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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
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
(Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of
the Act: NONE Securities registered pursuant to
Section 12(g) of the Act:
COMMON STOCK, PAR VALUE $.01 PER SHARE
(Title of class)
Indicate by check mark 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 by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ X ]
The aggregate market value of the voting stock held by non-affiliates of the
registrant as of February 26, 1999, based on the closing price of the Common
Stock on February 26, 1999 as reported on the Nasdaq National Market, was
approximately $639,425,242.
The number of shares outstanding of the registrant's common stock as of February
26, 1999 was 21,173,488.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive Proxy Statement to be delivered to
shareholders in connection with the registrant's Annual Meeting of Shareholders
to be held on May 25, 1999 are incorporated by reference into Part III of this
Annual Report on Form 10-K.
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AWARE, INC.
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1998
TABLE OF CONTENTS
PART I
<TABLE>
<S> <C> <C>
Item 1. Business.................................................................................... 3
Item 2. Properties.................................................................................. 18
Item 3. Legal Proceedings........................................................................... 18
Item 4. Submission of Matters to a Vote of Security Holders......................................... 18
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters...................... 19
Item 6. Selected Financial Data.................................................................... 20
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations............................................................................... 21
Item 8. Financial Statements and Supplementary Data................................................. 34
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure.................................................................................. 50
PART III
Item 10. Directors and Executive Officers of the Registrant.......................................... 51
Item 11. Executive Compensation...................................................................... 52
Item 12. Security Ownership of Certain Beneficial Owners and Management.............................. 52
Item 13. Certain Relationships and Related Transactions.............................................. 52
PART IV
Item 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K............................. 53
Signatures............................................................................................ 56
</TABLE>
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PART I
ITEM 1. BUSINESS
GENERAL
Aware, Inc. (the "Company" or "Aware") was incorporated in Massachusetts in
1986. During its first seven years, the Company was engaged primarily in
contract research, specializing in wavelet mathematics, digital compression, and
telecommunications, including digital modulation and coding. In 1993, Aware
shifted its business from contract research toward the development and licensing
of Digital Subscriber Line ("DSL") technology, as well as data and video
compression software. DSL technology increases the speed of data communications
over conventional copper telephone networks so that telephone companies
("telcos") can use their installed bases of copper telephone lines to provide
both residential and business customers with interactive data transmission at
speeds much higher than currently available.
Commencing in 1996, the Company complemented its DSL technology development and
licensing activities by offering DSL hardware products. The Company's product
strategy during this period was to demonstrate its technology in these products
and to fill trial equipment opportunities until widespread deployment of DSL
services began. In 1998, after continued DSL market evolution, the Company
refocused on licensing its DSL intellectual property and software to
semiconductor and equipment manufacturers to enable them to manufacture and sell
integrated circuits and products incorporating Aware technology. Although the
Company continues to sell certain DSL hardware products that support its
technology licensing activities, its principal business focus is on technology
licensing.
The Company also sells software-based compression products, including WSQ by
Aware, AccuPress for Radiology, AccuPress for Remote Sensing, AccuPress for
Multimedia, and SeisPact.
The Company's executive offices are located at 40 Middlesex Turnpike, Bedford,
Massachusetts, 01730, and its telephone number is (781) 276-4000.
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INDUSTRY BACKGROUND
Businesses and consumers are increasingly demanding high-speed network access in
order to take advantage of Internet services, such as electronic commerce, and
new data intensive network applications, such as telecommuting. Incumbent and
new competitive service providers, including service providers such as Regional
Bell Operating Companies, Competitive Local Exchange Carriers, and European
PTTs, initially have responded to these demands by significantly increasing the
data transmission speed and capacity of the core infrastructure, or "backbone,"
that links their central office locations. Service providers have made less
progress improving access speed and capacity along the "last mile" that connects
central office locations with homes and businesses. While large businesses have
the resources to take advantage of access technologies that leverage the use of
fiber optic cable or dedicated access lines (such as T-1 service), the cost and
availability of these technologies are prohibitive to other network users.
Without improved access technologies, many residential and small business users
will not be able to take full advantage of the range of existing and emerging
Internet services and data intensive applications.
Residential and small business users have begun to benefit from emerging
broadband technologies, which enable high-speed network access over a cable line
or a single telephone line. The cable industry recently has begun to leverage
its installed base of coaxial cable by marketing and installing cable modems
that provide high-speed access to residential and home office users through the
existing cable network. The Yankee Group expects the number of cable modem
subscribers to increase from 425,000 in 1998 to 4.3 million in 2002. The
deployment of cable modems has begun to validate the demand for broadband access
and to further demonstrate that consumers are willing to pay a premium for
increased access speed. Cable broadband access can involve significant
deployment costs, since cable providers must make substantial capital
investments to upgrade their networks to allow two-way transmissions and either
cable providers or users must hire technicians to complete in-house
installations. Moreover, the use of cable modems has raised user concerns about
the loss of access speed that occurs with increased use of a cable line, the
security of transmissions and the absence of choice of Internet service
providers.
Broadband access over existing telephone networks offers significant advantages
as a medium for providing high-speed network access to residential and small
business users. The worldwide telephone network of over 750 million copper wire
lines already spans the distance between central office locations and end users;
this "last mile" is where the bottleneck for deploying high-speed access exists.
Many residential and small business users currently rely on conventional
voiceband modems that use the telephone line as a relatively inexpensive way to
gain network access. The rate at which voiceband modems can transmit data has
evolved over the past two decades from 2.4 kilobits per second, or Kbps, to 56
Kbps, but current speeds are still too slow for some existing data applications
and will be unable to provide the bandwidth for many anticipated applications.
In addition, voiceband modems cannot support simultaneous voice and data
services.
Advances in semiconductor integration and digital signal processing have led to
the development of broadband access technology, known as Digital Subscriber Line
or DSL, technology, which can transmit data over telephone lines significantly
faster than voiceband modems. The first DSL technology, known as Asymmetric
Digital Subscriber Line or full-rate ADSL, was created in the late 1980s and
enables data to be transmitted at speeds more than 100 times faster than 56 Kbps
voiceband modems. Full-rate ADSL permits voice and data traffic to be
transmitted simultaneously on the same line, but this requires that a technician
install a filter, known as a "splitter," at each user's site, which increases
the deployment cost.
In October 1998, the International Telecommunications Union announced a new
global "splitterless" ADSL standard called "G.lite." G.lite services are capable
of providing data transmission speeds
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between ten and thirty times faster than those of voiceband modems, while
permitting voice and data traffic to be transmitted simultaneously without the
need to install splitters. G.lite-enabled modems can be installed in or
connected to personal computers, and then easily activated by users without
outside technical assistance or significant additional expense. As a result, the
combination of G.lite-enabled modems and G.lite-enabled service provider
equipment can provide high-speed network access to residences and small offices
at a lower cost than full-rate ADSL.
The deployment of DSL services requires a broad range of products from central
office equipment, such as telephone switches, digital subscriber line access
multiplexers and digital loop carriers, to internal and stand-alone personal
computer modems at end-user locations. Service providers typically put these new
broadband access products through a rigorous approval process before deploying
them on a broad basis. The approval process usually involves a number of phases,
including: (i) laboratory evaluation, in which the product is tested against
industry standards; (ii) technical trial, in which the product is tested in the
field with a small number of users; (iii) marketing trial, in which the product
is tested in the field with a larger number of users and the service provider
begins to train its personnel to install and maintain the product; (iv) initial
commercial deployment, in which the service provider makes the product available
to selected customers for selected applications; and (v) commercial deployment.
Full-rate ADSL technology has been going through the above process since 1996
and commercial deployments by telephone companies and other service providers
have commenced. A number of service providers, including Bell Atlantic, British
Columbia Telecom, Covad, Deutsche Telecom, GTE, SBC, Singapore Telecom and US
West are offering full-rate ADSL service in regions in North America, Europe and
Asia. These service providers are able to purchase full-rate ADSL equipment from
a large number of telecommunications and data communications companies,
including Alcatel, Cisco, Diamond Lane Communications, Ericsson, Newbridge
Networks and Nokia, many of whom use DSL chipsets from Analog Devices
incorporating Aware's technology. In addition, Compaq Computer Corporation and
Dell Computer Corporation have begun shipping personal computers with internal
DSL-enabled modems directly to end users. Compaq uses a dual-mode DSL-Lite and
56 Kbps solution from Lucent that incorporates Aware's DSL-Lite technology.
Aware believes that these deployments will increase market awareness of DSL
capabilities and therefore may accelerate the roll-out of DSL services.
TECHNOLOGY
Aware is a leading provider of DSL technology that meets the requirements of
chipset and equipment manufacturers for standard-compliant technology solutions.
The Company's core telecommunications technology is based on its research into
wavelet mathematics and digital communications. From that core technology, three
principal telecommunications technologies have emerged, including: (i) Full-rate
ADSL technology, (ii) DSL-Lite technology, and (iii) DWMT-based technology for
emerging broadband applications
Full-Rate ADSL Technology
Full-rate ADSL is a method for expanding the useable bandwidth of copper wire.
Typically, full-rate ADSL systems divide a 1.1 megahertz (MHz) bandwidth on
copper wire into three segments: (i) the 0 to 4 kilohertz (KHz) range is used
for plain old telephone service ("POTS"), (ii) the 26 KHz to 138 KHz range is
used to transmit data upstream, and (iii) the 138 KHz to 1.1 MHz range is used
to transmit information downstream. The American National Standards Institute
has published an industry standard (known as T1.413) for full-rate ADSL in the
United States. The International Telecommunications
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Union has established an identical global industry standard for full-rate ADSL,
known as G.992.1. The American National Standards Institute and International
Telecommunications Union specifications call for operation rates of up to 8 Mbps
downstream and up to 640 Kbps upstream when operating over telephone lines at a
distance of up to 18,000 feet.
In addition to higher-speed data capabilities, full-rate ADSL offers the
following advantages over voiceband modems:
(1) full-rate ADSL allows simultaneous voice and data traffic over a
single telephone line; and
(2) full-rate ADSL can easily distinguish between voice calls and data
calls because they each occupy different frequency bands. Today,
telephone company equipment does not distinguish between voice and
data calls. A data call lasts on average much longer than a voice
call. Because telephone company switches were designed based upon the
average length of a voice phone call, they become inefficient when a
large number of data calls are placed. Full-rate ADSL allows service
providers to take data traffic off the switch and alleviate this
bottleneck.
Standard compliant full-rate ADSL uses a modulation technique known as discrete
multitone, or DMT. DMT divides the upstream and downstream bands into a
collection of smaller frequency ranges of approximately 4 kHz each, called
subchannels. During transmission, each 4 kHz subchannel carries a portion of the
total data rate. By dividing the transmission bandwidth into a collection of
subchannels, DMT is able to adapt to the distinct characteristics of each
telephone line and maximize the data transmission rate. Telephone lines are best
suited for transmission of the low frequencies associated with voice traffic
(0-4 kHz). The high frequencies that are used for full-rate ADSL transmissions
experience distortion and attenuation when sent over telephone lines - the
higher the frequency, the more the attenuation. DMT effectively divides the data
into a collection of smaller bandwidth transmissions, each of which occupies a
frequency range and is optimized to maximize the data throughput in that range.
The American National Standards Institute and International Telecommunications
Union standards both established DMT as the standard modulation technique for
full-rate ADSL.
An alternative modulation technique to DMT is carrierless amplitude phase, or
CAP. CAP is a single-carrier modulation technique developed by AT&T Paradyne
Corp. The fundamental difference between CAP and DMT is that CAP treats each of
the upstream and downstream frequency ranges as a single element over which as
many information bits as possible are transmitted. CAP was not adopted as a
standard ADSL technology, and every major equipment supplier with products
incorporating CAP has announced its intention to migrate to DMT, although there
can be no assurances that these equipment suppliers will migrate to DMT, or, if
they do, at what rate.
Full-rate ADSL, however, requires the installation of a filter, or splitter, at
the end user's residence or place of business in order to handle simultaneous
data and voice traffic.
DSL-Lite Technology
In a significant improvement over full-rate ADSL, G.Lite (Aware's implementation
of G.Lite is called DSL-Lite) enables simultaneous voice traffic and data
traffic without requiring installation of a splitter. In the absence of a
splitter, the frequencies used by the DSL-Lite signal are subjected to numerous
voice traffic phenomena. For example, a telephone being picked up results in a
change in the characteristics of the frequencies used by DSL-Lite. Aware has
invented, implemented and applied for patents on proprietary signal processing
techniques that compensate for the effects of this and other related phenomena
and maintain DSL-Lite data transmission. These techniques enable "splitterless"
DSL.
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In 1997, the Universal ADSL Working Group was formed by Compaq, Intel, Microsoft
and others to promote development of a standard for splitterless DSL. At the
urging of this Group, the International Telecommunications Union began
development of a global standard G.lite, in late 1997. In October 1998, the
International Telecommunications Union determined the G.lite standard, which it
renamed G.992.2. G.992.2 is based upon DMT technology. Aware provided key
technical submissions involving splitterless operation, which avoids the costs
associated with the installation of a splitter.
G.lite specifies downstream data transmission rates of up to 1.5 Mbps and
upstream data transmission rates of up to 512 Kbps, at distances of up to 24,000
feet. Typically, G.lite systems divide a 550 KHz bandwidth on copper wire into
three segments: (i) the 0 to 4 kilohertz (KHz) range is used for POTS, (ii) the
26 KHz to 138 KHz range is used to transmit data upstream and (iii) the 138 KHz
to 550 KHz range is used to transmit information downstream.
DSL-Lite has several primary advantages over full-rate ADSL:
(1) DSL-Lite reduces the deployment costs of DSL services by eliminating
the need to install a splitter in every home;
(2) DSL-Lite-enabled modems allow consumers to plug broadband modems into
the wall in a "plug and play" format as they currently do with
voiceband equipment;
(3) DSL-Lite enables personal computer manufacturers to integrate DSL-Lite
capabilities into personal computers, just as they do with voiceband
modem technology; and
(4) DSL-Lite is designed to be compatible with full-rate ADSL equipment
installed in service provider central offices, enabling service
providers to use their installed full-rate ADSL equipment to provide
DSL-Lite functionality.
DWMT-based Technology For Emerging Broadband Applications
DMT divides a frequency range into the desired number of subchannels by using a
time-domain to frequency-domain transform. The subchannelization method used in
DMT technology utilizes a mathematical process called a Fourier transform. This
technique has been used in the telecommunications industry since the 1960s, but
has become more practical for high-speed, high-volume use as digital signal
processors have improved. Because of fundamental limits associated with these
transforms, the process of creating isolated subchannels is imperfect. These
imperfections inhibit modems from achieving theoretical performance limits in
real-world environments.
Aware has invented and patented a proprietary communications technology based on
wavelet mathematics called discrete wavelet multitone, or DWMT. Aware believes
that, as a result of its research and development of DWMT technology, it is a
leader in commercialization of wavelets for telecommunications. The wavelet
transform yields significantly better subchannelization than the Fourier
transform. This technique more closely approximates ideal subchannelization,
enabling DWMT technology to outperform DMT technology in a noisy environment.
Aware is developing a DWMT chipset capable of achieving higher-speed data
transmission. While full-rate ADSL occupies approximately 1 MHz of bandwidth,
Aware's DWMT chipset facilitates data transmission over more than 2 MHz of
bandwidth and supports the higher data rates associated with emerging broadband
technologies. Examples of emerging broadband technologies include:
Symmetric Digital Subscriber Line, or SDSL, enables data transmission rates from
1 Mbps to greater than 10 Mbps simultaneously in both directions on single
twisted-pair copper wire over distances of up to
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18,000 feet. Aware believes that SDSL can be used for business applications such
as interconnecting local area networks, as well as enhanced telephony
applications.
Very high-speed Digital Subscriber Line, or VDSL, is being designed with the
objective of providing performance up to six times faster than full-rate ADSL,
but it will be able to do so only over shorter distances. Aware believes that
VDSL technology will be part of the next generation of high-speed user access.
The goal of VDSL is to enable service providers to deliver a combination of
digital television, data dial-tone and regular telephone service on a single
twisted-pair copper wire. Because VDSL is capable of transmitting only over a
shorter distance, it will require service providers to deploy fiber optic cable
closer to the end user.
STRATEGY & BUSINESS MODEL
Aware licenses its DSL technology solutions -- including full-rate ADSL and
DSL-Lite -- to semiconductor manufacturers that supply chipsets to central
office equipment suppliers, modem manufacturers and personal computer makers, as
well as to equipment manufacturers that incorporate Aware technology into their
own products. Equipment manufacturers in turn provide their DSL-enabled products
to service providers seeking to provide DSL services, or to end users seeking to
subscribe to such services. To support its technology licensing activities, the
Company also markets its technology to equipment manufacturers and service
providers to encourage them to use Aware-based technology in their products or
services. Aware's strategy is based on the following key elements:
Serve as Independent Technology Provider. Only a few technology companies have
successfully developed DSL technology, and many of them are affiliated with
semiconductor or equipment manufacturers. This presents a significant and
growing opportunity for independent providers that are able to supply full-rate
ADSL and DSL-Lite technology to chipset manufacturers for DSL equipment markets.
Aware believes that, as the market for DSL broadband access products and
services grows, semiconductor manufacturers and other market participants will
demand an independent source of DSL technology.
Maintain DSL Technology Leadership. Aware's full-rate DSL technology was the
foundation for its development of DSL-Lite, a new technology that underlies, in
part, the recently established industry standard for G.lite. Aware regularly
interacts with equipment providers that sell DSL products to end users. Through
its relationships with these suppliers, who are customers of the Company's
licensees or direct customer's of Aware, Aware gains valuable product
development information regarding market trends, end user requirements and
technological requirements of products and services under development. Aware
intends to exploit its DSL technology leadership to develop the intellectual
property and software necessary to enable its customers to develop
next-generation DSL chipsets and products.
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Leverage Aware's and its Customers' Strengths. Aware's strategy is to leverage
the technology and expertise it has developed over years of research and
development efforts, without having to make significant expenditures to develop
the infrastructure required to sell equipment-based DSL products itself.
Instead, Aware combines its DSL technological leadership with the sales and
marketing resources and distribution channels of its licensees to create royalty
revenue. From Aware's customers' perspective, they are able to incorporate
Aware's DSL technology into their existing semiconductor products in order to
preserve the value of their product development investments. Furthermore, by
relying on Aware to provide the core DSL technology, Aware's customers can focus
their internal research and development resources on differentiating their
chipset products from those of their competitors.
Provide Flexible DSL Technology Solution. Aware has developed DSL technology
that can be incorporated into a variety of chipset architectures. Aware's DSL
technology enables chipset manufacturers to design and manufacture chipsets for
DSL products ranging from fully programmable products, such as digital signal
processing chips, to fully fixed function products, such as application specific
integrated circuits. Moreover, future end user demands regarding functionality
and price can be expected to drive the DSL technology needs of Aware's licensees
in ways that are difficult to predict. Aware will continue to provide DSL
technology supporting a broad range of DSL chipsets and products.
Influence the Establishment of Industry Standards. Aware has been and remains
deeply involved in industry-wide efforts to set DSL technology standards. Aware
recently took part in the international effort to develop a standard
splitterless ADSL solution, which resulted in the determination of the G.lite
standard by the International Telecommunications Union in October 1998. By
actively participating in the establishment of industry standards, Aware is
better able to influence development of the standards and to anticipate and
identify technological changes affecting the DSL industry. Once a DSL standard
has been determined, Aware implements its interpretations of the standard
consistently across its customer base, so that all products based on its DSL
technology are interoperable.
Reduction of Risk and Time-to-Market. By relying on Aware's experience, its
licensees can avoid many of the risks of development failure or delay they would
have faced in developing needed DSL technology internally. Given the complexity
of DSL technology, licensees of Aware's technology benefit from its seven years
of experience in designing, developing, integrating and deploying DSL
technology. If a semiconductor manufacturer elects to develop its own DSL
technology, the manufacturer's operating results and market position may be
adversely affected if, at the end of a lengthy development period, it has not
successfully completed development of the desired technology or if its products
are late to market.
AWARE'S TECHNOLOGY AND PRODUCT OFFERINGS
DSL TECHNOLOGY OFFERINGS
Aware is focused on developing and licensing its core intellectual property and
software for applications related to full-rate ADSL and DSL-Lite. Aware is also
working on next-generation broadband DSL applications, including technology for
VDSL solutions. Aware's DSL technology expertise, when applied in joint
development efforts with its licensees, has produced first-to-market chipsets
for both full-rate ADSL and DSL-Lite. This experience and expertise is offered
to customers in the following forms of intellectual property and software:
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Patents. Aware holds nine patents pertaining to multicarrier modulation for
broadband communications and has additional patents pending, all of which apply
to digital signal processing and digital communications. These patents underlie
Aware's technology offerings.
System models and designs. Aware provides system models and designs, which model
the components of a DSL chipset, including the digital and analog subsections,
through the use of software simulations and hardware emulations. System models
and designs include design optimization, trade-off studies and performance
analysis, all of which are accomplished through software modeling.
ASIC Cores. Aware provides application specific integrated circuit designs, or
ASIC cores, to its semiconductor manufacturer licensees to reduce development
time, increase throughput performance and reduce risk in DSL chipset
developments.
Run-time software. Aware's C and assembly code, configured to reside on either a
digital signal processor or microcontroller chip, provide handshake,
initialization, tracking and steady state modem functions. Software upgrades can
be made available as the technology is upgraded, providing greater flexibility.
For example, run-time software has been developed to upgrade Analog Devices'
full-rate ADSL chipsets to add DSL-Lite functionality.
Reference designs. Aware develops reference designs for DSL printed circuit
boards ("PCBs"). The goal behind Aware's reference designs is to provide
cost-optimized blueprints for its customers to lay-out DSL chipsets onto DSL
PCBs, so that the boards meet or exceed industry standard performance
benchmarks.
DSL HARDWARE PRODUCT OFFERINGS
Aware has developed and markets certain hardware products, which are
manufactured by third party contract manufacturers, to support the development
and deployment of chipsets and equipment incorporating the Company's technology.
Development Systems. Aware's development system is a tool that has been designed
to help its customers evaluate and build standard-compliant, DSL-based products
and services. Development systems are typically purchased by semiconductor
customers, equipment manufacturers, and service providers who are building
products or offering DSL services which incorporate standard-compliant DSL
technology.
Access Router. Aware has developed and markets a full-rate ADSL access router,
called the x200 Access Router. The x200 contains the Analog Devices/Aware
full-rate ADSL chipset along with software and hardware interfaces and reference
designs developed by Aware, and routing capability for various data
communications protocols. In a typical configuration, Aware's full-rate ADSL
access router is designed to receive data at speeds over 9 Mbps and send data at
speeds of up to 768 Kbps, is fully rate adaptive in 32 Kbps increments and is
capable of transmitting data over distances of more than 18,000 feet over
standard copper wire while maintaining telephone service through the use of a
splitter. The x200 has been marketed to several companies for use in their
equipment offerings. In addition, the x200 is often used as a technology
demonstrator in trade show demonstrations and service provider trials.
DWMT Chipset. Aware is developing a DWMT chipset capable of achieving
higher-speed data transmission. This chipset will be initially targeted at VDSL
applications.
COMPRESSION SOFTWARE TECHNOLOGY AND PRODUCTS
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Aware also develops data and video compression products. Since 1988, Aware has
developed expertise, trade secrets and intellectual property in the field of
wavelet transform-based data compression and has obtained several patents in
this area. Aware's wavelet compression technology enables digital image, video
and certain types of data to be compressed to between 1% and 10% of their
original size. Using wavelet compression, the decompressed data are not
bit-for-bit identical to the original data. A risk with this technique is that,
as the original data are increasingly compressed, a larger amount of error is
introduced into the decompressed data. However, compressed data can be
transmitted across networks faster and storage costs are reduced.
In 1993, Aware began an effort to produce commercially marketable wavelet image
compression software products. Aware currently offers five software-based
compression products and has an agreement with Analog Devices to produce and
market a wavelet video compression integrated circuit, for which Aware receives
royalties. Aware's compression products include the following: (i) WSQ by Aware,
which compresses digital fingerprint data for use by law enforcement agencies
such as the Federal Bureau of Investigation; (ii) AccuPress for Radiology, which
compresses digital radiographs and other types of medical imagery; (iii)
AccuPress for Multimedia, a general-purpose compression product; (iv) AccuPress
for Remote Sensing, which compresses satellite-based remote sensing imagery; and
(v) SeisPact, which companies in the oil and gas industry can use to store and
transmit large amounts of seismic data.
STRATEGIC CUSTOMERS
Aware's customer relationships are typically long-term, and involve extensive
joint product development efforts. Therefore, Aware carefully selects potential
licensees based on development compatibility, market position and the potential
for future royalty revenue. Aware considers the following six customers to be
of strategic importance:
Analog Devices Inc. Beginning in 1993, Analog Devices exclusively produced and
marketed chipsets incorporating Aware's full-rate ADSL technology pursuant to an
exclusive license, for which Aware receives royalties and development funding.
In March 1998, Analog Devices and Aware modified their relationship to a
non-exclusive one. Also in March 1998, Aware licensed its DSL-Lite technology to
Analog Devices on a non-exclusive basis. Multiple generations of Analog Devices'
DSL chipsets incorporate Aware's technology, including the first chipsets that
implement both full-rate ADSL and DSL-Lite technology. In September 1998, Analog
Devices announced that it had fifty customers for these chipsets, including
telecommunications leaders such as Lucent and Nortel, networking leaders such as
Cisco, and full-rate ADSL market leaders such as Ericsson and Newbridge
Networks.
Lucent Microelectronics Group. Aware provides DSL-Lite technology for Lucent's
Wildwire chipset, for which Aware receives royalties and development funding.
The resulting chipset is the first personal computer modem chipset for
high-speed Internet access incorporating both DSL-Lite and 56 Kbps technology.
In November 1998, Compaq began shipment of personal computers incorporating the
Wildwire chipset. Lucent Microelectronics Group is the number one seller of
chips for modem-equipped personal computers in North America, with a market
share in excess of 40%, and its customers include Compaq, Hewlett-Packard, IBM,
NEC and Gateway.
Siemens Semiconductor Group. In August 1998, Siemens Semiconductor and Aware
announced their agreement to integrate Aware's DSL-Lite technology into a
chipset for telephone company central office
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switches. This central office chipset will be a splitterless central office DSL
solution, which brings together Aware's DSL-Lite technology and Siemen's digital
signal processor, high-performance broadband subscriber line and converter
technologies.
Siemens Information and Communications Networks ("ICN") Group. In September
1998, Siemens ICN and Aware entered into an agreement under which the companies
are defining the next-generation architecture for Siemens' DSL-enabled EWSD
digital electronic switching system. Siemens EWSD product is the most widely
sold carrier-class switching system in the world. The relationship between the
companies is intended to produce a specification for Siemens DSL-enabled central
office switches, which will be based on Aware's DSL-Lite technology.
3COM/US Robotics. In March 1997, Aware licensed its full-rate ADSL technology to
3COM (then US Robotics) for use in 3COM's full-rate ADSL product offerings.
3COM/US Robotics DSL product line includes PCI cards, USB modems and office
routers. 3COM/US Robotics is one of the largest sellers of modems in the world.
ST Microelectronics. In December 1998, Aware entered into an agreement with ST
Microelectronics ("ST") to integrate Aware's DSL-Lite technology into ST's
advanced silicon process. The ST/Aware DSL solution brings together Aware's
DSL-Lite technology and ST's advanced integrated circuits for communications
applications. ST is the third largest seller of telecommunications chipsets in
the world.
SALES AND MARKETING
Aware's principal sales and marketing strategy is to propagate its DSL
technology with semiconductor manufacturers and telecommunications equipment
suppliers that wish to incorporate Aware's technology into their products. Due
to the complexity of Aware's technology, Aware's sales people must have a high
degree of technical sophistication in order to market effectively. Aware
believes that decisions involving the selection of its technology are frequently
made at senior levels within a prospective customer's organization.
Consequently, Aware relies significantly on presentations by senior management
to key employees of its customers. Aware expects to hire additional sales and
marketing employees to support the sales efforts of senior management and create
awareness for Aware's technology with semiconductor manufacturers, equipment
suppliers and service providers. As of December 31, 1998, the Company had eleven
people in its telecommunications sales and marketing organization.
The Company sells its software-based compression products primarily through OEMs
and systems integrators. As of December 31, 1998, there were three people in the
Company's compression software sales organization.
The Company derived approximately 29%, 18%, 14%, and 8% of its total revenue in
1998 from ADI, Lucent, Siemens, and 3COM/US Robotics, respectively. The Company
derived approximately 16%, 13%, and 12% of its total revenue in 1997 from
3COM/US Robotics, the United States government and ADI, respectively. The
Company derived approximately 22%, 17%, 12%, and 10% of its total revenue in
1996 from DSC Communications Corporation, ADI, the United States government, and
Teltrend, Inc., respectively. All revenue in 1998, 1997, and 1996 was derived
from unaffiliated customers.
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<PAGE> 13
COMPETITION
The markets for telecommunications products are intensely competitive. Aware
expects competition to increase in the immediate future, especially in the
DSL-Lite market. Aware intends to compete through its strategy of providing a
comprehensive DSL technology offering to a broad range of users throughout the
telecommunications chipsets and equipment markets. Because of its strategy,
Aware faces competition at several points.
Aware's success depends primarily on the willingness of semiconductor
manufacturers, equipment suppliers, personal computer manufacturers, and service
providers and other end users to invest in broadband digital services based on
Aware's DSL technology. Aware expects that its DSL technology and products will
compete not only with other products that increase the efficiency of digital
transmission technologies over copper wire, but also with other broadband
transmission technologies. Potential competitors include:
- other vendors of standards-based ADSL technology, such as Alcatel
Network Systems ("Alcatel"), Orckit Communications LimiTed ("Orckit"),
Texas Instruments, Inc. ("TI"), and PairGain Technologies, Inc.
("PairGain"), each of which is developing and selling its own
DMT-based DSL technology;
- vendors of non-standards-based ADSL technologies, such as Globespan
Technologies and Paradyne Corp., which are currently marketing their
non-DMT-based ADSL technology; and
- semiconductor manufacturers, such as Motorola, NEC, Intel, Analog
Devices, Lucent, and Siemens, and equipment suppliers sUch as Cisco,
Ericsson, and Nortel, which, although they are current or potential
customers, could intensify competition by internally developing their
own DSL technology solutions.
- vendors of alternative technologies, such as cable modem providers,
ISDN for Internet access, and wireless technologies;
Aware believes that, in the full-rate ADSL market, its DMT-based products are
more flexible and will enjoy greater potential for deployment than products
using the CAP modulation technique, which is a non-standard, proprietary,
single-source technology. However, CAP-based ADSL products were introduced prior
to DMT-based products and are more readily available than products incorporating
Aware's technology. Also, to date there has been only limited commercial
deployment of DMT-based ADSL products. Therefore, Aware is uncertain how
products incorporating its DSL technology will compare with products sold by
Alcatel, Orckit, TI, and PairGain, each of whom manufactures DMT-based ADSL
products.
The markets for Aware's wavelet image compression technology are competitive,
and are expected to become increasingly so in the near future. In addition,
Aware's WSQ Finger Print Compression product is an implementation of an open
standard and is therefore subject to competition.
Many of Aware's competitors and potential competitors, including Alcatel and TI,
have significantly greater financial, technological, manufacturing, marketing
and personnel resources than Aware. Aware cannot be sure that it will be able to
compete successfully or that competitive pressures will not materially and
adversely affect its business.
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<PAGE> 14
RESEARCH AND DEVELOPMENT
Aware believes that its future success depends on its ability to adapt to the
rapidly changing telecommunications environment and to meet its customers'
ongoing technology development needs. Aware's research and development
organization is organized around two groups. One group is primarily dedicated to
working with Aware's licensees to develop chipsets and equipment incorporating
Aware's DSL-Lite and full-rate ADSL technology. This group facilitates the
integration of Aware's technology with each licensee's existing products and
technology, which reduces the time-to-market for new chipsets and equipment and
leverages each licensee's existing investment. The other group focuses on
developing and enhancing Aware's core technology for future telecommunications
applications, which is essential to maintain Aware's competitive position. Key
development objectives include enhancements to Aware's ADSL and DSL-Lite
technologies, and developing DWMT-based and other technologies for emerging
broadband applications.
As of December 31, 1998, Aware had a research and development staff of 57
employees. Aware supplemented its staff with 6 contract engineers as of December
31, 1998. Subject to its ability to hire and retain engineers, Aware anticipates
that its research and development organization will grow significantly in the
future as a key component of Aware's strategy to further develop its core DSL
technology.
During the years ended December 31, 1998, 1997 and 1996, research and
development costs charged to operations were $3,886,935, $3,396,576, and
$1,043,682, respectively. Such costs are net of software development costs
capitalized in accordance with Statement of Financial Accounting Standards
("SFAS") No. 86. There were no SFAS 86 costs capitalized in 1998, 1997 or 1996.
14
<PAGE> 15
INTELLECTUAL PROPERTY
In the field of telecommunications technology, Aware holds nine patents for
multi-carrier communications systems. Aware has additional pending patent
applications that pertain to the application of multi-carrier technology to
broadband communications, including a patent application that pertains to its
splitterless DSL techniques. Aware also holds six patents for image compression
and processing, four patents for video compression, two patent for audio
compression, one patent for certain optical applications and one pending patent
for seismic data compression.
Although Aware has patented certain aspects of its technology, Aware relies
primarily on know-how and trade secrets to protect its intellectual property.
Aware attempts to protect its trade secrets and other proprietary information
through agreements with its customers, suppliers, employees and consultants, and
through security measures. Each of Aware's employees is required to sign a
nondisclosure and non-competition agreement. Although Aware intends to protect
its rights vigorously, there can be no assurance that these measures will be
successful. In addition, the laws of certain countries in which products
incorporating Aware's technology may be developed, manufactured or sold may not
protect Aware's intellectual property and product rights to the same extent as
the laws of the United States.
Aware's ability to compete may be affected by its ability to protect its
intellectual property. Aware believes, however, that because of the rapid pace
of technological change in the telecommunications industry, its technical
expertise and ability to enhance its DSL technology on a timely basis will be as
important in maintaining its competitive position as protection of its existing
intellectual property.
Many participants in the telecommunications industry have an increasing number
of patents and have frequently 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 Aware. In 1996, Aware
received letters from two companies, Amati Communications Corporation (since
acquired by Texas Instruments Inc.) and Telebit Corporation (since acquired by
Cisco Systems, Inc), each asserting that it owns certain U.S. and foreign
patents that are necessary for products that comply with the American National
Standards Institute standard for ADSL, claiming that Aware's ADSL technology
would infringe such patents, and offering Aware the opportunity to enter into a
license agreement with respect to such patents. Aware understands that Analog
Devices received similar letters. Aware reviewed the Amati and Telebit patents
and received an opinion of its patent counsel, Cesari and McKenna, based upon
Aware's oral description of its technology, to the effect that Aware's ADSL
technology does not infringe any valid claim of any of the Amati and Telebit
patents. Based upon this opinion, Aware believes that it does not require a
license under the Amati or Telebit patents in order to conduct its proposed
business. Aware has also received notice from Amati of the pendency of various
patent applications which Amati considers to be pertinent to the design and
operation of ADSL modems. Unless and until a patent actually issues, there can
be no infringement, and Aware has not examined any such patent applications or
received an opinion of patent counsel with respect thereto. Aware has not
received any further communication from either Texas Instruments/Amati or
Telebit regarding the foregoing since 1996.
In 1998 and 1999, Aware received letters from Bell Atlantic asserting that it
owns a U.S. patent that it believes is necessary for companies that manufacture
and sell ADSL equipment, and offering Aware the opportunity to enter into a
license agreement with respect to such patent. Aware reviewed the Bell Atlantic
patent and received an opinion of its patent counsel, Cesari and McKenna, to the
effect that Aware's ADSL technology does not infringe any valid claim of the
Bell Atlantic patent. Based upon this opinion, Aware believes that it does not
require a license under the Bell Atlantic patent in order to conduct its
proposed business.
15
<PAGE> 16
Despite these opinions and the passage of time, there can be no assurance that a
court to which the issue is submitted would not find that Aware's ADSL
technology infringes the Amati, Telebit, or Bell Atlantic patents, nor that
Amati, Telebit, or Bell Atlantic will not assert infringement again in the
future. If Aware is found to have infringed any of the patents, Aware could be
subject to substantial damages and an injunction preventing it from conducting
its business, and Aware's business could be materially and adversely affected.
Although Amati, Telebit, and Bell Atlantic have offered to license their patents
and their patent applications to Aware, there can be no assurance that any
license would be available on acceptable terms should Aware choose to pursue
such license or be found to infringe such patents. In addition, there can be no
assurance that other third parties will not assert infringement claims against
Aware in the future, that these assertions or those of Amati, Telebit and Bell
Atlantic will not result in protracted and costly litigation, or that Aware
would prevail in any such litigation or be able to license any valid patents
from third parties on commercially reasonable terms. Further, such litigation,
regardless of its outcome, could result in substantial costs to and diversion of
effort by Aware. Litigation may also be necessary to enforce Aware's
intellectual property rights. Any infringement claim or other litigation against
or by Aware could materially and adversely effect Aware's business.
GOVERNMENT REGULATION
The telecommunications industry, including many of the customers of Aware's
licensees, is subject to regulation by federal and state agencies, including the
Federal Communications Commission, or FCC, and various state public utility and
service commissions. While such regulation does not necessarily affect Aware
directly, the effects of such regulations on the customers of Aware's licensees
may, in turn, adversely affect Aware's business. FCC regulatory policies
affecting the availability of broadband access services and other terms on which
service providers conduct their business may impede Aware's plans for deployment
of its technology.
In February 1996, the Telecommunications Act was enacted. A primary factor in
passage of the Telecommunications Act was the desire to deregulate and foster
competition in the telecommunications markets. While Aware believes deregulation
and increased competition, in general, will be favorable to its operations and
business plan, the effect of the Telecommunications Act on the
telecommunications industry is unclear. However, the provision of broadband
access services over telephone wires may be subject to regulation under the 1996
Telecommunications Act. The FCC may interpret the Telecommunications Act to
require that incumbent local exchange carriers establish separate subsidiaries
in order to offer unregulated high-speed access services, or the FCC may require
that incumbent local exchange carriers make their high-speed access networks
available for use by potential competitors upon request. While it is unclear how
the FCC will interpret the Telecommunications Act, either of these options could
result in reduced investment in broadband access networks and could slow the
rollout of DSL access services, which could materially and adversely affect
Aware's business.
In addition, Aware's business may also be affected by the imposition of certain
tariffs, duties and other import restrictions on components that Aware's
licensees obtain from non-domestic suppliers or by the imposition of export
restrictions on products sold internationally and incorporating Aware's
technology. Internationally, governments of the United Kingdom, Canada,
Australia and numerous other countries actively promote and create competition
in the telecommunications industry. Changes in current or future laws or
regulations, in the U.S. or elsewhere, could materially and adversely affect
Aware's business.
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<PAGE> 17
MANUFACTURING
Sales of hardware products constitute a relatively small portion of Aware's
revenue, and Aware does not intend to produce such products in any material
quantity for the foreseeable future. Consequently, Aware relies on third party
contractor manufacturers to assemble and test substantially all of its products.
Aware's internal manufacturing capacity is limited to final test and assembly of
certain products. Other than chipsets, which are available from strategic
customers, the Company believes that other components for its equipment-based
products are available from a number of suppliers.
EMPLOYEES
At December 31, 1998, Aware employed 86 people, including 57 in research and
development, 14 in sales and marketing, 3 in manufacturing and 12 in finance and
administration. All of these employees were based in Massachusetts. Aware
supplements its regular employees as necessary with temporary and contract
personnel. At December 31, 1998, Aware engaged 7 temporary and contract
personnel, primarily working in research and development. None of Aware's
employees is represented by a labor union. Aware considers its employee
relations to be good.
Aware believes that its future success will depend in large part on the service
of its technical and senior management personnel and upon Aware's ability to
attract and retain highly qualified technical, sales and marketing and
managerial personnel. Competition for highly qualified personnel is intense, and
there can be no assurance that Aware will be able to retain its key managerial
and technical employees or that it will be able to attract and retain additional
highly qualified personnel in the future.
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<PAGE> 18
ITEM 2. PROPERTIES
Aware's headquarters and business operations are located in a 72,000 square foot
office building in Bedford, Massachusetts. Aware purchased the building in 1997.
Aware believes that its Bedford facility is substantially utilized, well
maintained and suitable for Aware's operations, and that additional space will
be available as needed.
ITEM 3. LEGAL PROCEEDINGS
There are no 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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of 1998.
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<PAGE> 19
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company has one class of stock outstanding, its common stock, which has a
par value of $.01 per share. The Company's common stock is traded on the Nasdaq
National Market under the symbol AWRE. The following table sets forth the high
and the low sales prices as reported on the Nasdaq National Market from January
1, 1997 to December 31, 1998.
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
---------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1998
High $15 1/8 $15 1/8 $11 3/4 $27 3/16
Low 10 7/16 10 1/4 4 3/4 4 3/4
1997
High 14 7/8 16 7/8 15 1/8 14 15/16
Low 8 5/8 8 1/2 9 5/8 9 1/8
</TABLE>
As of February 19, 1999, the Company had approximately 156 shareholders of
record. This number does not include shareholders from whom shares were held in
a "nominee" or "street" name. The Company has never paid cash dividends on its
common stock and anticipates it will continue to reinvest any earnings to
finance future operations.
The Company did not sell any equity securities that were not registered under
the Securities Act during the three months ended December 31, 1998.
The Company sold 3,910,000 shares of the Company's Common Stock, par value $.01
per share, on August 14, 1996 and September 9, 1996, pursuant to a Registration
Statement on Form S-1 (File No. 333-06807), which was declared effective by the
Securities and Exchange Commission on August 8, 1996 (the "Effective Date"). The
managing underwriters of the offering were BancBoston Robertson Stephens, Inc.
and ING Barrings Furman Selz LLC. The aggregate gross proceeds of the offering
were $39,100,000. The Company's total expenses in connection with the offering
were $3,937,000, of which $2,737,000 was for underwriting discounts and
commissions and $1,200,000 was for other expenses paid to persons other than
directors or officers of the Company, persons owning more than 10 percent of any
class of equity securities of the Company, or affiliates of the Company
(collectively, "Affiliates"). The Company's net proceeds from the offering were
$35,163,000. From the Effective Date through December 31, 1998, the Company used
(i) approximately $12,406,000 of such net proceeds to purchase and renovate a
commercial office building, which the Company now uses as its headquarters, and
to acquire computers, software and other equipment and (ii) approximately
$4,898,000 of such net proceeds for working capital. None of these payments were
made to Affiliates. As of December 31, 1998 the Company had approximately
$17,859,000 of proceeds remaining from the offering, and pending use of the
proceeds, the Company intends to invest such proceeds primarily in short-term,
interest-bearing, investment-grade securities, including money market
instruments.
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<PAGE> 20
ITEM 6. SELECTED FINANCIAL DATA
The following selected historical financial data has been derived from the
Company's audited consolidated financial statements. The historical financial
data should be read in conjunction with the Company's consolidated financial
statements and notes thereto included in Item 8.
<TABLE>
<CAPTION>
(in 000's, except per share data)
Year Ended December 31, 1998 1997 1996 1995 1994
- -------------------------------------------------------------------------------------------------------------------
Statements of Operations Data
<S> <C> <C> <C> <C> <C>
Revenue $11,796 $ 6,198 $ 5,301 $3,260 $3,827
Loss from operations (3,951) (6,157) (538) (454) (1,095)
Net income (loss) (2,249) (4,448) 259 (343) (1,012)
Net income (loss) per share - basic ($0.11) ($0.23) $0.02 ($0.29) ($0.88)
Net income (loss) per share - diluted ($0.11) ($0.23) $0.01 ($0.29) ($0.88)
Balance Sheet Data
Cash and short-term investments $26,567 $26,104 $36,719 $2,154 $2,566
Working capital 28,813 26,774 38,280 2,516 2,877
Total assets 40,162 39,281 40,123 3,228 3,930
Total liabilities 1,028 1,661 676 309 684
Total stockholders' equity 39,134 37,620 39,446 2,920 3,246
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
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<PAGE> 21
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
From its incorporation in 1986 until 1993, Aware was primarily engaged in
research, specializing in wavelet mathematics, digital compression, and
telecommunications, including digital modulation and coding. In 1993, Aware
shifted its business from contract research toward development and licensing of
Digital Subscriber Line, or DSL, and other broadband technologies, as well as
data and video compression software. Commencing in 1996 and 1997, Aware began to
complement its DSL technology licensing and development activities by offering
DSL products, including modems, access routers, transceiver modules and
development systems. Aware's two principal objectives with respect to its
product business were to demonstrate its DSL technology through its products,
and to fill trial equipment opportunities until widespread deployment of DSL
services began.
In the second quarter of 1998, Aware made a decision to focus primarily on
licensing its intellectual property and software to semiconductor and equipment
manufacturers that desire to vertically integrate Aware's technology to enable
them to manufacture and sell integrated circuits incorporating Aware technology.
Aware also markets its technology to (i) telecommunications and data
communications equipment companies to encourage them to design Aware technology
into their products, and (ii) service providers to encourage them to deploy
services, such as high-speed Internet access, based on Aware technology.
Additionally, Aware will continue to sell DSL development systems to support its
technology licensing business, as well as sell software-based compression
products.
Aware's decision to focus its strategic direction on intellectual property and
software licensing was driven by the following factors: (i) consolidation within
the industry among DSL technology providers created an opportunity for
independent technology suppliers to fill a demand by semiconductor companies for
such technology; (ii) Aware amended its agreement with Analog Devices, Inc.
("ADI") in March 1998 from an exclusive to a non-exclusive relationship, thus
allowing Aware to license its technology to other semiconductor companies; (iii)
Aware believes that its DSL intellectual property offers semiconductor companies
valuable patent rights, time-to-market and risk reduction opportunities; and
(iv) the entry of well-established companies with superior manufacturing and
distribution capabilities increased pressure on DSL equipment pricing and caused
Aware to conclude that there were other companies that could more competitively
manufacture, distribute and support DSL equipment.
In the fourth quarter of 1998, the Company reclassified its revenue categories
to reflect the change in its strategic direction and to improve the
meaningfulness of its financial statement disclosure. Aware previously
classified its revenue into product revenue, license and royalty revenue, and
research and development revenue. Aware has reclassified its revenue into the
following three line items:
PRODUCT SALES consist primarily of revenue from the sale of hardware
and software products that Aware ships to customers on a recurring
basis, such as full-rate ADSL modems, access routers, transceiver
modules, development systems, and compression software.
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
completion of development milestones or the provision of customer
support by Aware. Remaining contract revenue consists primarily of
license fees, which are due upon transfers of pre-existing intellectual
property or upon pre-determined dates. Contract revenue also includes
revenue from U.S. government research contracts.
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<PAGE> 22
ROYALTIES consist of royalty payments to Aware under development and
license agreements. Royalties are due upon shipment of chipset or
equipment products by Aware's customers. Such royalty payments are
based on a fixed dollar amount for each unit of product shipped or a
percentage of net revenue from the sale of customer products.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain line items
from the Company's consolidated statements of operations as a percentage of
total revenue:
<TABLE>
<CAPTION>
Year ended December 31, 1998 1997 1996
--------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenue:
Product sales 26.2 % 39.3 % 31.7 %
Contract revenue 70.2 60.3 68.3
Royalties 3.6 0.4 -
--------------------------------------------------------------------------------------
Total revenue 100.0 100.0 100.0
Costs and expenses:
Cost of product sales 11.8 20.2 15.7
Cost of contract revenue 46.0 56.1 41.3
Research and development 33.0 54.7 19.7
Sales and marketing 24.0 36.9 14.5
General and administrative 18.7 31.4 18.9
--------------------------------------------------------------------------------------
Total costs and expenses 133.5 199.3 110.1
Loss from operations (33.5) (99.3) (10.1)
Other income and expense 3.4 - -
Interest income 11.0 27.5 15.0
--------------------------------------------------------------------------------------
Net income (loss) (19.1) % (71.8) % 4.9 %
=======================================================================================
</TABLE>
PRODUCT SALES
Product sales increased 27.0% from $2.4 million in 1997 to $3.1 million in 1998.
As a percentage of total revenue, product sales decreased from 39.3% in 1997 to
26.2% in 1998. The dollar increase was primarily due to the availability of
hardware products, such as ADSL development systems and the Company's x200
Access Router, for a greater portion of the year in 1998. Hardware product sales
were also higher as the result of shipments of prototype transceiver modules and
customer premises equipment. The dollar increase in hardware product sales was
partially offset by lower revenue from the sale of compression software
products. Lower compression software sales were primarily the result of a
significant sale to a single customer in 1997 that did not reoccur to the same
degree in 1998.
Product sales increased 44.9% from $1.7 million in 1996 to $2.4 million in 1997.
As a percentage of total revenue, product sales increased from 31.7% in 1996 to
39.3% in 1997. The dollar increase was primarily due to higher revenue from the
sale of: (i) transceiver module and development system hardware products, which
were introduced in the second quarter of 1997, and (ii) compression software
products. Increased compression software sales were primarily the result of a
significant sale to a single
22
<PAGE> 23
customer in 1997 that did not occur in 1996. Higher product sales from the sale
of new hardware products and compression software products were partially offset
by a modest decline in revenue from the sale of modems.
CONTRACT REVENUE
Contract revenue increased 121.7% from $3.7 million in 1997 to $8.3 million in
1998. As a percentage of total revenue, contract revenue increased from 60.3% in
1997 to 70.2% in 1998. The dollar increase was primarily due to a substantial
increase in contract revenue from Aware's lead telecommunications semiconductor
customers, including ADI, Lucent, and Siemens. Higher contract revenue from
these lead customers was attributable to new projects with ADI, up-front license
payments from ADI for early ADI customer access to the Company's DSL-Lite
software, and the addition of Lucent and Siemens as new customers. The dollar
increase in telecommunications contract revenue was partially offset by a
decline in U.S. government research contract revenue.
Contract revenue increased 3.2% from $3.6 million in 1996 to $3.7 million in
1997. As a percentage of total revenue, contract revenue decreased from 68.3% in
1996 to 60.3% in 1997. The slight dollar increase is primarily due to the
effects of the initial stages of a fundamental shift in Aware's business. The
shift consisted of a transition away from contracts that involved the
integration of Aware-based ADSL and hybrid fiber coaxial cable chipsets into
customers' equipment towards contracts that involved the integration of Aware's
intellectual property and software into customers' semiconductor products. As a
result of this shift, contract revenue from new semiconductor and equipment
manufacturer customers was higher, and contract revenue from ADSL and hybrid
fiber coaxial cable equipment customers was lower. The net effect of the shift
resulted in flat year over year telecommunications contract revenue. Contract
revenue was also slightly higher due to a modest increase in U.S. government
contract revenue.
ROYALTIES
Royalties increased from $25,000 in 1997 to $418,000 in 1998. As a percentage of
total revenue, royalties increased from 0.4% in 1997 to 3.6% in 1998. The dollar
increase was primarily due to ADSL chipset royalty payments from several of the
Company's lead semiconductor customers. ADSL chipset royalty payments were
driven by initial shipments of chipsets to manufacturers of central office
equipment and customer premise equipment, including personal computers.
Royalties increased from no revenue in 1996 to $25,000 in 1997. As a percentage
of total revenue, royalties increased from 0.0% in 1996 to 0.4% in 1997. The
dollar increase was primarily due to chipset royalty payments from ADI, which
began in the fourth quarter of 1997.
COST OF PRODUCT SALES
Cost of product sales consists primarily of: (i) direct material, direct labor,
and overhead costs to produce the Company's products, (ii) cost of goods for
purchases of finished inventory from third party suppliers, and (iii) provisions
for excess and obsolete inventory. Cost of product sales increased 11.4% from
$1.3 million in 1997 to $1.4 million in 1998. As a percentage of product sales,
cost of product sales decreased from 51.4% in 1997 to 45.1% in 1998. The dollar
increase in cost of product sales was primarily due to higher volume shipments
of hardware products in 1998. The decrease in cost of product sales as a
percentage of product sales was primarily due to increased sales of higher
margin hardware products in 1998. This rate benefit was partially offset by a
higher percentage of hardware products in the product sales mix compared to
compression software products, which carry significantly lower product costs
than those for hardware products.
23
<PAGE> 24
Cost of product sales increased 50.6% from $831,000 in 1996 to $1.3 million in
1997. As a percentage of product sales, cost of product sales increased from
49.5% in 1996 to 51.4% in 1997. The dollar increase in cost of product sales was
primarily due to higher volume shipments of hardware products as well as higher
production overhead costs in 1997. The slight increase in cost of product sales
as a percentage of product sales was due to a combination of two factors that
had a mostly offsetting effect on one another. Increasing the cost of product
sales percentage were higher manufacturing overhead costs. Decreasing the cost
of product sales percentage was a lower percentage of hardware products in the
product sales mix compared to compression software products, which carry
significantly lower product costs than those for hardware products.
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 56.2% from $3.5 million
in 1997 to $5.4 million in 1998. As a percentage of contract revenue, cost of
contract revenue decreased from 93.0% in 1997 to 65.6% in 1998. The dollar
increase in cost of contract revenue was primarily due to new projects with ADI,
and the addition of new customer projects with Lucent and Siemens in 1998.
Increased spending related to these new projects and customers was partially
offset by: (i) lower spending on U.S. government research projects, and (ii) no
spending on the Company's hybrid fiber coaxial cable ("HFC") telephony project
with DSC Communications Corporation ("DSC"), which was suspended in the third
quarter of 1997. The decrease in cost of contract revenue as a percentage of
contract revenue was primarily due to: (i) up-front license revenue from ADI,
which had minimal cost of contract revenue associated with it, and (ii) the
suspension of the DSC project, which was unprofitable in 1997.
Cost of contract revenue increased 58.7% from $2.2 million in 1996 to $3.5
million in 1997. As a percentage of contract revenue, cost of contract revenue
increased from 60.5% in 1996 to 93.0% in 1997. The dollar increase in cost of
contract revenue was primarily due to higher spending on projects with: (i) ADI
for ADSL chipset development, and (ii) several equipment customers for whom the
Company was integrating Aware-technology-based chipsets into their equipment,
including the HFC telephony project for DSC. The increase in cost of contract
revenue as a percentage of contract revenue was primarily due to: (i) the DSC
project, which was profitable in 1996 and unprofitable in 1997, and (ii) the
receipt of certain license revenue from ADI in 1996, which had minimal cost of
contract revenue associated with it.
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 basic research and development. Research and development
expense increased 14.4% from $3.4 million in 1997 to $3.9 million in 1998. As a
percentage of total revenue, research and development expense decreased from
54.7% in 1997 to 33.0% in 1998. The dollar increase was primarily due to higher
spending for engineering efforts to develop and enhance Aware's: (i) DSL-Lite
and full-rate ADSL technology and software, (ii) Very high-speed Digital
Subscriber Line ("VDSL") technology and chipsets, (iii) full-rate ADSL and
DSL-Lite application specific integrated circuit ("ASIC") cores, and (iv)
compression software technology. Higher spending on these engineering efforts
was partially offset by lower spending related to the development of the
Company's x200 Access Router.
Research and development expense increased 225.4% from $1.0 million in 1996 to
$3.4 million in 1997. As a percentage of total revenue, research and development
expense increased from 19.7% in 1996 to
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<PAGE> 25
54.7% in 1997. The dollar increase was primarily due to higher spending for
engineering efforts to develop and enhance the Company's x200 Access Router,
DSL-Lite technology, and VDSL and Symmetrical Digital Subscriber Line ("SDSL")
technologies.
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. Sales and marketing expense increased 23.8% from $2.3
million in 1997 to $2.8 million in 1998. As a percentage of total revenue, sales
and marketing expense decreased from 36.9% in 1997 to 24.0% in 1998. The dollar
increase was primarily due to non-recurring costs incurred in 1998 to better
align the sales organization to execute on the Company's intellectual property
and software licensing strategy.
Sales and marketing expense increased 197.1% from $769,000 in 1996 to $2.3
million in 1997. As a percentage of total revenue, sales and marketing expense
increased from 14.5% in 1996 to 36.9% in 1997. The dollar increase was primarily
due to: (i) the addition of sales staff to establish channels of distribution
for the Company's products and technology; (ii) the addition of marketing staff;
and (iii) increased levels of advertising and promotion to create awareness for
Aware's products, including participation in major industry trade shows.
GENERAL AND ADMINISTRATIVE EXPENSE
General and administrative expense consists primarily of salaries for
administrative personnel, facilities costs, expenses related to being a public
company and professional services, such as legal and audit expenses. General and
administrative expense increased 13.5% from $1.9 million in 1997 to $2.2 million
in 1998. As a percentage of total revenue, general and administrative expense
decreased from 31.4% in 1997 to 18.7% in 1998. The dollar increase was primarily
due to additions to the Company's finance and information systems organizations
to support organizational growth.
General and administrative expense increased 93.6% from $1.0 million in 1996 to
$1.9 million in 1997. As a percentage of total revenue, general and
administrative expense increased from 18.9% in 1996 to 31.4% in 1997. The dollar
increase was primarily due to: (i) additions to Aware's finance, information
systems and administrative organizations to support organizational growth, and
(ii) investor relations and public company expenses.
OTHER INCOME AND EXPENSE
Other income consists of rental income from real estate leases. Other income and
expense increased from $0 in 1997 to $405,000 in 1998. 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. That sublease was completed in January 1999 and the
Company does not anticipate any further sublease income.
INTEREST INCOME
Interest income decreased 24.1% from $1.7 million in 1997 to $1.3 million in
1998. The dollar decrease resulted primarily from lower cash balances
attributable to: (i) the purchase and renovation of the Company's 72,000 square
foot headquarters building; (ii) the acquisition of computers, software,
25
<PAGE> 26
furniture, and other equipment primarily used in engineering activities; and
(iii) the use of cash to fund operating losses.
Interest income increased 114.2% from $798,000 in 1996 to $1.7 million in 1997.
The dollar increase was primarily the result of higher average cash balances due
to the investment of net proceeds from Aware's initial public offering for the
full year, as opposed to approximately five months in 1996.
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 $30.3 million, which
expire in 2003 through 2013, and federal research and development credit
carryforwards of approximately $1.3 million, which expire in 2003 through 2013.
At December 31, 1998, Aware also had available state net operating loss
carryforwards of approximately $24.1 million, which expire in 1999 through 2003,
and state research and development and investment tax credit carryforwards of
approximately $996,000, which expire in 2006 through 2013. Of the total net
operating loss carryforwards, approximately $12.0 million 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.
LIQUIDITY AND CAPITAL RESOURCES
Since its inception in March 1986, Aware has financed its activities primarily
through the sale of stock, including an initial public offering in August 1996
that generated net proceeds of $35.2 million. In the years ended December 31,
1996, 1997 and 1998, Aware received net proceeds of $1.1 million, $2.6 million
and $3.8 million, respectively, from the exercise of employee stock options.
Aware's operating activities used net cash of $586,000, $2.7 million and $2.3
million in the years ended December 31, 1996, 1997 and 1998. Cash used in
operations was primarily related to funding operating losses and working capital
requirements in all three years.
In the years ended December 31, 1996, 1997, and 1998, the Company made capital
expenditures of $1.1 million, $10.6 million, and $1.0 million, respectively.
Capital expenditures in all three years consist of spending on computer hardware
and software, laboratory equipment, and furniture used principally in
engineering activities. Capital spending in 1997 includes the purchase and
renovation of a 72,000 square foot commercial office building for $8.2 million,
which now serves as the Company's headquarters. The Company has no material
commitments for capital expenditures.
At December 31, 1998, Aware had cash, cash equivalents and short-term
investments of $26.6 million. Aware believes that its cash, cash equivalents and
short-term investments, will be sufficient to fund its operations for at least
the next twelve months.
26
<PAGE> 27
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 is making a detailed
assessment of (1) software that the Company licenses to third parties and (2)
software that the Company uses internally. The assessment is nearly complete and
the Company has begun 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.
The Company has reviewed the software it uses internally to determine whether it
is Year 2000 compliant. In those instances in which installed software is not
already Year 2000 compliant, the Company is planning either to replace
non-compliant software with Year 2000 compliant software or to obtain patches
that will make such software Year 2000 compliant. The Company is in the process
of obtaining and implementing the replacement software and patches, a process
that the Company expects to complete by mid 1999. 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.
27
<PAGE> 28
FACTORS THAT MAY AFFECT FUTURE RESULTS
Certain statements contained in this Annual Report, 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 this Annual Report on Form 10-K.
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 since inception. As
of December 31, 1998, the Company had an accumulated deficit of $17.0 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, there can be no
assurance that it will continue to grow in future quarters or that it will grow
enough to enable 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 acceptance of DSL broadband access,
generally, and of Aware's DSL-Lite and full-rate ADSL technology in particular;
(ii) demand for the Company's licensees' chipsets and products that incorporate
Aware technology, particularly DSL-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
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<PAGE> 29
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 five-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 the
Company's technology applications and to make the necessary investment to
successfully produce chipsets and products using 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 use the Company's technology. The failure of the
Company's licensees to achieve significant sales of chipsets and products
incorporating Aware's technology could materially and adversely affect the
Company's business.
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
29
<PAGE> 30
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 deploy
Aware's DSL technology in their services.
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.
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 in limited numbers,
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 and does not have significant sales of
hardware products, 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
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<PAGE> 31
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. The Company may be unknowingly
infringing the proprietary rights of others, which could result in significant
liability. 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.
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 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. Many of the Company's competitors and potential
competitors have significantly greater financial, technological, manufacturing,
marketing and personnel resources than the Company. The Company's competitors
include vendors of standards-based
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<PAGE> 32
and non-standards-based ADSL technology, as well as vendors of alternative
technologies, such as cable modems and wireless services. Furthermore, the
Company believes that its principal competition may come from its licensees and
prospective licensees, many of which are evaluating and developing products
based on alternative technologies. 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 1997 and 1998, 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.
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; and (vii) developments or announcements with respect to industry
standards, patents or proprietary rights. 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.
FUTURE ADOPTION OF ACCOUNTING PRONOUNCEMENTS
In 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133
establishes accounting and reporting standards for
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<PAGE> 33
derivative instruments, including certain derivative instruments embedded in
other contracts, and for hedging activities. The provisions of SFAS No. 133 are
effective for periods beginning after June 15, 1999. The Company is currently
evaluating the impact of SFAS No. 133 on the consolidated financial statements.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
CASH AND CASH EQUIVALENTS
As of December 31, 1998, 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 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 consolidated financial
position.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEPENDENT AUDITORS' REPORT
We have audited the accompanying consolidated balance sheets of Aware, Inc. (the
"Company") and its subsidiary as of December 31, 1998 and 1997, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the three years in the period ended December 31, 1998. Our audits also
included the financial statement schedule listed in the Index at Item 14. These
financial statements and the financial statement schedule are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements and the financial statement schedule based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of the Company and its
subsidiary at December 31, 1998 and 1997, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1998, in conformity with generally accepted accounting principles. Also, in
our opinion, such financial statement schedule, when considered in relation to
the basic consolidated financial statements taken as a whole, present fairly, in
all material respects, the information set forth therein.
/s/ Deloitte & Touche LLP
- --------------------------
Boston, Massachusetts
January 26, 1999
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AWARE, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31, 1998 1997
- -----------------------------------------------------------------------------------------------------------------------
ASSETS
Current assets:
<S> <C> <C>
Cash and cash equivalents $ 23,512,242 $ 23,496,508
Short-term investments 3,054,717 2,607,411
Accounts receivable (less allowance for doubtful
accounts of $100,000 in 1998 and $50,000 in 1997) 2,901,724 1,824,119
Inventories 120,911 215,622
Prepaid expenses 252,050 290,847
- -----------------------------------------------------------------------------------------------------------------------
Total current assets 29,841,644 28,434,507
- -----------------------------------------------------------------------------------------------------------------------
Property and equipment, net of accumulated depreciation and
amortization of $2,860,516 in 1998 and $1,330,281 in 1997 10,320,581 10,846,025
- -----------------------------------------------------------------------------------------------------------------------
Total assets $ 40,162,225 $ 39,280,532
=======================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 479,705 $ 1,075,126
Accrued expenses 127,525 185,676
Accrued compensation 324,669 326,558
Accrued professional 84,000 73,370
Deferred revenue 12,500 --
- -----------------------------------------------------------------------------------------------------------------------
Total current liabilities 1,028,399 1,660,730
- -----------------------------------------------------------------------------------------------------------------------
Commitments and contingent liabilities
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, 20,911,388 in 1998 and 19,646,024 in 1997 209,114 196,460
Additional paid-in capital 55,938,189 52,640,360
Accumulated deficit (17,013,477) (14,764,056)
Treasury stock -- (452,962)
- -----------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 39,133,826 37,619,802
- -----------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 40,162,225 $ 39,280,532
=======================================================================================================================
</TABLE>
The accompanying notes are an integral part of the financial statements.
35
<PAGE> 36
AWARE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Year Ended December 31, 1998 1997 1996
- --------------------------------------------------------------------------------------------------
Revenue:
<S> <C> <C> <C>
Product sales $ 3,093,294 $ 2,435,365 $ 1,680,660
Contract revenue 8,285,364 3,737,786 3,620,449
Royalties 417,672 24,900 --
- --------------------------------------------------------------------------------------------------
Total revenue 11,796,330 6,198,051 5,301,109
- --------------------------------------------------------------------------------------------------
Costs and expenses:
Cost of product sales 1,393,941 1,251,677 831,241
Cost of contract revenue 5,431,136 3,477,561 2,191,117
Research and development 3,886,935 3,396,576 1,043,682
Selling and marketing 2,829,596 2,285,726 769,395
General and administrative 2,205,951 1,943,187 1,003,948
- --------------------------------------------------------------------------------------------------
Total costs and expenses 15,747,559 12,354,727 5,839,383
- --------------------------------------------------------------------------------------------------
Loss from operations (3,951,229) (6,156,676) (538,274)
Other income and expense 404,930 -- --
Interest income 1,296,878 1,708,340 797,656
- --------------------------------------------------------------------------------------------------
Net income (loss) before provision for income taxes (2,249,421) (4,448,336) 259,382
Provision for income taxes -- -- --
- --------------------------------------------------------------------------------------------------
Net income (loss) ($ 2,249,421) ($ 4,448,336) $ 259,382
==================================================================================================
Net income (loss) per share - basic ($ 0.11) ($ 0.23) $ 0.02
Net income (loss) per share - diluted ($ 0.11) ($ 0.23) $ 0.01
==================================================================================================
Weighted average shares - basic 20,343,339 19,328,252 10,841,919
Weighted average shares - diluted 20,343,339 19,328,252 17,991,446
==================================================================================================
</TABLE>
The accompanying notes are an integral part of the financial statements.
36
<PAGE> 37
AWARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year ended December 31, 1998 1997 1996
- ---------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
<S> <C> <C> <C>
Net income (loss) ($ 2,249,421) ($ 4,448,336) $ 259,382
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 1,530,235 901,976 352,715
Increase (decrease) from changes in assets and
liabilities:
Accounts receivable (1,077,605) (169,139) (1,154,152)
Unbilled accounts receivable -- 110,722 5,539
Inventories 94,711 231,912 (407,821)
Prepaid expenses 38,797 (267,421) (8,955)
Accounts payable (595,421) 737,787 225,820
Accrued expenses (49,410) 286,821 151,492
Deferred revenue 12,500 (40,000) (10,000)
- ---------------------------------------------------------------------------------------------------------
Net cash used in operating activities (2,295,614) (2,655,678) (585,980)
- ---------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Purchases of property and equipment (1,004,791) (10,581,073) (1,116,238)
Net sales (purchases) of short-term investments (447,306) 3,019,314 (5,626,725)
- ---------------------------------------------------------------------------------------------------------
Net cash used in investing activities (1,452,097) (7,561,759) (6,742,963)
- ---------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Proceeds from issuance of common stock, net of
issuance costs 3,763,445 2,621,672 36,267,535
- ---------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 3,763,445 2,621,672 36,267,535
- ---------------------------------------------------------------------------------------------------------
Increase (decrease) in cash and cash equivalents 15,734 (7,595,765) 28,938,592
Cash and cash equivalents, beginning of period 23,496,508 31,092,273 2,153,681
- ---------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of period $ 23,512,242 $ 23,496,508 $ 31,092,273
=========================================================================================================
- ---------------------------------------------------------------------------------------------------------
SUPPLEMENTAL NONCASH DISCLOSURES:
Retirement of treasury stock $ 452,962 -- --
Conversion of preferred stock to common stock -- -- $ 127,998
- ---------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of the financial statements.
37
<PAGE> 38
AWARE, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Convertible Preferred Stock Common
Series B Series C Series D Series E Stock
<S> <C> <C> <C> <C> <C>
- ---------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1995 $ 15,875 $ 13,525 $ 69,166 $ 29,432 $ 11,670
- ---------------------------------------------------------------------------------------------------------------------------------
Issuance of common stock in initial
public offering, net of issuance costs, -- -- -- -- 39,100
3,910,000 shares
Exercise of common stock options,
1,083,162 shares -- -- -- -- 10,832
Conversion of preferred stock to common
stock, 12,799,800 shares (15,875) (13,525) (69,166) (29,432) 127,998
Net income -- -- -- -- --
- ---------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1996 -- -- -- -- 189,600
- ---------------------------------------------------------------------------------------------------------------------------------
Exercise of common stock options,
686,127 shares -- -- -- -- 6,860
Net loss -- -- -- -- --
- ---------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1997 196,460
- ---------------------------------------------------------------------------------------------------------------------------------
Exercise of common stock options,
1,258,171 shares -- -- -- -- 12,582
Issuance of common stock under employee
stock purchase plan, 7,193 shares -- -- -- -- 72
Retirement of treasury stock -- -- -- -- --
Net loss -- -- -- -- --
- ---------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1998 $ -- $ -- $ -- $ -- $ 209,114
=================================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
Additional Total
Paid-In Accumulated Treasury Stockholders'
Capital Deficit Stock Equity
<S> <C> <C> <C> <C>
- -------------------------------------------------------------------------------------------------------------
Balance, December 31, 1995 $ 13,807,945 ($10,575,102) ($ 452,962) $ 2,919,549
- -------------------------------------------------------------------------------------------------------------
Issuance of common stock in initial
public offering, net of issuance costs, 35,123,900 -- -- 35,163,000
3,910,000 shares
Exercise of common stock options,
1,083,162 shares 1,093,703 -- -- 1,104,535
Conversion of preferred stock to common
stock, 12,799,800 shares -- -- -- --
Net income -- 259,382 -- 259,382
- -------------------------------------------------------------------------------------------------------------
Balance, December 31, 1996 50,025,548 (10,315,720) (452,962) 39,446,466
- -------------------------------------------------------------------------------------------------------------
Exercise of common stock options,
686,127 shares 2,614,812 -- -- 2,621,672
Net loss -- (4,448,336) -- (4,448,336)
- -------------------------------------------------------------------------------------------------------------
Balance, December 31, 1997 52,640,360 (14,764,056) (452,962) 37,619,802
- -------------------------------------------------------------------------------------------------------------
Exercise of common stock options,
1,258,171 shares 3,688,194 -- -- 3,700,776
Issuance of common stock under employee
stock purchase plan, 7,193 shares 62,597 -- -- 62,669
Retirement of treasury stock (452,962) -- 452,962 --
Net loss -- (2,249,421) -- (2,249,421)
- -------------------------------------------------------------------------------------------------------------
Balance, December 31, 1998 $ 55,938,189 ($17,013,477) $ $ 39,133,826
=============================================================================================================
</TABLE>
The accompanying notes are an integral part of the financial statements.
38
<PAGE> 39
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF BUSINESS
Aware, Inc. (the "Company") designs, develops, licenses and markets
Digital Subscriber Line ("DSL") technology that enables high-speed
Internet access over existing telephone networks. The Company licenses its
intellectual property and software to semiconductor manufacturers and
equipment manufacturers who sell chips and equipment incorporating Aware's
technology. Aware also markets to equipment companies to encourage them to
design Aware's technology into their products, and to service providers to
encourage them to deploy new broadband services based on Aware's
technology. The Company's technology includes intellectual property and
software products such as patents, systems designs, semiconductor cores,
run-time software, and hardware designs. The Company also offers hardware
products, such as DSL development tools and customer premises equipment,
as well as image compression software products.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION - The consolidated financial statements include the
accounts of Aware, Inc. and its subsidiary. All significant intercompany
transactions have been eliminated.
CASH AND CASH EQUIVALENTS - Cash and cash equivalents consist primarily of
demand deposits, money market funds, commercial paper, and discount notes
in highly liquid short-term instruments with original maturities of three
months or less from the date of purchase and are stated at cost, which
approximates market.
SHORT-TERM INVESTMENTS - The Company follows Statement of Financial
Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments
in Debt and Equity Securities". At December 31, 1998 and 1997, the Company
had categorized all securities as "available-for-sale," since the Company
may liquidate these investments currently. In calculating realized gains
and losses, cost is determined using specific identification. SFAS No. 115
requires that unrealized gains and losses on available-for-sale securities
be excluded from earnings and reported in a separate component of
stockholders' equity. As of December 31, 1998 and 1997, unrealized gains
and losses were not material.
The amortized cost of securities, which approximates fair value, consists
of the following at December 31, 1998 and 1997:
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------
MATURITY
LESS THAN ONE ONE TO
TYPE OF SECURITY YEAR FIVE YEARS TOTAL
-----------------------------------------------------------------------------------
<S> <C> <C> <C>
1998
CORPORATE DEBT SECURITIES $1,027,935 - $1,027,935
U.S. AGENCY SECURITIES 2,026,782 - 2,026,782
-----------------------------------------------------------------------------------
TOTAL $3,054,717 - $3,054,717
-----------------------------------------------------------------------------------
1997
CORPORATE DEBT SECURITIES $1,574,474 - $1,574,474
U.S. AGENCY SECURITIES 1,032,937 - 1,032,937
-----------------------------------------------------------------------------------
TOTAL $2,607,411 - $2,607,411
-----------------------------------------------------------------------------------
</TABLE>
39
<PAGE> 40
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
ALLOWANCE FOR DOUBTFUL ACCOUNTS - Accounts are charged to the allowance
for doubtful accounts as they are deemed uncollectible based on a periodic
review of the accounts. Bad debt expense was approximately $60,000,
$26,000, and $20,000 for 1998, 1997, and 1996, respectively.
INVENTORIES - Inventories are stated at the lower of cost or market with
cost being determined by the first-in, first-out ("FIFO") method.
PROPERTY AND EQUIPMENT - Property and equipment are stated at cost.
Depreciation and amortization of property and equipment is provided using
the straight-line method over the estimated useful lives of the assets
ranging from three to thirty years.
The Company accounts for the impairment of long-lived assets in accordance
with the provisions of SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of."
REVENUE RECOGNITION - Effective January 1, 1998, the Company adopted
Statement of Position 97-2, Software Revenue Recognition ("SOP"). This SOP
applies to all entities that earn revenue on products containing software,
where software is not incidental to the product as a whole. The adoption
of this statement did not have a material effect on the Company's
consolidated financial position or results of operations.
Product sales consist primarily of revenue from the sale of modems, access
routers, transceiver modules, development systems, and compression
software. Product sales are recognized upon shipment.
Contract revenue includes revenue from development and license agreements
that the Company has entered into with semiconductor and equipment
manufacturers. These agreements typically provide licensees the right to
use the Company's proprietary technology and to receive engineering
implementation services and customer support. Accordingly, contract
revenue under these agreements typically consists of license fees,
engineering service fees, customer support, and in some instances,
nonrefundable, prepaid royalties. The majority of contract revenue is due
upon the completion of milestones or the provision of customer support by
the Company. Remaining contract revenue consists primarily of license
fees, which are due upon transfers of pre-existing intellectual property
or upon pre-determined dates.
Contract revenue related to license fees is recognized when a definitive
agreement is reached, technology transfers have been effected, and no
contingent factors are present. Contract revenue related to engineering
service fees is generally recognized as milestone deliverables are
achieved under the terms of the respective agreements. Contract revenue
related to customer support fees is generally recognized as support
services are provided.
Contract revenue also consists of revenue from U.S. government research
contracts. Revenue from government contracts is generally recognized as
services are performed.
The Company recognizes royalties upon notification of sale by its
licensees. The terms of the Company's agreements generally require
licensees to give notification to the Company and to pay royalties within
45 days of the end of the quarter during which the sales take place.
INCOME TAXES - The Company accounts for income taxes under SFAS No. 109,
"Accounting for Income Taxes." SFAS No. 109 requires the Company to
compute deferred income taxes based on
40
<PAGE> 41
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
the differences between the financial statement and tax basis of assets
and liabilities using enacted rates in effect in the years in which the
differences are expected to reverse. SFAS No. 109 also requires the
Company to establish valuation allowances to offset temporary deductible
differences, net operating loss carryforwards and tax credits, which are
not likely to be realized.
CAPITALIZATION OF SOFTWARE COSTS - The Company capitalizes certain
internally generated software development costs after technological
feasibility of the product has been established. Capitalized software
costs also include amounts paid for purchased software, which has reached
technological feasibility. Such costs are amortized, on a
product-by-product basis, on a straight-line basis over their useful
economic lives (generally two to four years), or the ratio of current
gross revenues to total gross current and future revenues, whichever is
greater. There were no capitalized software costs at December 31, 1998,
1997 and 1996, because such costs incurred subsequent to the establishment
of technological feasibility, but prior to commercial availability, were
immaterial.
CONCENTRATION OF RISK - At December 31, 1998 and 1997, the Company had
bank cash balances and money market investments, in excess of federally
insured deposit limits of approximately $26,467,000 and $26,004,000,
respectively.
Concentration of credit risk with respect to accounts receivable is
limited to $922,000, $734,000, and $585,000 with three customers at
December 31, 1998 and to $524,000, $400,000 and $154,000 with three
customers at December 31, 1997.
STOCK-BASED COMPENSATION - The Company grants stock options for a fixed
number of shares to employees with an exercise price equal to the fair
value of the shares at the date of grant. As permitted by SFAS No. 123,
"Accounting for Stock-Based Compensation", the Company accounts for stock
option grants in accordance with Accounting Principles Board ("APB")
Opinion No. 25, "Accounting for Stock Issued to Employees." Accordingly,
the Company recognized no compensation expense for stock option grants.
NET INCOME (LOSS) PER SHARE - Basic earnings per share is computed using
the weighted average number of common shares outstanding during each year.
Diluted earnings per common share reflects the effect of the Company's
outstanding options and convertible securities, except where such items
would be anti-dilutive. Because of the net loss reported in 1998 and 1997,
basic and diluted per share amounts are the same.
USE OF ESTIMATES - The preparation of the Company's financial statements
in conformity with generally accepted accounting principles necessarily
requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and to disclose contingent
assets and liabilities at the balance sheet date. Significant estimates
include reserves for doubtful accounts, reserves for excess and obsolete
inventory, useful lives of fixed assets, valuation allowance for deferred
income tax assets, and accrued liabilities. Actual results may differ from
these estimates.
FAIR VALUE OF FINANCIAL INSTRUMENTS - The carrying amounts of cash and
cash equivalents, short-term investments, accounts receivable, accounts
payable and accrued expenses approximate fair value because of their
short-term nature.
RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS - Effective January 1, 1998,
the Company adopted Statement of Financial Accounting Standards No. 130,
"Reporting Comprehensive Income", which requires businesses to disclose
comprehensive income and its components in their general-purpose
41
<PAGE> 42
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
financial statements. Comprehensive income (loss) is equal to net income
(loss) for the years ended December 31, 1998, 1997 and 1996.
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 131, "Disclosures about Segments of an Enterprise
and Related Information", which requires disclosures of certain financial
and descriptive information about a company's operating segments. The
Company organizes itself as one segment reporting to the chief operating
decision-maker. Revenue consists of product sales, contract revenue,
and royalties.
FUTURE ADOPTION OF ACCOUNTING PRONOUNCEMENTS - In 1998, the Financial
Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 establishes accounting
and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging
activities. The provisions of SFAS No. 133 are effective for periods
beginning after June 15, 1999. The Company is currently evaluating the
impact of SFAS No. 133 on the consolidated financial statements.
RECLASSIFICATIONS - Certain prior period amounts have been reclassified to
be consistent with the current period presentation.
3. INVENTORIES
Inventories consisted of the following at December 31:
<TABLE>
<CAPTION>
1998 1997
-----------------------------------------------------------------------------------------
<S> <C> <C>
RAW MATERIALS $13,091 $163,555
WORK-IN-PROCESS - -
FINISHED GOODS 107,820 52,067
-----------------------------------------------------------------------------------------
TOTAL $120,911 $215,622
=========================================================================================
</TABLE>
42
<PAGE> 43
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following at December 31:
<TABLE>
<CAPTION>
1998 1997
---------------------------------------------------------------------------------------------
<S> <C> <C>
LAND
$1,080,000 $1,080,000
BUILDING AND IMPROVEMENTS
7,217,953 7,144,656
COMPUTER EQUIPMENT
2,624,729 1,996,164
FURNITURE AND FIXTURES
501,610 401,979
OFFICE EQUIPMENT
205,389 142,313
MANUFACTURING EQUIPMENT
262,610 262,610
PURCHASED SOFTWARE
1,288,806 1,148,584
---------------------------------------------------------------------------------------------
TOTAL
13,181,097 12,176,306
LESS ACCUMULATED DEPRECIATION AND AMORTIZATION
(2,860,516) (1,330,281)
---------------------------------------------------------------------------------------------
NET
$10,320,581 $10,846,025
==============================================================================================
</TABLE>
5. INCOME TAXES
Deferred income tax assets at December 31 are attributable to the
following:
<TABLE>
<CAPTION>
1998 1997
- ------------------------------------------------------------------------------------------------------
<S> <C> <C>
FEDERAL NET OPERATING LOSS CARRYFORWARDS $ 10,304,000 $ 5,641,000
RESEARCH AND DEVELOPMENT AND OTHER TAX CREDIT CARRYFORWARDS 2,505,000 1,526,000
STATE NET OPERATING LOSS CARRYFORWARDS 1,513,000 880,000
DEPRECIATION 90,000 41,000
ACCRUED EXPENSES 171,000 88,000
PREPAID EXPENSES -- (94,000)
DEFERRED REVENUE 5,000 --
- ------------------------------------------------------------------------------------------------------
TOTAL 14,588,000 8,082,000
LESS VALUATION ALLOWANCE (14,588,000) (8,082,000)
- ------------------------------------------------------------------------------------------------------
NET $ -- $ --
=======================================================================================================
</TABLE>
A valuation allowance is provided against temporary deductible differences, net
operating loss carryforwards and tax credits, which are not likely to be
realized. During 1998 and 1997, the net valuation allowance was increased to
fully reserve gross deferred tax assets.
A reconciliation of the U.S. federal statutory rate to the effective tax rate is
as follows:
43
<PAGE> 44
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
1998 1997 1996
- ---------------------------------------------------------------------------------
<S> <C> <C> <C>
FEDERAL STATUTORY RATE (34)% (34)% 34%
STATE RATE, NET OF FEDERAL BENEFIT (6) (6) 6
TAX CREDITS (44) (17) (69)
OPERATING LOSSES AND TAX CREDITS WITH NO CURRENT TAX
BENEFIT 84 57 69
TAX BENEFIT FROM THE UTILIZATION OF NET
OPERATING LOSS CARRYFORWARDS -- -- (40)
- --------------------------------------------------------------------------------
EFFECTIVE TAX RATE - % - % - %
================================================================================
</TABLE>
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 $30.3
million, which expire in 2003 through 2013, and federal research and
development credit carryforwards of approximately $1.3 million, which
expire in 2003 through 2013. At December 31, 1998, Aware also had
available state net operating loss carryforwards of approximately $24.1
million, which expire in 1999 through 2003, and state research and
development and investment tax credit carryforwards of approximately
$996,000, which expire in 2006 through 2013. Of the total net operating
loss carryforwards, approximately $12.0 million 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.
6. STOCKHOLDERS' EQUITY
COMMON STOCK - In 1996, the Company increased the number of shares of
authorized common stock from 18,650,000 to 30,000,000.
In August 1996, the Company completed an initial public offering of its
common stock consisting of 3,910,000 shares at $10.00 per share. Proceeds
to the Company, net of issuance costs, were approximately $35,163,000
(issuance costs were approximately $3,937,000).
In accordance with the terms of the underlying agreements, all outstanding
shares of Series B, C, D, and E convertible preferred stock were
automatically converted into common stock upon completion of the initial
public offering.
PREFERRED STOCK - In 1996, the Company authorized 1,000,000 shares of
$1.00 par value preferred stock.
44
<PAGE> 45
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. STOCK COMPENSATION PLANS
At December 31, 1998, the Company has three stock-based compensation
plans, which are described below. The Company adopted SFAS No. 123, but,
as permitted, applies APB Opinion No. 25 and related Interpretations in
accounting for its plans. Accordingly, no compensation cost has been
recognized for its fixed stock option plans and its employee stock
purchase plan. The Company has no performance-based stock option plans.
Had compensation cost for the Company's three stock-based compensation
plans been determined based on the fair value at the grant dates for
awards under those plans consistent with the method of SFAS No. 123, the
Company's net income (loss) and per share amounts would have been adjusted
to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
Year ended December 31, 1998 1997 1996
---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
NET INCOME (LOSS) As reported ($2,249,421) ($4,448,336) $259,382
Pro forma ($7,432,112) ($8,531,745) ($4,403,824)
BASIC EARNINGS (LOSS) PER SHARE As reported ($0.11) ($0.23) $0.02
Pro forma ($0.37) ($0.44) ($0.41)
DILUTED EARNINGS (LOSS) PER SHARE As reported ($0.11) ($0.23) $0.01
Pro forma ($0.37) ($0.44) ($0.24)
</TABLE>
The fair value of options on their grant date was measured using the
Black-Scholes option pricing model. Key assumptions used to apply this
pricing model are as follows:
<TABLE>
<CAPTION>
Year ended December 31, 1998 1997 1996
-----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
AVERAGE RISK-FREE INTEREST RATE 5.15% 6.48% 6.25%
EXPECTED LIFE OF OPTION GRANTS 5 years 5 years 4 years
EXPECTED VOLATILITY OF UNDERLYING STOCK 89% 96% 97%
Expected dividend yield - - -
-----------------------------------------------------------------------------------------------
</TABLE>
FIXED STOCK OPTION PLANS - The Company has two fixed option plans. Under
the 1990 Incentive and Nonstatutory Stock Option Plan, the Company may
grant incentive stock options or nonqualified stock options to its
employees and directors for up to 2,873,002 shares of common stock. Under
the 1996 Stock Option Plan, the Company may grant incentive stock options
or nonqualified stock options to its employees and directors. During 1998,
the Board of Directors authorized an increase in the number of shares
available for grant under the 1996 Stock Option Plan from 3,000,000 to
5,000,000 shares. Under both plans, options are granted at an exercise
price as determined by the Board of Directors; have a maximum term of ten
years; and generally vest over three to five years.
45
<PAGE> 46
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENT
A summary of the status of the Company's two fixed stock option plans as
of December 31, 1998, 1997, and 1996, and changes during the years ending
on those dates is presented below:
<TABLE>
<CAPTION>
1998 1997 1996
-------------------------------------------------------------------------------------
Wgtd. Avg. Wgtd. Avg. Wgtd. Avg.
Shares Exer. Price Shares Exer. Price Shares Exer. Price
-------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
OUTSTANDING AT
beginning of year 3,554,171 $7.01 3,396,408 $5.01 2,757,500 $1.21
GRANTED 1,477,217 10.30 913,186 12.20 1,818,250 9.10
EXERCISED 1,258,171 2.94 686,127 3.82 1,083,162 1.02
FORFEITED OR CANCELLED 676,174 11.58 69,296 9.10 96,180 14.54
=========================================================================================================================
OUTSTANDING AT
end of year 3,097,043 $9.24 3,554,171 $7.01 3,396,408 $5.01
=========================================================================================================================
OPTIONS EXERCISABLE AT YEAR
END 1,278,888 1,754,552 1,343,617
WEIGHTED-AVERAGE GRANT DATE
FAIR VALUE OF OPTIONS GRANTED
DURING THE YEAR $7.40 $9.28 $6.07
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
The following table summarizes information about stock options outstanding
at December 31, 1998:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
----------------------------------------------------------- -------------------------------------
Number Weighted-Avg. Number
Range of Exercise Outstanding at Remaining Weighted-Avg. Exercisable Weighted-Avg.
Prices 12/31/98 Contractual Life Exercise Price At 12/31/98 Exercise Price
----------------------------------------------------------- -------------------------------------
<S> <C> <C> <C> <C> <C>
$1 TO 2 249,199 6.3 years $ 1.32 246,453 $ 1.32
5 TO 6 378,362 9.7 5.50 25,598 5.50
8 TO 9 921,962 7.4 8.25 745,451 8.25
10 TO 11 388,117 8.3 10.33 134,150 10.27
11 TO 12 586,467 9.5 11.54 81,019 11.50
12 TO 15 525,936 8.4 12.80 16,092 12.75
18 TO 24 47,000 9.9 22.91 30,125 23.44
=========================================================== ==================================
3,097,043 8.3 $ 9.24 1,278,888 $ 7.69
=========================================================== ==================================
</TABLE>
EMPLOYEE STOCK PURCHASE PLAN - In June 1996, the Company adopted an
Employee Stock Purchase Plan (the "ESPP Plan") under which eligible
employees may purchase common stock at a price equal to 85% of the lower
of the fair market value of the common stock at the beginning or end of
each six-month offering period. Participation in the ESPP Plan is limited
to 6% of an employee's compensation, may be terminated at any time by the
employee and automatically ends on termination of employment with the
Company. A total of 100,000 shares of common stock have been reserved for
issuance. As of December 31, 1998 there were 92,807 shares available for
future issuance under the ESPP Plan. The Company commenced implementation
of the plan in June 1998 and issued 7,193 common shares during 1998. No
shares were issued under the plan in 1997 and 1996.
46
<PAGE> 47
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. COMMITMENTS AND CONTINGENT LIABILITIES
LEASE COMMITMENTS - In 1995, the Company entered into a three-year
noncancelable operating lease for its principal office and research
facilities commencing June 1, 1995. In November 1996, the Company entered
into a twelve-month operating lease for additional space for its research
facilities commencing December 1, 1996. In November 1997, both of these
leases were either terminated or allowed to lapse at no cost to the
Company, and the Company moved into a new building that it had purchased.
At December 31, 1998, the Company has no material operating leases.
Rental expense was approximately $4,000, $308,000, and $143,000 in 1998,
1997 and 1996, respectively.
LITIGATION - 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.
9. TRANSACTIONS WITH RELATED PARTIES
CONSULTING AGREEMENTS - In prior years, the Company had paid consulting
fees for scientific research and development services provided by certain
stockholders. The total charges from related parties approximated $8,000
in 1996. There were no amounts due to related parties at December 31,
1998, 1997 and 1996.
10. MAJOR CUSTOMERS
The portion of total revenue that was derived from major customers was as
follows:
<TABLE>
<CAPTION>
Year ended December 31, 1998 1997 1996
------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CUSTOMER A 29% 12% 17%
CUSTOMER B 18% 6% -
CUSTOMER C 14% - -
CUSTOMER D 8% 16% -
CUSTOMER E 4% 13% 12%
CUSTOMER F - 7% 22%
CUSTOMER G - - 10%
------------------------------------------------------------------------------------------
</TABLE>
47
<PAGE> 48
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. EMPLOYEE BENEFIT PLAN
In 1994, the Company established a qualified 401(k) Retirement Plan (the
"Plan") under which employees are allowed to contribute certain
percentages of their pay, up to the maximum allowed under Section 401(k)
of the Internal Revenue Code. Company contributions to the Plan are at the
discretion of the Board of Directors. Company contributions were $58,000
in 1998, and there were no Company contributions in 1997 and 1996.
12. NET INCOME (LOSS) PER SHARE
A reconciliation of weighted average shares used for the basic computation
and that used for the diluted computation is as follows:
<TABLE>
<CAPTION>
Year ended December 31, 1998 1997 1996
------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Weighted average shares - basic 20,343,339 19,328,252 10,841,919
DILUTIVE EFFECT OF:
CONVERTIBLE PREFERRED STOCK - - 5,467,106
OPTIONS - - 1,682,421
================================================================================================
WEIGHTED AVERAGE SHARES - DILUTED 20,343,339 19,328,252 17,991,446
================================================================================================
</TABLE>
For the years ended December 31, 1998 and 1997, potential common shares
are not included in the per share calculations for diluted EPS, because
the effect of their inclusion would be anti-dilutive. Anti-dilutive
potential shares not included in per share calculations for 1998 and 1997
were 1,027,457 and 1,676,311, respectively. For the year ended December
31, 1996, options to purchase 1,737,750 shares of common stock at an
average weighted price of $8.57 per share were outstanding, but were not
included in the computation of diluted EPS because the options' exercise
prices were greater than the average market price of the common shares.
48
<PAGE> 49
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
13. QUARTERLY RESULTS OF OPERATIONS - UNAUDITED
The following table presents unaudited quarterly operating results for each
of the Company's eight quarters in the two-year period ended December 31,
1998:
<TABLE>
<CAPTION>
1998
----------------------------------------------------------------
Quarters ended March 31 June 30 Sept. 30 Dec. 31
--------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenue $2,004,016 $2,431,504 $3,346,693 $4,014,117
Income (loss) from operations (1,893,126) (1,715,539) (503,411) 160,847
Net income (loss) (1,455,437) (1,290,978) (77,772) 574,766
--------------------------------------------------------------------------------------------------------------
Net income (loss) per share - basic ($0.07) ($0.06) ($0.00) $0.03
Net income (loss) per share - diluted ($0.07) ($0.06) ($0.00) $0.03
==============================================================================================================
</TABLE>
<TABLE>
<CAPTION>
1997
----------------------------------------------------------------
Quarters ended March 31 June 30 Sept. 30 Dec. 31
--------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenue $1,801,085 $1,870,417 $722,500 $1,804,049
Loss from operations (724,586) (748,143) (2,569,699) (2,114,248)
Net loss (276,302) (275,398) (2,145,946) (1,750,690)
--------------------------------------------------------------------------------------------------------------
Net loss per share - basic ($0.01) ($0.01) ($0.11) ($0.09)
Net loss per share - diluted ($0.01) ($0.01) ($0.11) ($0.09)
==============================================================================================================
</TABLE>
49
<PAGE> 50
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
50
<PAGE> 51
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information with respect to Directors and Executive Officers and compliance with
Section 16(a) of the Exchange Act may be found in the sections captioned
"Directors and Executive Officers" and "Section 16(a) Beneficial Ownership
Reporting Compliance" appearing in the Company's definitive Proxy Statement to
be delivered to shareholders in connection with the Annual Meeting of
Shareholders to be held on Tuesday, May 25, 1999. Such information is
incorporated herein by reference.
EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of the Company as of February 28, 1999 are:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Michael A. Tzannes..................... 37 President, Chief Executive Officer, and Director
David C. Hunter........................ 43 Executive Vice President, Chief Operating Officer, and
Director
Richard P. Moberg...................... 43 Chief Financial Officer and Treasurer
Edmund C. Reiter....................... 35 Senior Vice President
</TABLE>
Michael A. Tzannes has been Aware's President and Chief Executive Officer since
April 1998 and has served as a director of Aware since March 1998. From
September 1997 to April 1998, he served as the Company's Chief Technology
Officer and General Manager of Telecommunications. Mr. Tzannes served as Aware's
Senior Vice President, Telecommunications from April 1996 to September 1997, as
Aware's Vice President, Telecommunications from December 1992 to April 1996, as
a Senior Member of Aware's Technical Staff from January 1991 to November 1992,
and as a consultant to the Company from October 1990 to December 1990. From 1986
to 1990, he was a Staff Engineer at Signatron, Inc., a telecommunications
technology and systems developer. Mr. Tzannes received a Ph.D. in electrical
engineering from Tufts University, an M.S. from the University of Michigan at
Ann Arbor, and a B.S. from the University of Patras, Greece.
David C. Hunter has served as the Executive Vice President and Chief Operating
Officer and a director of Aware since May 1998. Mr. Hunter joined Aware in May
1996 as Senior Vice President, Product Development and served in that capacity
until May 1998. From 1982 to April 1996, Mr. Hunter served as Vice President,
Research and Development of I.D.E. Corporation ("IDEA"), a manufacturer of data
communications equipment. Mr. Hunter was a founder and director of IDEA. Mr.
Hunter received an M.B.A. with high distinction from the Harvard Graduate School
of Business Administration and a B.S. with distinction from Cornell University.
Richard P. Moberg joined Aware in June 1996 as Chief Financial Officer and
Treasurer. From December 1990 to June 1996, Mr. Moberg held a number of
positions at Lotus Development Corporation, a computer software developer,
including Corporate Controller from June 1995 to June 1996, Assistant Corporate
Controller from May 1993 to June 1995, and Director of Financial Services from
December 1990 to May 1993. Mr. Moberg received an M.B.A. from Bentley College
and a B.B.A. in accounting from the University of Massachusetts at Amherst.
Edmund C. Reiter has been Senior Vice President of Aware since May 1998. Prior
to that, he served as Aware's Vice President, Advanced Products from August 1995
to May 1998, Aware's Manager of Product Development for still image compression
products from June 1994 to August 1995, as a Senior Member of Aware's Technical
Staff from November 1993 to June 1994, and as a Member of Aware's
51
<PAGE> 52
Technical Staff from December 1992 to November 1993. Mr. Reiter served as Senior
Scientist at New England Research, Inc. from January 1991 to November 1992. Mr.
Reiter received a Ph.D. from the Massachusetts Institute of Technology and a
B.S. from Boston College.
ITEM 11. EXECUTIVE COMPENSATION
Information with respect to this item may be found in the section captioned
"Compensation of Directors and Executive Officers" appearing in the Company's
definitive Proxy Statement to be delivered to shareholders in connection with
the Annual Meeting of Shareholders to be held on Tuesday, May 25, 1999. Such
information is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information with respect to this item may be found in the section captioned
"Security Ownership of Certain Beneficial Owners and Management" appearing in
the Company's definitive Proxy Statement to be delivered to shareholders in
connection with the Annual Meeting of Shareholders to be held on Tuesday, May
25, 1999. Such information is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information with respect to this item may be found in the section captioned
"Certain Transactions" appearing in the Company's definitive Proxy Statement to
be delivered to shareholders in connection with the Annual Meeting of
Shareholders to be held on Tuesday, May 25, 1999. Such information is
incorporated herein by reference.
52
<PAGE> 53
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K
(A) (1) INDEX TO FINANCIAL STATEMENTS
The following consolidated financial statements are included in Part II,
Item 8:
Page
Independent Auditors' Report..................................... 34
Consolidated Balance Sheets as of December 31, 1998.............. 35
Consolidated Statements of Operations for each of the three
years ended December 31, 1998................................ 36
Consolidated Statements of Cash Flows for each of the
three years ended December 31, 1998.......................... 37
Consolidated Statements of Stockholders' Equity for each of
the three years ended December 31, 1998..................... 38
Notes to Consolidated Financial Statements....................... 39
(2) INDEX TO FINANCIAL STATEMENT SCHEDULE
Page
Schedule II - Valuation and Qualifying Accounts.................. 55
Schedules other than those listed above have been omitted since they
are either not required or not applicable or the information is
otherwise included.
(3) INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION OF EXHIBIT
----------- ----------------------
3.1 Amended and Restated Articles of Organization (filed as
Exhibit 3.2 to the Company's Registration Statement on
Form S-1, File No. 333-6807 and incorporated herein by
reference).
3.2 Amended and Restated By-Laws (filed as Exhibit 3.3 to the
Company's Form 10-Q for the quarter ended June 30, 1996
and incorporated herein by reference).
10.1 1990 Incentive and Non-Statutory Stock Option Plan (filed
as Exhibit 10.2 to the Company's Registration Statement on
Form S-1, File No. 333-6807 and incorporated herein by
reference).
10.2 1996 Stock Option Plan (filed as Exhibit 10.3 to the
Company's Registration Statement on Form S-1, File No.
333-6807 and incorporated herein by reference).
10.3 1996 Employee Stock Purchase Plan (filed as Exhibit 10.4
to the Company's Registration Statement on Form S-1, File
No. 333-6807 and
53
<PAGE> 54
incorporated herein by reference).
10.4 Form of Director Indemnification Agreement (filed as
Exhibit 10.13 to the Company's Registration Statement on
Form S-1, File No. 333-6807 and incorporated herein by
reference).
10.5 Agreement of Purchase and Sale by and between Aware, Inc.
and The Mitre Corporation dated as of June 6, 1997 (filed
as Exhibit 10.1 to the Company's Form 10-Q for the quarter
ended September 30, 1997 and incorporated herein by
reference).
10.6 Employment Agreement of James C. Bender, dated October 27,
1994, as amended on December 20, 1996 and April 23, 1998
(filed as Exhibit 10.1 to the Company's Form 10-Q for the
quarter ended March 31, 1998 and incorporated herein by
reference).
11.1* Computation of basic and diluted net income (loss) per
share.
21.1* Subsidiaries of Registrant
23.1* Consent of Independent Accountants
23.2* Consent of Cesari & McKenna
* Filed herewith.
(B) Reports on Form 8-K
No reports on Form 8-K were filed during the fourth quarter of 1998.
54
<PAGE> 55
SCHEDULE II
AWARE, INC.
VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 31, 1998, 1997, 1996
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------------
COL. A COL. B COL. C (1) COL. C (2) COL. D COL. E
- -------------------------------------------------------------------------------------------------------------------------
ADDITIONS
-------------------------------------
BALANCE AT CHARGED TO CHARGED DEDUCTIONS BALANCE
BEGINNING COSTS AND TO OTHER CHARGED TO AT END
OF PERIOD EXPENSES ACCOUNTS RESERVES OF PERIOD
- -------------------------------------------------------------------------------------------------------------------------
Allowance for doubtful
accounts receivable:
<S> <C> <C> <C> <C> <C>
1998. . . . . . . . . . . . $50,000 $50,000 - - $100,000
1997. . . . . . . . . . . . $35,000 $25,923 - $10,923 $50,000
1996. . . . . . . . . . . . $5,300 $19,698 $20,000 $9,998 $35,000
Allowance for sales
returns and allowances:
1998. . . . . . . . . . . . $50,000 - - - $50,000
1997. . . . . . . . . . . . - - $50,000 - $50,000
1996. . . . . . . . . . . . - - - - -
Inventory reserves:
1998. . . . . . . . . . . . $16,667 $274,999 - $107,861 $183,805
1997. . . . . . . . . . . . $300,000 $275,000 - $558,333 $16,667
1996. . . . . . . . . . . . - $365,000 - $65,000 $300,000
</TABLE>
55
<PAGE> 56
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
AWARE, INC.
By: /s/ Michael A. Tzannes
Michael A. Tzannes, Chief Executive Officer &
President
Date: March 24, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities indicated on the 24th day of March 1999.
SIGNATURE TITLE
--------- -----
/s/ Michael A. Tzannes Chief Executive Officer, President, and Director
Michael A. Tzannes (Principal Executive Officer)
/s/ Richard P. Moberg Chief Financial Officer, Treasurer
Richard P. Moberg (Principal Financial and Accounting Officer)
/s/ John K. Kerr Chairman of the Board of Directors
John K. Kerr
/s/ David Ehreth Director
David Ehreth
/s/ David C. Hunter Executive Vice President, Chief Operating
David C. Hunter Officer, and Director
/s/ John S. Stafford, Jr. Director
John S. Stafford, Jr.
56
<PAGE> 1
EXHIBIT 11.1
AWARE, INC.
COMPUTATION OF BASIC AND DILUTED
NET INCOME (LOSS) PER SHARE
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Net income (loss) .................................................. ($ 2,249,421) ($ 4,448,336) $ 259,382
============ ============ ============
Weighted average number of common shares outstanding:
Common stock ................................................. 20,343,339 19,328,252 10,841,919
Other ........................................................ - - -
------------ ------------ ------------
Common shares outstanding for purpose of calculating basic
net income per share ................................ 20,343,339 19,328,252 10,841,919
Common stock equivalents to reflect dilution:
Convertible preferred common stock equivalent shares ..... - - 5,467,106
Option common stock equivalents shares ................... - - 1,682,421
------------ ------------ ------------
Total shares for purpose of calculating diluted net
income per share ........................................ 20,343,339 19,328,252 17,991,446
============ ============ ============
Basic net income (loss) per share .................................. ($ 0.11) ($ 0.23) $ 0.02
============ ============ ============
Diluted net income (loss) per share ................................ ($ 0.11) ($ 0.23) $ 0.01
============ ============ ============
</TABLE>
<PAGE> 1
EXHIBIT 21.1
SUBSIDIARIES OF REGISTRANT
NAME OF ORGANIZATION JURISDICTION
- -------------------- ------------
Aware Security Corporation ...................................... Massachusetts
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in Registration Statement No.
333-15805 of Aware, Inc. on Form S-8, of our report dated January 26, 1999,
appearing in this Annual Report on Form 10-K of Aware, Inc. for the year ended
December 31, 1998.
/s/ Deloitte & Touche LLP
Boston, Massachusetts
March 26, 1999
<PAGE> 1
EXHIBIT 23.2
CONSENT OF CESARI & MCKENNA
March 26, 1999
Aware, Inc.
40 Middlesex Turnpike
Bedford, Massachusetts 01730
Ladies and Gentlemen:
We are familiar with the Annual Report on Form 10-K of Aware, Inc., a
Massachusetts corporation (the "Company"), with respect to its fiscal year ended
December 31, 1998. We hereby consent to the reference to our firm in the
Company's Annual Report on Form 10-K and to the incorporation by reference of
that reference into the Company's Registration Statement on Form S-8 filed with
the Securities and Exchange Commission (registration no. 333-15805).
Very truly yours,
Cesari & McKenna
By: /s/ Martin J. O'Donnell
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<EXCHANGE-RATE> 1
<CASH> 26,567
<SECURITIES> 0
<RECEIVABLES> 3,002
<ALLOWANCES> 100
<INVENTORY> 121
<CURRENT-ASSETS> 29,842
<PP&E> 13,181
<DEPRECIATION> 2,861
<TOTAL-ASSETS> 40,162
<CURRENT-LIABILITIES> 1,028
<BONDS> 0
0
0
<COMMON> 209
<OTHER-SE> 38,925
<TOTAL-LIABILITY-AND-EQUITY> 40,162
<SALES> 3,093
<TOTAL-REVENUES> 11,796
<CGS> 1,394
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 14,354
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (2,249)
<INCOME-TAX> 0
<INCOME-CONTINUING> (2,249)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,249)
<EPS-PRIMARY> (0.11)
<EPS-DILUTED> (0.11)
</TABLE>
