to
increase significantly for the foreseeable future. If alternative high-speed
network access technologies supplant telephone lines as an access medium, the
Company's business could be materially and adversely affected.
Limited Intellectual Property Protection; Risk of Third Party Claims of
Infringement
Because Aware is a technology provider, its ability to protect its intellectual
property and to operate without infringing the intellectual property rights of
others is critical to its success. The Company regards its technology as
proprietary, and has a number of patents and pending patent applications. The
Company also relies on a combination of trade secrets, copyright and trademark
law and non-disclosure agreements to protect its unpatented intellectual
property. Despite these precautions, it may be possible for a third party to
copy or otherwise obtain and use Aware's technology without authorization.
Although the Company intends to defend its intellectual property as necessary,
there can be no assurance that the steps the Company has taken will be adequate
to prevent misappropriation.
A large and increasing number of participants in the telecommunications industry
have applied for or obtained patents. Some of these patent holders have
demonstrated a readiness to commence litigation based on allegations of patent
and other intellectual property infringement. Third parties may assert exclusive
patent, copyright and other intellectual property rights to technologies that
are important to the Company's business. From time to time, Aware has received
claims from other companies that its technology may infringe their patent
rights. While the Company believes its technology does not infringe the
intellectual property of others, there can be no assurance that it does not.
Intellectual property rights can be uncertain and can involve complex legal and
factual questions. If Aware were found to have infringed any third party's
patents, then it could be subject to substantial damages and an injunction
preventing it from conducting its business.
Rapid Technological Change; Reliance on Fundamental Technology; Importance
of Timely New Product Development
The telecommunications and semiconductor industries are characterized by rapid
technological change, with new generations of products and technology being
introduced periodically and with ongoing evolutionary improvements. The Company
has derived a substantial portion of its revenue from its DSL technology and
expects that this dependence on its fundamental technology will continue for the
foreseeable future. The introduction or market acceptance of competing
technology which renders the Company's DSL technology less desirable or obsolete
would have a rapid and material adverse effect on the Company's business,
results of operations and financial condition. The announcement of new
technologies by the Company could cause licensees or equipment companies to
delay or defer entering into arrangements for the use of the Company's
technology, which could have a material adverse effect on the Company's
business, financial condition and results of operations.
16
<PAGE> 17
The Company's operating results will depend to a significant extent on its
ability to introduce enhancements and new generations of its DSL technology
which keep pace with other changes in the semiconductor and telecommunications
industries and which achieve rapid market acceptance. The Company must
continually devote significant engineering resources to addressing the
ever-increasing need for technical innovations. Technical innovations of the
type that will be required for the Company to be successful are inherently
complex and require long development cycles, and there can be no assurance that
the Company's development efforts will ultimately be successful. In addition,
these innovations must be completed before changes in the semiconductor and
telecommunications industries have rendered them obsolete, must be available
when equipment companies require them, and must be sufficiently compelling to
cause semiconductor and equipment companies to enter into licensing arrangements
with Aware for the new technology. There can be no assurance that Aware will be
able to meet these requirements. Moreover, significant technological innovations
generally require a substantial investment before their commercial viability can
be determined. There can be no assurance that the Company will have the
financial resources necessary to fund future development, that the Company's
licensees will continue to share certain research and development costs with the
Company as they have in the past, or that revenues from enhancements or new
generations of the Company's technology, even if successfully developed, will
exceed the costs of development.
Competition
The semiconductor and telecommunications industries in which the Company's
technology is utilized are intensely competitive and have been characterized by
price erosion, rapid technological change, short product life cycles, cyclical
market patterns and increasing foreign and domestic competition. The Company
believes that its principal competition comes from its licensees and prospective
licensees, many of which are evaluating and developing products based on their
own or alternative technologies. The Company's licensees' products compete with
other semiconductor vendors' products, which are not based on the Company's
technology. Further high-speed DSL service offerings over telephone networks
will compete with vendors of alternative network technologies, such as cable
modems and wireless services. Many of the Company's competitors and potential
competitors have significantly greater financial, technological, manufacturing,
marketing and personnel resources than the Company. There can be no assurance
that the Company will be able to compete successfully or that competition will
not adversely affect the Company's business.
Dependence on Hiring and Retaining Personnel
The Company believes that its future success will depend significantly on its
ability to attract, motivate and retain additional highly-skilled technical,
managerial and marketing personnel. Competition for qualified engineers is
intense and there are a limited number of available persons with the necessary
knowledge and experience in DSL, chip design and related technologies. Finding,
training and integrating additional qualified personnel is likely to be
difficult and expensive, and the Company may be unable to do so successfully.
During 1998 and the first nine months of 1999, the Company was not able to hire
all of the engineers it had contemplated in its business plans. If the Company
is unable to hire and retain a sufficient number of engineers, its business
could be materially and adversely affected.
17
<PAGE> 18
Volatility of Stock Price
The market price of the Company's common stock could fluctuate substantially
based on a variety of factors, including: (i) quarterly fluctuations in the
Company's operating results; (ii) changes in the Company's relationships with
its licensees; (iii) announcements of technological innovations or new products
by the Company, its licensees or its competitors; (iv) changes in earnings
estimates by public market analysts; (v) key personnel losses; (vi) sales of
common stock; (vii) developments or announcements with respect to industry
standards, patents or proprietary rights; and (viii) developments or
announcements with respect to service offerings or equipment offerings for
high-speed network access. In addition, the equity markets have experienced
volatility that has particularly affected the market prices of equity securities
of many high technology companies and that often has been unrelated or
disproportionate to the operating performance of such companies. These broad
market fluctuations may adversely affect the market price of the Company's
common stock.
Year 2000
See "Year 2000 Compliance" above for a description of the risks the Company
faces in connection with Year 2000 issues.
Government Regulation
The extensive regulation of the telecommunications industry by federal, state
and foreign regulatory agencies, including the Federal Communications
Commission, or FCC, and various state public utility and service commissions,
could affect the Company through the effects of such regulation on its licensees
and their customers. Changes in current or future laws or regulations, in the
United States or elsewhere, could materially and adversely affect the Company's
business.
18
<PAGE> 19
ITEM 3:
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
CASH AND CASH EQUIVALENTS
As of September 30, 1999, the Company is exposed to market risks which primarily
include changes in U.S. interest rates.
The Company maintains a portion of its cash and cash equivalents in financial
instruments with purchased maturities of three months or less. These financial
instruments are subject to interest rate risk and will decline in value if
interest rates increase. Due to the short duration of these financial
instruments, an immediate increase in interest rates would not have a material
effect upon the Company's financial position.
SHORT-TERM INVESTMENTS
The Company does not hold derivative financial instruments in its short-term
investment portfolio. Short-term investments consist of instruments that meet
high quality standards consistent with the Company's investment policy. The
Company's policy dictates that all short-term investments mature in 18 months or
less. All short-term investments in the Company's portfolio at September 30,
1999 bear interest at fixed rates and mature within one year. Due to the
relatively short duration of the financial instruments in the portfolio, an
immediate increase in interest rates would not have a material effect upon the
Company's financial position.
19
<PAGE> 20
PART II. OTHER INFORMATION
ITEM 1:
LEGAL PROCEEDINGS
There are no material pending legal proceedings to which the Company
is a party or to which any of its properties are subject which, either
individually or in the aggregate, are expected by the Company to have a material
adverse effect on its business, financial position or results of operations.
20
<PAGE> 21
ITEM 6:
EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
None
(b) REPORTS ON 8-K
None
- --------------------
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
AWARE, INC.
Date: November 5, 1999 By: /s/ Michael A. Tzannes
-----------------------------------
Michael A. Tzannes, Chief Executive
Officer and President
Date: November 5, 1999 By: /s/ Richard P. Moberg
-----------------------------------
Richard P. Moberg, Vice President
and Chief Financial Officer
(Principal Financial and Accounting
Officer)
21
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