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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, 2001
COMMISSION FILE NUMBER 000-21129
AWARE, INC.
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(Exact Name of Registrant as Specified in Its Charter)
MASSACHUSETTS 04-2911026
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(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
40 MIDDLESEX TURNPIKE, BEDFORD, MASSACHUSETTS 01730
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(Address of Principal Executive Offices)
(Zip Code)
(781) 276-4000
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(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
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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 March 12, 2002, based on the closing price of the Common Stock
on March 12, 2002 as reported on the Nasdaq National Market, was approximately
$140,823,207.
The number of shares outstanding of the registrant's common stock as of March
12, 2002 was 22,667,009.
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 31, 2002 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, 2001
TABLE OF CONTENTS
PART I
Item 1. Description of the Business............................................................... 3
Item 2. Properties................................................................................ 8
Item 3. Legal Proceedings......................................................................... 9
Item 4. Submission of Matters to a Vote of Security Holders....................................... 9
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters..................... 10
Item 6. Selected Financial Data................................................................... 10
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations............................................................................. 11
Item 7 (A). Quantitative and Qualitative Disclosures About Market Risk................................ 23
Item 8. Consolidated Financial Statements and Supplementary Data.................................. 24
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure................................................................................ 40
PART III
Item 10. Directors and Executive Officers of the Registrant........................................ 40
Item 11. Executive Compensation.................................................................... 41
Item 12. Security Ownership of Certain Beneficial Owners and Management............................ 41
Item 13. Certain Relationships and Related Transactions............................................ 41
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.......................... 42
Signatures............................................................................................... 43
2
PART I
ITEM 1. DESCRIPTION OF THE BUSINESS
COMPANY OVERVIEW
We are a worldwide leader in the development and marketing of intellectual
property for broadband communications. We license our intellectual property to
semiconductor companies that build integrated circuits based on our technology.
Our principal offering to date has been Digital Subscriber Line ("DSL")
technology for the telecommunications industry. DSL enables telephone companies
to use their existing copper telephone lines to offer broadband services.
Our principal DSL offering is a technology package for Asymmetric Digital
Subscriber Line ("ADSL"). ADSL is a broadband service that is primarily targeted
at residential telephone customers for high-speed Internet access. ADSL has been
standardized for global use by the International Telecommunications Union
("ITU"). Our ADSL technology package is compliant with applicable ITU standards.
We have complemented our core ADSL technology offering with technologies aimed
at enhancing the value of ADSL to telephone companies. These complementary
technologies enable advanced capabilities such as new voice services and
diagnostic testing. We also have projects underway to develop other forms of
DSL, as well as other broadband technologies. We play an active role in setting
standards for broadband technologies so that we can anticipate and develop
technology that meets the needs of changing markets.
During 2001, approximately 78% of our revenue came from licensing ADSL
intellectual property. We license our intellectual property worldwide through
our direct sales force. Our lead semiconductor customers are Analog Devices,
Inc., Infineon Technologies, AG and Intel Corporation. The remainder of our
revenue came from the sale of hardware and software products. Our hardware
products help customers develop and test their ADSL products. Our software
products compress digital images and data for law enforcement and other
applications.
We are headquartered in Bedford, Massachusetts. Our telephone number is (781)
276-4000, and our website is www.aware.com. Incorporated in Massachusetts in
1986, we employed 165 people at December 31, 2001. Our stock is traded on the
Nasdaq National Market under the symbol AWRE.
INDUSTRY BACKGROUND
ADSL INDUSTRY BACKGROUND. Telephone companies began tests and trials of ADSL
technology in the mid 1990s. Commercial deployment of ADSL services began in
modest volumes in 1999. During 2000 and 2001, the rate of deployment of ADSL
services accelerated dramatically, particularly outside of the United States.
According to announcements by major telephone companies, there were
approximately 17.5 million global ADSL subscribers at the end of 2001, with
approximately 11.5 million of those customers being added in 2001 alone. There
were approximately 4.4 million U.S. subscribers as compared with 13.1 million
non-U.S. subscribers as of December 31, 2001.
Some of the largest suppliers of ADSL service in North America are SBC, Verizon,
Bell South, Qwest, and Bell Canada. In Europe, some of the largest providers are
Deutsche Telekom, France Telecom, Belgacom, Telecom Italia, and Telia. Large
Asian providers include Korea Telecom and Hanaro in Korea; NTT and Yahoo
Broadband in Japan; and Chunghwa in Taiwan.
Telephone companies are able to purchase ADSL equipment from a number of
telecommunications equipment suppliers. Some of the leading suppliers of ADSL
equipment include Alcatel Alsthom S.A. ("Alcatel"), Cisco Systems, Inc., ECI
Telecom, LTD, Intel Corporation ("Intel"), Lucent Technologies Inc., Samsung
Corporation, Siemens AG, and a number of Asian modem manufacturers.
Telecommunications equipment suppliers are able to purchase ADSL chipsets from a
number of suppliers, including Alcatel, Analog Devices Inc. ("ADI"), Broadcom
Corporation ("Broadcom"), Centillium Communications, Inc. ("Centillium"),
GlobespanVirata, Inc. ("GlobespanVirata"), Infineon Technologies AG (`Infineon")
and Texas Instruments Incorporated ("TI").
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SEMICONDUCTOR INDUSTRY BACKGROUND. During the 1980s and 1990s, the semiconductor
industry moved from vertically integrated companies to horizontally specialized
companies. Vertically integrated semiconductor companies used to perform the
entire semiconductor process from design to manufacture to sales. Today the
industry consists of separate companies focused on various horizontal processes
within the semiconductor industry. Horizontal groups within the semiconductor
industry now include capital equipment companies, independent foundries, design
automation shops, fabless semiconductor companies, and semiconductor
intellectual property ("IP") companies.
The semiconductor intellectual property industry has matured and grown over the
last five years. The availability of field-proven technology from independent IP
suppliers allows semiconductor manufacturers to achieve greater financial
flexibility, reduce engineering development risks, and reduce the time it takes
to get products to market.
Semiconductor intellectual property may be classified into four principal
categories:
|X| SIMPLE IP consists of designs for standard chip functions, such as
timers and clocks, memory management, hardware controllers, or USB
interfaces.
|X| MICROPROCESSOR IP consists of processor cores that are used to build
general-purpose processors, configurable processors, or digital
signal processors.
|X| SEMICONDUCTOR MANUFACTURING PROCESS IP consists of libraries of
intellectual property that are used during the semiconductor
manufacturing process.
|X| COMPLEX SYSTEM-LEVEL IP consists of complete systems solutions for
specific applications that are usually based on standards or
patents. Examples of Complex System-Level IP include ADSL, Code
Division Multiple Access ("CDMA"), Global System for Mobile
telecommunications ("GSM"), Global Positioning System ("GPS"),
Wireless Local Area Networking ("WLAN"), and chip-connection
technology for Dynamic Random Access Memory ("DRAM").
Our intellectual property is focused on Complex System-Level IP for applications
involving broadband communications, and in particular ADSL.
AWARE ADSL INTELLECTUAL PROPERTY
ADSL technology was first created in the late 1980s. ADSL technology expands the
useable bandwidth of copper wire so that telephone companies can offer
high-speed data services over their existing telephone networks. ADSL is a
point-to-point technology that connects the end user to a telephone company's
central office. ADSL equipment is deployed at each end of the copper wire in
order to enable the service. ADSL is targeted at the residential market and is
designed to transmit data at speeds more than 100 times faster than 56 kilobits
per second ("Kbps") voiceband modems. Actual transmission speeds depend on the
length and condition of the existing wire.
An ADSL system divides the bandwidth on a copper wire into three segments. The
first segment is used for plain old telephone service ("POTS"). The second
segment is used to transmit data upstream from the user to the central office.
The third segment is used to transmit data downstream from the central office to
the user.
The ITU has approved standards for ADSL based on a modulation technique known as
discrete multitone or DMT. Two types of DMT-based ADSL have been standardized by
the ITU: 1) full-rate ADSL and 2) G.Lite.
Full-rate ADSL can transmit data at speeds up to 8 megabits per second ("Mbps")
downstream and up to 640 Kbps upstream. Full-rate ADSL was first standardized in
1995 by the American National Standards Institute as T1.413, and then by the ITU
in 1999 as G.992.1. Standard compliant full-rate ADSL requires the installation
of voice-data "splitters" in residences by telephone company technicians. In
order to alleviate the time required to install splitters, telephone companies
began providing "microfilters" to their residential customers so that the
customers could install one of these devices on every telephone and fax machine
in their home. While effective, the alternative microfilter solution is not
compliant with the full-rate ADSL standard.
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G.Lite can transmit data at speeds up to 1.5 Mbps downstream and up to 512 Kbps
upstream without requiring voice-data splitters or microfilters. G.Lite was
intended to make the installation of ADSL faster and less expensive for
telephone companies. G.Lite was first standardized by the ITU in 1999 as
G.992.2.
Today, most ADSL service offerings by telephone companies are based on a hybrid
of full-rate ADSL and G.Lite. The hybrid service, while primarily based on the
full-rate ADSL standard, uses microfilters installed by end users instead of
splitters installed by telephone companies, and operates at data rates ranging
from hundreds of Kbps to multiple Mbps depending on the price charged by
telephone companies.
The core ADSL technology package that we license to customers includes a
complete implementation of the ITU standard for full-rate ADSL and G.Lite. The
ITU is currently working on a new standard for both full-rate ADSL and G.Lite.
We intend to offer an ADSL technology package for these new standards. We
provide patent rights, system designs, hardware designs, software, and
engineering services as part of our standard offering. We have complemented our
core ADSL technology offering with technologies aimed at enhancing the value of
ADSL to telephone companies. Several important innovations that we have
developed over the last several years include our "channelized voice" technology
and our Dr. DSL(R) diagnostic testing technology.
Channelized voice technology expands an ADSL service offering so that in
addition to ADSL's normal high-speed data service and POTS, it can also deliver
multiple lines of digitized voice. All of these services can be offered on a
single line of copper wire. Channelized voice transports voice calls within the
physical layer of the ADSL link, which eliminates the need for packetization of
voice traffic into upper layer protocols such as ATM and IP. This new technology
allows telephone companies to offer toll-quality, second-line voice service to
residential telephone consumers without the need to install new wires or
equipment. We have named our version of channelized voice "VeDSL(TM)" for
Voice-enabled DSL. We began licensing a technology package for VeDSL in 2000.
Our Dr. DSL technology is designed to assist service providers with
provisioning, monitoring, and maintenance of their DSL services by enabling them
to collect important information about their copper loop plant. Dr. DSL also
provides subscribers with tools they can use to assist with provisioning and
maintenance. The primary goal of Dr. DSL is to reduce the number of calls
subscribers make to customer service representatives, as well as the number of
visits technicians must make to subscriber locations. Specific Dr. DSL features
include loop length measurement, bridged tap measurement, crosstalk disturber
detection and management, subscriber self-installation, and in-home diagnostics.
We began licensing a technology package for Dr. DSL in 2000.
AWARE BUSINESS MODEL & STRATEGY
We have adopted an intellectual property business model under which we license
our broadband technology on a nonexclusive and worldwide basis to semiconductor
companies that manufacture and sell products that incorporate our technology.
Our licensees sell integrated circuits to equipment companies that incorporate
those integrated circuits into their products.
Our business model and strategy are designed to:
|X| offer the semiconductor industry an independent source of broadband
technology;
|X| provide multiple and flexible technology solutions for numerous
silicon and equipment architectures;
|X| offer systems-level intellectual property for specific applications
that are based on worldwide standards;
|X| leverage our customers' distribution capabilities;
|X| contribute to industry standards by offering our expertise, which
allows us to anticipate technological changes; and
|X| generate revenue through a combination of license fees, engineering
service fees, and royalties.
5
AWARE ADSL HARDWARE PRODUCTS
In addition to our intellectual property licensing business, we sell
ADSL-related hardware products. Our hardware products are intended to support
the development of chipsets and equipment that use our technology. We sell these
products directly to semiconductor and ADSL equipment companies. These products
consist primarily of development systems, test systems, and modules.
Development systems are designed to help our customers build ADSL chipsets by
providing them with a means to conduct performance and interoperability testing
during product development. Test systems are designed to help ADSL modem
manufacturers test their products during production without requiring them to
purchase expensive central office equipment. Modules are board-level products
that contain all of the components of an ADSL system so that customers can
facilitate the rapid integration of ADSL technology into their lab or field test
equipment.
AWARE COMPRESSION SOFTWARE PRODUCTS
We also develop and sell image and data compression products. Since 1988, we
have developed intellectual property in the field of wavelet transform-based
data compression. Our compression technology enables digital images and certain
types of data to be compressed to between 1% and 10% of their original size. Our
compression software products are sold to OEMs that integrate the software into
their equipment-based solutions. Our principal compression software products are
described below.
|X| WSQ BY AWARE compresses digital fingerprint data for use by law
enforcement agencies such as the Federal Bureau of Investigation.
|X| Our electronic ID product suite includes NISTPACK BY AWARE, SEQUENCE
CHECK BY AWARE, CJIS WEB BY AWARE, ACCUFACE BY AWARE, AND ACCUPRINT
BY AWARE. These products are used by law enforcement agencies to
format, edit, validate, store, and print fingerprint and facial
images.
|X| JPEG 2000 CODEC BY AWARE provides a solution for the compression and
decompression of still images using the high-quality, wavelet-based
method defined by the JPEG 2000 standard.
|X| SEISPACT(R) is used by companies in the oil and gas industry to
store and transmit large amounts of seismic data gathered at sea
back to shore-based processing centers.
|X| We also license radiology compression software, which compresses
digital radiographs and other types of medical imagery.
RESEARCH AND DEVELOPMENT
Semiconductor intellectual property markets are characterized by rapid
technological changes and advances. Accordingly, we make substantial investments
in the design and development of new technologies, and for significant
improvement of existing technologies. Our research and development activities
are focused on the further development of our ADSL technology, including
incorporating new industry standards that we expect will be adopted. We have
also announced several extensions to our core ADSL technology package over the
last several years, including VeDSL, Dr. DSL, and Fast ADSL. We have also
announced that we are developing technology for G.SHDSL (ITU standard G991.2),
wireless local area networking, and powerline communications.
As of December 31, 2001, we had an engineering staff of 129 employees,
representing 78% of our total employee staff. During the years ended December
31, 2001, 2000, and 1999, research and development expenses charged to
operations were $10.1 million, $5.9 million, and $3.6 million, respectively. In
addition, because our license agreements often call for us to provide
engineering development services to our customers, a portion of our total
engineering costs has been allocated to cost of contract revenue. We expect that
we will continue to invest substantial funds in research and development
activities.
SALES AND MARKETING
Our principal sales and marketing strategy is to license our ADSL intellectual
property to semiconductor manufacturers. We believe that decisions involving the
selection of our technology are frequently made at senior levels within a
prospective customer's organization. Consequently, we rely significantly on
presentations by our
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senior management to key employees at prospective customers. As of December 31,
2001, we had fourteen people in our broadband sales and marketing organization.
Customers who have licensed our ADSL technology include ADI, Agere Systems, Inc.
("Agere"), Infineon, Intel, Legerity, Inc. (formerly Advanced Micro Devices'
Communication Products Division), NEC Corporation, ST Microelectronics ("ST"),
Sigmatel, Inc., and 3COM/US Robotics.
In 2001, we derived approximately 52% and 14% of our total revenue from ADI and
Intel, respectively. In 2000, we derived approximately 51% of our total revenue
from ADI. In 1999, we derived approximately 22%, 12%, 11% and 10% of our total
revenue from ADI, Agere, Intel, and Infineon, respectively. All revenue in 2001,
2000, and 1999 was derived from unaffiliated customers.
We sell our software-based compression products primarily through OEMs and
systems integrators. As of December 31, 2001, there were three people in our
compression software sales organization.
COMPETITION
We intend to compete by offering comprehensive packages of standards-based,
complex, system-level, broadband technology. Our success as an intellectual
property supplier depends on the willingness and ability of semiconductor
manufacturers to design, build and sell integrated circuits based on our
intellectual property. The semiconductor industry is intensely competitive and
has been characterized by:
|X| price erosion;
|X| rapid technological change;
|X| short product life cycles;
|X| cyclical market patterns; and
|X| increasing foreign and domestic competition.
As an intellectual property supplier to the semiconductor industry, we face
intense competition from internal development teams within potential
semiconductor customers. We must convince potential licensees to license from us
rather than develop technology internally. Furthermore, semiconductor customers,
who have licensed our intellectual property, may choose to abandon joint
development projects with us and develop chipsets themselves without using our
technology. In addition to competition from internal development teams, we
compete against other independent suppliers of intellectual property. We
anticipate intense competition from suppliers of intellectual property for DSL,
wireless local area networking, and powerline applications.
The market for ADSL chipsets is also intensely competitive. Our success within
the ADSL industry requires that ADSL equipment manufacturers buy chipsets from
our semiconductor licensees, and that telephone companies buy ADSL equipment
from those equipment manufacturers. Our customers' chipsets compete with
products from other vendors of standards-based and ADSL chipsets, including
Alcatel, Broadcom, Centillium, Conexant Systems, Inc ("Conexant"),
GlobespanVirata, and TI.
ADSL services offered over copper telephone networks also compete with
alternative broadband transmission technologies that use the telephone network
as well as other network architectures. Alternative technologies for the
telephone network include symmetric high speed DSL (also known as HDSL, SDSL and
G.SHDSL), and very high speed DSL, also known as VDSL. These technologies are
based on techniques other than those used by ADSL to transport high-speed data
over telephone lines. Alternative technologies that use other network
architectures to provide high-speed data service include cable modems using
cable networks, and wireless solutions using wireless networks. We cannot assure
you that these alternative broadband technologies will not be more successful
than ADSL.
Many of our current and prospective ADSL licensees, as well as chipset
competitors that compete with our semiconductor licensees, including Alcatel,
Broadcom, Conexant, GlobespanVirata and TI, have significantly greater
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financial, technological, manufacturing, marketing and personnel resources than
we do. We cannot assure you that we will be able to compete successfully or that
competitive pressures will not seriously harm our business.
The markets for our wavelet image compression technology are competitive, and
are expected to become increasingly more competitive in the near future.
PATENTS AND INTELLECTUAL PROPERTY
We rely on a combination of nondisclosure agreements and other contractual
provisions, as well as patent, trademark, trade secret and copyright law to
protect our proprietary rights. We have an active program to protect our
proprietary technology through the filing of patents. As of December 31, 2001,
we had 15 issued patents and 49 pending patent applications pertaining to
telecommunications and signal processing technology. We also had 12 issued
patents and 1 pending patent application pertaining to image compression, video
compression, audio compression, seismic data compression and optical
applications.
Although we have patented certain aspects of our technology, we rely primarily
on trade secrets to protect our intellectual property. We attempt to protect our
trade secrets and other proprietary information through agreements with our
licensees, suppliers, employees and consultants, and through security measures.
Each of our employees is required to sign a non-disclosure and non-competition
agreement. Although we intend to protect our rights vigorously, we cannot assure
you that these measures will be successful. In addition, effective intellectual
property protection may be unavailable or limited in certain foreign countries.
Third parties may assert exclusive patent, copyright and other intellectual
property rights to technologies that are important to us. Over the last several
years, we have received letters from third parties suggesting that we may be
obligated to license such intellectual property rights. While we believe our
technology offerings do not infringe the intellectual property rights of others,
we cannot assure you that they do not.
MANUFACTURING
Sales of hardware products constitute a relatively small portion of our total
revenue. Since our primary strategic focus is IP licensing, we do not intend to
produce hardware products in any material quantity for the foreseeable future.
Consequently, we rely on third party contract manufacturers to assemble and test
substantially all of our products. Our internal manufacturing capacity is
limited to final test and assembly of certain products. Other than ADSL
chipsets, which are available from our customers, we believe that other
components for our equipment-based products are available from a number of
suppliers.
EMPLOYEES
At December 31, 2001, we employed 165 people, including 129 in engineering, 17
in sales and marketing, 3 in manufacturing and 16 in finance and administration.
Of these employees, 161 were based in Massachusetts. None of our employees is
represented by a labor union. We consider our employee relations to be good.
We believe that our future success will depend in large part on the service of
our technical and senior management personnel and upon our ability to attract
and retain highly qualified technical, sales and marketing and managerial
personnel. Competition for highly qualified personnel is intense. We cannot
assure you that we will be able to retain our key managerial and technical
employees or that we will be able to attract and retain additional highly
qualified personnel in the future.
ITEM 2. PROPERTIES
We believe that our existing facilities are adequate for our current needs and
that additional space sufficient to meet our needs for the foreseeable future
will be available on reasonable terms. We currently occupy:
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1. 72,000 square feet of office space in Bedford, Massachusetts, which
serves as our headquarters. This site is used for our research and
development, sales and marketing, and administrative activities. We
own this facility.
2. 1,265 square feet of research and development space in Lafayette,
California. This facility is currently leased for a 3-year term,
which expires on August 31, 2004.
ITEM 3. LEGAL PROCEEDINGS
From time to time we are involved in litigation incidental to the conduct of our
business. We are not party to any lawsuit or proceeding that, in our opinion, is
likely to seriously harm our business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the fourth
quarter ended December 31, 2001.
9
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock is the only class of stock we have outstanding, and it trades
on the Nasdaq National Market under the symbol AWRE. The following table sets
forth the high and the low sales prices of our common stock as reported on the
Nasdaq National Market from January 1, 2000 to December 31, 2001.
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
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2001
High...................... $21.00 $10.50 $9.05 $8.63
Low....................... 8.50 7.30 3.17 3.76
2000
High...................... $67.00 $55.00 $61.44 $39.75
Low....................... 30.44 24.63 35.00 16.50
As of March 12, 2002, we had approximately 157 shareholders of record. This
number does not include shareholders from whom shares were held in a "nominee"
or "street" name. We have never paid cash dividends on our common stock and we
anticipate that we will continue to reinvest any earnings to finance future
operations.
We did not sell any equity securities that were not registered under the
Securities Act of 1933 during the three months ended December 31, 2001.
ITEM 6. SELECTED FINANCIAL DATA
In the table below, we provide you with our selected consolidated financial
data. We have prepared this information using our audited financial statements
for the years ended December 31, 2001, 2000, 1999, 1998, and 1997. When you read
this selected financial data, it is important that you read it along with
Management's Discussion and Analysis of Financial Condition and Results of
Operations, our historical consolidated financial statements, and the related
notes to the financial statements, which can be found in Item 8.
Year ended December 31, 2001 2000 1999 1998 1997
- ---------------------------------------------------------------------------------------------------------------------
(in thousands, except per share data)
STATEMENTS OF OPERATIONS DATA
Revenue.................................. $18,547 $30,667 $20,527 $11,796 $6,198
Income (loss) from operations............ (4,823) 9,490 3,321 (3,951) (6,157)
Cumulative effect of change in
accounting principle (1)............. - (1,618) - - -
Net income (loss)........................ (2,520) 13,414 4,898 (2,249) (4,448)
Net income (loss) per share - basic...... ($0.11) $0.60 $0.23 ($0.11) ($0.23)
Net income (loss) per share - diluted.... ($0.11) $0.56 $0.21 ($0.11) ($0.23)
BALANCE SHEET DATA
Cash and short-term investments.......... $57,284 $57,503 $36,265 $26,567 $26,104
Working capital.......................... 59,608 67,146 41,348 28,813 26,774
Total assets............................. 78,103 81,450 54,482 40,162 39,281
Total liabilities........................ 1,947 3,117 1,514 1,028 1,661
Total stockholders' equity............... 76,156 78,333 52,968 39,133 37,618
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(1) Effective January 1, 2000, we adopted Securities and Exchange Commission
Staff Accounting Bulletin No. 101, Revenue Recognition in Financial
Statements ("SAB 101") and recorded the impact in 2000. In 1999, the pro
forma effect of retroactive application of SAB 101 would have resulted in
net income of $3.280 million and net income per share, basic and diluted,
of $0.15 and $0.14, respectively. There was no pro forma effect on 1998
and 1997.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
The following table sets forth, for the years indicated, certain line items from
our consolidated statements of operations stated as a percentage of total
revenue:
Year ended December 31,
---------------------------------------------------
2001 2000 1999
---------------------------------------------------
Revenue:
Product sales....................................... 21 % 15 % 27 %
Contract revenue.................................... 44 40 52
Royalties........................................... 35 45 21
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Total revenue..................................... 100 100 100
Costs and expenses:
Cost of product sales............................... 3 3 7
Cost of contract revenue............................ 37 29 34
Research and development............................ 54 19 18
Selling and marketing............................... 16 8 12
General and administrative.......................... 16 10 13
---------------------------------------------------
Total costs and expenses......................... 126 69 84
Income (loss) from operations.......................... (26) 31 16
Interest income........................................ 12 9 8
---------------------------------------------------
Income (loss) before benefit from income taxes and
cumulative effect of change in accounting principle (14) 40 24
Benefit from income taxes.............................. - 9 -
---------------------------------------------------
Income (loss) before cumulative effect of change in.... (14) 49 24
accounting principle
---------------------------------------------------
Cumulative effect of change in accounting principle.... - (5) -
---------------------------------------------------
Net income (loss)...................................... (14) % 44 % 24 %
===================================================
PRODUCT SALES
Product sales consist primarily of revenue from the sale of ADSL equipment and
compression software products. The products that comprise ADSL equipment sales
are primarily test and development systems, modules, and modems.
Product sales decreased 18% from $4.7 million in 2000 to $3.8 million in 2001.
As a percentage of total revenue, product sales increased from 15% in 2000 to
21% in 2001. The dollar decrease was primarily due to a decrease in revenue from
the sale of test and development systems, which was partially offset by an
increase in revenue from the sale of compression software. Test and development
system revenue decreased primarily because our semiconductor and equipment
customers curtailed chipset development and manufacturing activities during
2001. Their curtailment
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of ADSL activities was a function of difficult economic conditions in the
semiconductor and telecommunications industries. Compression software revenue
was higher due to a large sale of our electronic identification products in the
first quarter of 2001.
Product sales decreased 16% from $5.5 million in 1999 to $4.7 million in 2000.
As a percentage of total revenue, product sales decreased from 27% in 1999 to
15% in 2000. The dollar decrease was primarily due to lower revenue from the
sale of modems. Modem revenue was lower because we phased out the development
and sale of our x200 Access Router during 2000.
CONTRACT REVENUE
Contract revenue consists primarily of license and engineering service fees that
we receive under agreements with our customers to develop ADSL chipsets.
Contract revenue decreased 32% from $12.2 million in 2000 to $8.3 million in
2001. As a percentage of total revenue, contract revenue increased from 40% in
2000 to 44% in 2001. The dollar decrease was primarily due to a difficult
semiconductor industry environment. Both existing and prospective ADSL chipset
licensees were reluctant to begin new development projects given the uncertainty
in the semiconductor and telecommunications industries. During 2001, customers
and potential customers cautiously evaluated new chipset projects or postponed
projects as they waited for conditions to improve. We are uncertain when the
market conditions we faced in 2001 will improve.
Contract revenue increased 15% from $10.6 million in 1999 to $12.2 million in
2000. As a percentage of total revenue, contract revenue decreased from 52% in
1999 to 40% in 2000. The dollar increase was primarily due to new chipset
development projects with existing and new semiconductor customers. Our
technology package was in higher demand in 2000, because existing and new
customers were encouraged by rapid growth of the ADSL market and the potential
opportunity it afforded them.
ROYALTIES
Royalties consist of royalty payments that we receive under licensing
agreements. We receive royalties from customers for the right to use our
technology in their chipsets or solutions.
Royalties decreased 53% from $13.9 million in 2000 to $6.5 million in 2001. As a
percentage of total revenue, royalties decreased from 45% in 2000 to 35% in
2001. The decrease in royalties was primarily due to a decrease in ADSL chipset
sales by ADI, our largest customer. We believe there are two principal factors
behind the decline in ADI's chipset sales. First, while end user demand for ADSL
service remains strong, particularly outside of the United States, more ADSL
chipsets were sold in 2000 than were required by new subscribers. Resulting
equipment overcapacity at telephone companies' central offices, and excess
chipset inventory at ADSL equipment manufacturers slowed industry-wide chipset
sales. Second, the glut of ADSL chipsets and central office equipment capacity
caused chipset selling prices to drop sharply. We are uncertain when the market
conditions we faced in 2001 will improve.
Royalties increased 215% from $4.4 million in 1999 to $13.9 million in 2000. As
a percentage of total revenue, royalties increased from 21% in 1999 to 45% in
2000. The increase in royalties was primarily due to a sharp increase in ADSL
chipset sales in 2000 in general and the success of ADI, our largest customer,
in particular. We believe that this increase was driven by growing deployments
of ADSL service primarily in the U.S. and Korea.
COST OF PRODUCT SALES
Since the cost of compression software license sales is minimal, cost of product
sales consists primarily of ADSL equipment sales. Cost of product sales
decreased 24% from $0.8 million in 2000 to $0.6 million in 2001. As a percentage
of product sales, cost of product sales decreased from 18% in 2000 to 16% in
2001. In terms of dollars, the decrease in cost of product sales was primarily
due to lower sales of ADSL test and development systems. The improvement in
product margins was primarily due to a greater proportion of compression
software sales in the product sales revenue mix.
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Cost of product sales decreased 39% from $1.4 million in 1999 to $0.8 million in
2000. As a percentage of product sales, cost of product sales decreased from 25%
in 1999 to 18% in 2000. The decrease in cost of product sales dollars and the
improvement in product margins were primarily due to a lower percentage of lower
margin x200 modem sales in 2000.
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 customer development projects. Our total engineering
costs are allocated between cost of contract revenue and research and
development expense. In a given period, the allocation of engineering costs
between cost of contract revenue and research and development is a function of
the level of effort expended on each. As a particular technology matures from
the development stage to integration into customer chips, engineering costs
shift from research and development to cost of contract revenue.
Cost of contract revenue decreased 22% from $8.8 million in 2000 to $6.8 million
in 2001. As a percentage of contract revenue, cost of contract revenue increased
from 72% in 2000 to 83% in 2001. In terms of dollars, the decrease in cost of
contract revenue was primarily due to fewer customer projects in 2001 as
compared with 2000. The increase in cost of contract revenue as a percentage of
contract revenue was primarily due to a lack of new customers in 2001, which was
caused by economic and industry conditions. The percentage increase is also due
to the mix of license fees and engineering service fees in contract revenue in
2001 as compared with 2000.
Cost of contract revenue increased 25% from $7.1 million in 1999 to $8.8 million
in 2000. As a percentage of contract revenue, cost of contract revenue increased
from 67% in 1999 to 72% in 2000. The dollar increase was primarily due to new
chipset development projects with existing and new semiconductor customers, and
the nature of the customer projects we performed in 2000. We engaged in projects
in 2000 that involved ASIC (application specific integrated circuit) core
developments, specific DSP-based code developments, and developments involving
the combination of ASIC cores and DSP code. These projects had greater
development costs associated with them, because they involved a greater degree
of engineering services.
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 engineering projects to enhance and extend our broadband
intellectual property offerings, and our compression software technology.
Research and development expense increased 71% from $5.9 million in 2000 to
$10.1 million in 2001. As a percentage of total revenue, research and
development expense increased from 19% in 2000 to 54% in 2001. The dollar
increase was primarily due to increased spending on internal research and
development projects, including improvements to our core ADSL technology
offering, projects such as VeDSL, Dr. DSL, G.SHDSL, wireless local area network
communications, powerline communications, as well as other development projects.
Research and development expense increased 63% from $3.6 million in 1999 to $5.9
million in 2000. As a percentage of total revenue, research and development
expense increased from 18% in 1999 to 19% in 2000. The dollar increase in
spending was primarily due to increased spending on internal research and
development projects, including new ADSL technology developments, VeDSL, Dr. DSL
and other projects. Higher spending on these projects was partially offset by
lower spending on our x200 modem product.
SELLING AND MARKETING EXPENSE
Selling and marketing expense consists primarily of salaries for sales and
marketing personnel, travel, advertising and promotion, recruiting, and
facilities expense. Sales and marketing expense increased 15% from $2.5 million
in 2000 to $2.9 million in 2001. As a percentage of total revenue, sales and
marketing expense increased from 8% in 2000 to 16% in 2001. The dollar increase
was primarily due to the addition of sales and marketing staff during 2001.
Sales and marketing expense decreased 2% from $2.6 million in 1999 to $2.5
million in 2000. As a percentage of total revenue, sales and marketing expense
decreased from 12% in 1999 to 8% in 2000. The dollar decrease was primarily due
to lower spending on public relations.
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GENERAL AND ADMINISTRATIVE EXPENSE
General and administrative expense consists primarily of salaries for
administrative personnel, facilities costs, and public company, bad debt, legal,
and audit expenses. General and administrative expense decreased 6% from $3.1
million in 2000 to $2.9 million in 2001. As a percentage of total revenue,
general and administrative expense increased from 10% in 2000 to 16% in 2001.
The dollar decrease was primarily due to lower provisions for bad debts, which
was partially offset by increased spending on salaries.
General and administrative expense increased 20% from $2.6 million in 1999 to
$3.1 million in 2000. As a percentage of total revenue, general and
administrative expense decreased from 13% in 1999 to 10% in 2000. The dollar
increase was primarily due to higher administration, investor relations and bad
debt expenses.
INTEREST INCOME
Interest income decreased 19% from $2.8 million in 2000 to $2.3 million in 2001.
The dollar decrease was primarily due to lower interest rates earned on our cash
balances.
Interest income increased 81% from $1.6 million in 1999 to $2.8 million in 2000.
The dollar increase is primarily due to higher cash balances. Higher cash
balances were due to positive cash flows from operations and stock option
exercises during 2000.
INCOME TAXES
We made no provision for income taxes in 2001 because we had a net loss. As of
December 31, 2001, we had net deferred tax assets of $7.1 million, which we
believed was more likely than not that we would realize based on our projected
taxable income in the next two years. The remaining deferred tax assets were
fully reserved due to the uncertainty of realization. We will continue to
evaluate, on a quarterly basis, the positive and negative evidence affecting the
realizability of our deferred tax assets.
In the fourth quarter of 2000, we determined that based on our expected future
taxable income, it was more likely than not that we would realize a portion of
our tax assets. Accordingly, we recorded a deferred tax asset of $7.1 million at
December 31, 2000, which consisted of an income statement tax benefit of $2.7
million for tax loss carryforwards and research and development credits, and an
adjustment to additional paid-in capital of $4.4 million for stock option
related deductions.
We made no provision for income taxes in 1999 as our historical net losses
resulted in tax loss carryforwards that we used to offset any tax expense.
At December 31, 2001, we had federal net operating loss carryforwards of
approximately $56.1 million, which begin to expire in 2003, and federal research
and development credit carryforwards of approximately $6.7 million, which begin
to expire in 2003. At December 31, 2001, we also had available state net
operating loss carryforwards of approximately $53.7 million, which begin to
expire in 2002, and state research and development and investment tax credit
carryforwards of approximately $3.9 million, which begin to expire in 2003.
Of the total net operating loss and research and development tax credit
carryforwards for which a valuation allowance was recorded approximately $3.0
million will be credited to the statement of operations as a tax benefit, if
realized in the future. The remainder of the net operating loss and research and
development tax credit carryforwards for which a valuation allowance was
recorded are attributable to the exercise of stock options and the tax benefit
will be credited to additional paid-in capital, if realized in the future.
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE
Effective January 1, 2000 we changed our method of revenue recognition in
accordance with Securities and Exchange Commission Staff Accounting Bulletin No.
101, Revenue Recognition in Financial Statements. Previously, we recognized
contract revenue under multiple element agreements upon completion of contract
milestones or upon transfer of intellectual property. Under the accounting
method we adopted retroactive to January
14
1, 2000, we now recognize contract revenue under multiple element agreements by
recording total license and engineering fees for the entire contract on a
straight-line basis over the estimated contract performance period, subject to
the limitation that cumulative revenue through the end of any period may not
exceed cumulative contract payments through that same period. The cumulative
effect of the change on prior years resulted in a charge to income of $1.6
million for the year ended December 31, 2000. For the years ended December 31,
2001 and 2000, we recognized $0.9 million and $0.7 million in revenue,
respectively, that was included in the cumulative effect adjustment as of
January 1, 2000.
LIQUIDITY AND CAPITAL RESOURCES
Since our inception in March 1986, we have financed our activities primarily
through the sale of stock. In the years ended December 31, 2001, 2000 and 1999,
we received net proceeds from the issuance of stock under employee stock plans
of $0.3 million, $7.6 million and $8.9 million, respectively. Our operating
activities provided net cash of $1.2 million, $14.5 million and $4.3 million in
the years ended December 31, 2001, 2000 and 1999, respectively. Cash provided by
operations during 2001 was primarily due to the collection of accounts
receivables, which was partially offset by a decrease in deferred revenue. Cash
provided by operations during 2000 and 1999 was primarily due to our
profitability.
In the years ended December 31, 2001, 2000, and 1999, we made capital
expenditures of $1.4 million, $1.3 million, and $3.1 million, respectively.
Capital expenditures in all three years consisted of spending on computer
hardware and software, laboratory equipment, and furniture used principally in
engineering activities. Capital spending in 1999 also included the renovation of
the third floor of our headquarters building for $1.5 million. We have no
material commitments for capital expenditures.
At December 31, 2001, we had cash, cash equivalents and short-term investments
of $57.3 million. We believe that our cash, cash equivalents and short-term
investments will be sufficient to fund our operations for at least the next
twelve months.
CRITICAL ACCOUNTING POLICIES
We consider certain accounting policies related to revenue recognition and the
valuation of deferred tax assets to be critical accounting policies.
REVENUE RECOGNITION. We derive our revenue from three sources (i) product
revenue, which includes revenue from the sale of ADSL equipment and compression
software products, (ii) contract revenue, which includes license and engineering
service fees that we receive under customer agreements, and (iii) royalties that
we receive under customer contracts.
As prescribed by Securities and Exchange Commission Staff Accounting Bulletin
No. 101, Revenue Recognition in Financial Statements, we recognize revenue when
there is persuasive evidence of an arrangement, the sales price is fixed or
determinable, collection of the related receivable is reasonably assured, and
delivery has occurred or services have been rendered. As described below, we
make significant judgments and estimates during the process of determining
revenue for any particular accounting period.
In determining revenue recognition, we assess whether fees associated with
revenue transactions are fixed or determinable and whether or not collection is
reasonably assured. We make a judgment whether fees are fixed or determinable
based on the payment terms associated with that transaction. We assess
collection based on a number of factors, including past transaction history with
the customer and the credit-worthiness of the customer. If we determine that
collection of a fee is not reasonably assured, we defer the fee and recognize
revenue at the time collection becomes reasonably assured, which is generally
upon receipt of cash.
In addition to these general revenue recognition judgments, we make specific
judgments and estimates with respect to the recognition of contract revenue. We
categorize customer contracts as either single element licensing agreements or
multiple element licensing agreements.
15
Contract revenue under single element licensing agreements is recognized when
technology transfers have been delivered or when engineering services have been
completed in accordance with defined milestones. Revenue recognized under single
element agreements requires us to make judgments regarding the completeness of
complex technology or service deliverables. While our customer agreements
generally do not contain customer acceptance provisions, we must make judgments
that our deliverables have been made in accordance with the terms of underlying
agreements.
Contract revenue under multiple element licensing agreements is recognized by
recording total license and engineering fees for the entire contract on a
straight-line basis over the estimated contract performance period, subject to
the limitation that cumulative revenue through the end of any period may not
exceed cumulative contract payments through that same period. Revenue recognized
under multiple element agreements requires us to make estimates of contract
performance periods. The estimate of this period is subject to revision as the
product is being developed under a contract, and a revision may result in an
increase or decrease to the quarterly revenue for that contract. Revenue
recognized under multiple element agreements also involves judgments regarding
the completeness of contract milestones as described in the previous paragraph.
ACCOUNTING FOR INCOME TAXES. As part of the process of preparing our
consolidated financial statements we are required to estimate our current tax
expense. We must also estimate temporary and permanent differences that result
from differing treatment of certain items for tax and accounting purposes. These
differences result in deferred tax assets, which are included in our
consolidated balance sheet. We must then assess the likelihood that our deferred
tax assets will be recovered from future taxable income and to the extent that
we believe that recovery is not likely, we must establish a valuation allowance.
To the extent we establish a valuation allowance or increase this allowance in a
period, we must include an expense with the tax provision in the statement of
operations.
Significant management judgment is required in determining our provision for
income taxes, our deferred tax assets, and any valuation allowance recorded
against our net deferred tax assets. Our deferred tax assets relate to net
operating losses and research and development tax credits that we are carrying
forward into future tax periods. As of December 31, 2001, we had a total of
$33.8 million of deferred tax assets for which we had recorded a valuation
allowance of $26.7 million resulting in $7.1 million of net deferred tax assets.
Our net deferred tax assets represent that portion of our total deferred tax
assets that we estimated were more likely than not to be realized based on our
estimate of projected taxable income in the next two years. In the event that
our actual results differ from this estimate, or we are able to project taxable
income beyond two years, we may need to change our valuation allowance, which
could materially affect our financial position and results of operations.
Of the total valuation allowance, approximately $3.0 million relates to net
operating loss and research and development tax credit carryforwards that are
attributable to operations and will be credited to the statement of operations
as a tax benefit, if realized in the future. The remainder of the valuation
allowance relates to net operating loss and research and development tax credit
carryforwards that are attributable to the exercise of stock options and the tax
benefit will be credited to additional paid-in capital, if realized in the
future.
RECENT ACCOUNTING PRONOUNCEMENTS
In August 2001, the FASB issued Statement of Financial Accounting Standards No.
144 ("SFAS 144"), "Accounting for the Impairment or Disposal of Long-Lived
Assets." SFAS 144 supercedes FASB Statement No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long Lived Assets to Be Disposed Of."
SFAS 144 applies to all long-lived assets (including discontinued operations)
and consequently amends Accounting Principles Board Opinion No. 30, "Reporting
Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business." SFAS 144 is effective for financial statements issued for fiscal
years beginning after December 15, 2001. We will adopt SFAS 144 in the first
quarter of 2002. We are currently determining the impact, if any, SFAS 144 will
have on our financial position and results of operations.
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FACTORS THAT MAY AFFECT FUTURE RESULTS
SOME OF THE INFORMATION IN THIS FORM 10-K CONTAINS FORWARD-LOOKING STATEMENTS
THAT INVOLVE SUBSTANTIAL RISKS AND UNCERTAINTIES. YOU CAN IDENTIFY THESE
STATEMENTS BY FORWARD-LOOKING WORDS SUCH AS "MAY," "WILL," "EXPECT,"
"ANTICIPATE," "BELIEVE," "ESTIMATE," "CONTINUE" AND SIMILAR WORDS. YOU SHOULD
READ STATEMENTS THAT CONTAIN THESE WORDS CAREFULLY BECAUSE THEY: (1) DISCUSS OUR
FUTURE EXPECTATIONS; (2) CONTAIN PROJECTIONS OF OUR FUTURE OPERATING RESULTS OR
FINANCIAL CONDITION; OR (3) STATE OTHER "FORWARD-LOOKING" INFORMATION. HOWEVER,
WE MAY NOT BE ABLE TO PREDICT FUTURE EVENTS ACCURATELY. THE RISK FACTORS LISTED
IN THIS SECTION, AS WELL AS ANY CAUTIONARY LANGUAGE IN THIS FORM 10-K, PROVIDE
EXAMPLES OF RISKS, UNCERTAINTIES AND EVENTS THAT MAY CAUSE OUR ACTUAL RESULTS TO
DIFFER MATERIALLY FROM THE EXPECTATIONS WE DESCRIBE IN OUR FORWARD-LOOKING
STATEMENTS. YOU SHOULD BE AWARE THAT THE OCCURRENCE OF ANY OF THE EVENTS
DESCRIBED IN THESE RISK FACTORS AND ELSEWHERE IN THIS FORM 10-K COULD MATERIALLY
AND ADVERSELY AFFECT OUR BUSINESS. WE ASSUME NO OBLIGATION TO UPDATE ANY
FORWARD-LOOKING STATEMENTS.
OUR QUARTERLY RESULTS ARE UNPREDICTABLE AND MAY FLUCTUATE SIGNIFICANTLY. Our
quarterly revenue and operating results are difficult to predict and may
fluctuate significantly from quarter to quarter. Because our revenue components
fluctuate and are difficult to predict, and our expenses are largely independent
of revenues in any particular period, it is difficult for us to accurately
forecast revenues and profitability. We generally recognize contract revenues
ratably over the period during which we expect to provide engineering services.
While this means that contract revenues from current licenses are generally
predictable, changes can be introduced by a reevaluation of the length of the
development period. The initial estimate of this period is subject to revision
as the product being developed under a contract nears completion, and a revision
may result in an increase or decrease to the quarterly revenue for that
contract. In addition, accurate prediction of revenues from new licensees is
difficult because the development of a business relationship with a potential
licensee is a lengthy process, frequently spanning a year or more, and the
fiscal period in which a new license agreement will be entered into, if at all,
and the financial terms of such an agreement are difficult to predict. Contract
revenues also include fees for engineering services, which are dependent upon
the varying level of assistance desired by licensees and, therefore, the revenue
from these services is also difficult to predict.
It is also difficult for us to make accurate forecasts of royalty revenues.
Royalties are recognized in the quarter in which we receive a report from a
licensee regarding the shipment of licensed integrated circuits in the prior
quarter, and are dependent upon fluctuating sales volumes and/or prices of chips
containing our technology, all of which are beyond our ability to control or
assess in advance.
Our business is subject to a variety of additional risks, which could materially
adversely affect quarterly and annual operating results, including:
|X| market acceptance of our broadband technologies by semiconductor
companies;
|X| the extent and timing of new license transactions with semiconductor
companies;
|X| changes in our and our licensees' development schedules and levels
of expenditure on research and development;
|X| the loss of a strategic relationship with a licensee;
|X| equipment companies' acceptance of integrated circuits produced by
our licensees;
|X| the loss by a licensee of a strategic relationship with an equipment
company customer;
|X| announcements or introductions of new technologies or products by us
or our competitors;
|X| delays or problems in the introduction or performance of
enhancements or of future generations of our technology;
|X| delays in the adoption of new industry standards or changes in
market perception of the value of new or existing standards;
|X| competitive pressures resulting in lower contract revenues or
royalty rates;
17
|X| personnel changes, particularly those involving engineering and
technical personnel;
|X| costs associated with protecting our intellectual property;
|X| the potential that licensees could fail to make payments under their
current contracts;
|X| ADSL market-related issues, including:
o lower ADSL chipset unit demand brought on by excess
channel inventory; and
o lower average selling prices for ADSL chipsets as a
result of market surpluses.
|X| regulatory developments; and
|X| general economic trends and other factors.
As a result of these factors, we believe that period-to-period comparisons of
our revenue levels and operating results are not necessarily meaningful. You
should not rely on our quarterly revenue and operating results to predict our
future performance.
WE HAVE BEGUN TO EXPERIENCE NET LOSSES. We had a net loss during 2001 after two
consecutive years of net income. We expect that we will have a net loss during
the first quarter of 2002. We may continue to experience losses beyond the first
quarter of 2002 if the semiconductor and telecommunications markets do not
recover from the downturn that began in 2001.
WE HAVE A UNIQUE BUSINESS MODEL. The success of our business model depends upon
our ability to license our technology to semiconductor and equipment companies,
and our customers' willingness and ability to sell products that incorporate our
technology so that we may receive significant royalties that are consistent with
our plans and expectations.
We face numerous risks in successfully obtaining suitable licensees on terms
consistent with our business model, including, among others:
|X| we must typically undergo a lengthy and expensive process of
building a relationship with a potential licensee before there is
any assurance of a license agreement with such party;
|X| we must persuade semiconductor and equipment manufacturers with
significant resources to rely on us for critical technology on an
ongoing basis rather than trying to develop similar technology
internally;
|X| we must persuade potential licensees to bear development costs
associated with our technology applications and to make the
necessary investment to successfully produce chipsets and products
using our technology; and
|X| we must successfully transfer technical know-how to licensees.
Moreover, the success of our business model also depends on the receipt of
royalties from licensees. Royalties from our licensees are often based on the
selling prices of our licensees' chipsets and products, over which we have
little or no control. We also have little or no control over our licensees'
promotional and marketing efforts. Our licensees are not required to pay us
royalties unless they use our technology. They are not prohibited from competing
against us.
Our business could be seriously harmed if:
|X| we cannot obtain suitable licensees;
|X| our licensees fail to achieve significant sales of chipsets or
products incorporating our technology; or
|X| we otherwise fail to implement our business strategy successfully.
WE DEPEND SUBSTANTIALLY UPON A LIMITED NUMBER OF LICENSEES. There are a
relatively limited number of semiconductor and equipment companies to which we
can license our broadband technology in a manner consistent
18
with our business model. If we fail to maintain relationships with our current
licensees or fail to establish a sufficient number of new licensee
relationships, our business could be seriously harmed. We cannot assure you that
our prospective customers will not use their superior size and bargaining power
to demand license terms that are unfavorable to us.
WE DERIVE A SIGNIFICANT AMOUNT OF REVENUE FROM ONE CUSTOMER. In 2000 and 2001,
we derived 51% and 52%, respectively of our total revenue from ADI. ADI was the
first customer to license ADSL technology from us in 1993 and their chipsets are
the most mature implementations of our technology in the market. Our royalty
revenues to date have been primarily due to sales of ADI chipsets that use our
ADSL technology. While we expect to see an increase in the number of our
customers with ADSL chipsets on the market, our revenue in the near term is
highly dependent upon ADI's ability to maintain its market share and pricing.
The ADSL market has experienced significant price erosion, which has adversely
affected ADI's ADSL revenue, which in turn has adversely affected our royalty
revenue. To the extent that ADI has lost market share, or loses market share in
the future, or experiences further price erosion in its ADSL chipsets, our
royalty revenue could continue to decline.
OUR SUCCESS REQUIRES ACCEPTANCE OF OUR TECHNOLOGY BY EQUIPMENT COMPANIES. Due to
our business strategy, our success is dependent on our ability to generate
significant royalties from our licensing arrangements with semiconductor
manufacturers. Our ability to generate significant royalties is materially
affected by the willingness of equipment companies to purchase integrated
circuits that incorporate our technology from our licensees. There are other
competitive solutions available for equipment companies seeking to offer
broadband communications products. We face the risk that equipment manufacturers
will choose those alternative solutions. Generally, our ability to influence
equipment companies' decision whether to purchase integrated circuits that
incorporates our technology is limited.
We also face the risk that equipment companies that elect to use integrated
circuits that incorporate our technology into their products will not compete
successfully against other equipment companies. Many factors beyond our control
could influence the success or failure of a particular equipment company that
uses integrated circuits based on our technology, including:
|X| competition from other businesses in the same industry;
|X| market acceptance of its products;
|X| its engineering, sales and marketing, and management capabilities;
|X| technical challenges of developing its products unrelated to our
technology; and
|X| its financial and other resources.
Even if equipment companies incorporate our chipsets based on our intellectual
property into their products, we cannot be sure that their products will achieve
commercial acceptance or result in significant royalties to us.
OUR SUCCESS REQUIRES TELEPHONE COMPANIES TO INSTALL ADSL SERVICE IN VOLUME. The
success of our ADSL licensing business depends upon telephone companies
installing ADSL service in significant volumes. Factors that affect the volume
deployment of ADSL service include:
|X| the desire of telephone companies to install ADSL service, which is
dependent on the development of a viable business model for ADSL
service, including the capability to market, sell, install and
maintain the service;
|X| the pricing of ADSL services by telephone companies;
|X| the quality of telephone companies' networks;
|X| government regulations; and
|X| the willingness of residential telephone customers to demand ADSL
service in the face of competitive service offerings, such as cable
modems.
19
If telephone companies do not install ADSL service in significant volumes, or if
telephone companies install ADSL service in significant volumes, but their
service offerings are not based on our technology, our business will be
seriously harmed.
WE RELY ON THE ADSL MARKET; UNIT VOLUMES AND CHIPSET PRICING. The royalties we
receive are influenced by many of the risks faced by the ADSL market in general;
including reduced average selling prices ("ASPs") during periods of surplus. In
2001, the ADSL industry experienced an oversupply of ADSL chipsets and central
office equipment. Excessive inventory levels led to soft chipset demand, which
in turn lead to declining ASPs. Such price decreases, and the corresponding
decreases in per unit royalties received by us, can be sudden and dramatic.
Lower unit demand and pricing pressures may continue during the first half of
2002 and beyond. There can be no assurance that decreases in ADSL chipset prices
or in per unit royalties received by us will not seriously harm our business.
OUR INTELLECTUAL PROPERTY IS SUBJECT TO LIMITED PROTECTION. Because we are a
technology provider, our ability to protect our intellectual property and to
operate without infringing the intellectual property rights of others is
critical to our success. We regard our technology as proprietary, and we have a
number of patents and pending patent applications. We also rely on a combination
of trade secrets, copyright and trademark law and non-disclosure agreements to
protect our unpatented intellectual property. Despite these precautions, it may
be possible for a third party to copy or otherwise obtain and use our technology
without authorization.
As part of our licensing arrangements, we typically work closely with our
semiconductor and equipment manufacturer licensees, many of whom are also our
potential competitors, and provide them with proprietary know-how necessary for
their development of customized chipsets based on our ADSL technology. Although
our license agreements contain non-disclosure provisions and other terms
protecting our proprietary know-how and technology rights, it is possible that,
despite these precautions, some of our licensees might obtain from us
proprietary information that they could use to compete with us in the
marketplace. Although we intend to defend our intellectual property as
necessary, we cannot be sure that the steps we have taken will be adequate to
prevent misappropriation.
In the future, we may choose to bring legal action to enforce our intellectual
property rights. Any such litigation could be costly and time-consuming for us,
even if we were to prevail. Moreover, even if we are successful in protecting
our proprietary information, we cannot be sure that our competitors will not
independently develop technologies substantially equivalent or superior to our
technology. The misappropriation of our technology or the development of
competitive technology could seriously harm our business.
Our technology may infringe the intellectual property rights of others. A large
and increasing number of participants in the telecommunications industry have
applied for or obtained patents. Some of these patent holders have demonstrated
a readiness to commence litigation based on allegations of patent and other
intellectual property infringement. Third parties may assert exclusive patent,
copyright and other intellectual property rights to technologies that are
important to our business. From time to time, we have received claims from other
companies that our technology infringes their patent rights. While we believe
our technology offerings do not infringe the intellectual property of others, we
cannot be sure. Intellectual property rights can be uncertain and can involve
complex legal and factual questions. We may be unknowingly infringing the
proprietary rights of others, which could result in significant liability for
us. If we were found to have infringed any third party's patents, then we could
be subject to substantial damages and an injunction preventing us from
conducting our business.
OUR BUSINESS IS SUBJECT TO RAPID TECHNOLOGICAL CHANGE. The semiconductor and
telecommunications industries, as well as the market for high-speed network
access technologies, are characterized by rapid technological change, with new
generations of products being introduced regularly and with ongoing evolutionary
improvements. We expect to depend on our ADSL technology for a substantial
portion of our revenue for the foreseeable future. Therefore, we face risks that
others could introduce competing technology that renders our ADSL technology
less desirable or obsolete. Also, the announcement of new technologies could
cause our licensees or their customers to delay or defer entering into
arrangements for the use of our existing technology. Either of these events
could seriously harm our business.
20
We expect that our business will depend to a significant extent on our ability
to introduce enhancements and new generations of our ADSL technology as well as
new technologies that keep pace with changes in the telecommunications and
broadband industries and that achieve rapid market acceptance. We must
continually devote significant engineering resources to achieving technical
innovations. These innovations are complex and require long development cycles.
Moreover, we may have to make substantial investments in technological
innovations before we can determine their commercial viability. We may lack
sufficient financial resources to fund future development. Also, our licensees
may decide not to share certain research and development costs with us. Revenue
from technological innovations, even if successfully developed, may not be
sufficient to recoup the costs of development.
One element of our business strategy is to assume the risks of technology
development failure while reducing such risks for our licensees. In the past, we
have spent significant amounts on development projects that did not produce any
marketable technologies or products, and we cannot assure you that it will not
occur again.
WE FACE INTENSE COMPETITION FROM A WIDE RANGE OF COMPETITORS. Our success as an
intellectual property supplier depends on the willingness and ability of
semiconductor manufacturers to design, build and sell integrated circuits based
on our intellectual property. The semiconductor industry is intensely
competitive and has been characterized by price erosion, rapid technological
change, short product life cycles, cyclical market patterns and increasing
foreign and domestic competition.
As an intellectual property supplier to the semiconductor industry, we face
intense competition from internal development teams within potential
semiconductor customers. We must convince potential licensees to license from us
rather than develop technology internally. Furthermore, semiconductor customers,
who have licensed our intellectual property, may choose to abandon joint
development projects with us and develop chipsets themselves without using our
technology. In addition to competition from internal development teams, we
compete against other independent suppliers of intellectual property. We
anticipate intense competition from suppliers of intellectual property for DSL,
wireless local area networking, and powerline applications.
The market for ADSL chipsets is also intensely competitive. Our success within
the ADSL industry requires that ADSL equipment manufacturers buy chipsets from
our semiconductor licensees, and that telephone companies buy ADSL equipment
from those equipment manufacturers. Our customers' chipsets compete with
products from other vendors of standards-based and ADSL chipsets, including
Alcatel, Broadcom, Centillium, Conexant, GlobespanVirata, and TI.
ADSL services offered over copper telephone networks also compete with
alternative broadband transmission technologies that use the telephone network
as well as other network architectures. Alternative technologies for the
telephone network include symmetric high speed DSL (also known as HDSL, SDSL and
G.SHDSL), and very high speed DSL, also known as VDSL. These DSL technologies
are based on techniques other than those used by ADSL to transport high-speed
data over telephone lines. Alternative technologies that use other network
architectures to provide high-speed data service include cable modems using
cable networks, and wireless solutions using wireless networks. We cannot assure
you that these alternative broadband technologies will not be more successful
than ADSL.
Many of our current and prospective ADSL licensees, as well as chipset
competitors that compete with our semiconductor licensees, including Alcatel,
Broadcom, Conexant, GlobespanVirata and TI, have significantly greater
financial, technological, manufacturing, marketing and personnel resources than
we do. We cannot assure you that we will be able to compete successfully or that
competitive pressures will not seriously harm our business.
WE REQUIRE ADDITIONAL HIGHLY QUALIFIED ENGINEERING PERSONNEL. Our future success
will depend significantly on our ability to attract, motivate and retain
additional highly qualified engineering 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 we may be unable to do so
successfully. In the past, we were
21
not able to hire all of the engineers that we wanted to hire. If we are unable
to hire and retain a sufficient number of engineers, our business could be
seriously harmed.
OUR STOCK PRICE MAY BE EXTREMELY VOLATILE. Volatility in our stock price may
negatively affect the price you may receive for your shares of common stock and
increases the risk that we could be the subject of costly securities litigation.
The market price of our common stock has fluctuated substantially and could
continue to fluctuate based on a variety of factors, including:
|X| quarterly fluctuations in our operating results;
|X| changes in future financial guidance that we may provide to
investors and public market analysts;
|X| changes in our relationships with our licensees;
|X| announcements of technological innovations or new products by us,
our licensees or our competitors;
|X| changes in ADSL market growth rates as well as investor perceptions
regarding the investment opportunity that companies participating in
the ADSL industry afford them;
|X| changes in earnings estimates by public market analysts;
|X| key personnel losses;
|X| sales of common stock; and
|X| 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 our common stock.
OUR BUSINESS MAY BE AFFECTED BY GOVERNMENT REGULATIONS. The extensive regulation
of the telecommunications industry by federal, state and foreign regulatory
agencies, including the Federal Communications Commission, and various state
public utility and service commissions, could affect us through the effects of
such regulation on our licensees and their customers. In addition, our business
may also be affected by the imposition of certain tariffs, duties and other
import restrictions on components that our customers obtain from non-domestic
suppliers or by the imposition of export restrictions on products sold
internationally and incorporating our technology. Changes in current or future
laws or regulations, in the United States or elsewhere, could seriously harm
affect our business.
22
ITEM 7 (A). QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to market risk relates primarily to our investment portfolio, and
the effect that changes in interest rates would have on that portfolio. Our
investment portfolio includes:
|X| Cash and cash equivalents, which consist of financial instruments
with original maturities of three months or less; and
|X| Investments, which consist of financial instruments that meet the
high quality standards specified in our investment policy. This
policy dictates that all instruments mature in 3 years or less, and
limits the amount of credit exposure to any one issue, issuer, and
type of instrument.
We do not use derivative financial instruments for speculative or trading
purposes. As of December 31, 2001 and 2000, all of our investments matured in
twelve months or less. Due to the short duration of the financial instruments we
invest in, we do not expect that an increase in interest rates would result in
any material loss to our investment portfolio.
23
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
The following consolidated financial statements of Aware, Inc. are filed as part
of this Report on Form 10-K:
CONSOLIDATED FINANCIAL STATEMENTS:
Page
----
Report of Independent Accountants...................................... 25
Consolidated Balance Sheets as of December 31, 2001 and 2000........... 26
Consolidated Statements of Operations for each of the three
years in the period ended December 31, 2001........................ 27
Consolidated Statements of Cash Flows for each of the
three years in the period ended December 31, 2001.................. 28
Consolidated Statements of Stockholders' Equity for each of
the three years in the period ended December 31, 2001.............. 29
Notes to Consolidated Financial Statements............................. 30
FINANCIAL STATEMENT SCHEDULE:
PAGE
Schedule II - Valuation and Qualifying Accounts........................ 39
24
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of Aware, Inc.:
In our opinion, the consolidated financial statements listed in the accompanying
index present fairly, in all material respects, the financial position of Aware,
Inc. and its subsidiary at December 31, 2001 and 2000, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2001 in conformity with accounting principles generally accepted in
the United States of America. In addition, in our opinion, the financial
statement schedule listed in the accompanying index presents fairly, in all
material respects, the information set forth therein when read in conjunction
with the related consolidated financial statements. These financial statements
and financial statement schedule are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements and financial statement schedule based on our audits. We conducted
our audits of these statements in accordance with auditing standards generally
accepted in the United States of America, which 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,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
As discussed in Note 2 to the consolidated financial statements, effective
January 1, 2000, the Company changed its method of recognizing revenue.
PRICEWATERHOUSECOOPERS LLP
Boston, Massachusetts
January 28, 2002
25
AWARE, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
DECEMBER 31,
-----------------------------------
2001 2000
---------------- ---------------
ASSETS
Current assets:
Cash and cash equivalents............................................. $36,056 $51,662
Short-term investments................................................ 21,228 5,841
Accounts receivable (less allowance for doubtful......................
accounts of $380 in 2001 and $402 in 2000) 1,383 5,200
Inventories........................................................... 282 167
Deferred tax assets................................................... 1,811 7,093
Prepaid expenses and other current assets............................. 795 300
---------------- ---------------
Total current assets............................................ 61,555 70,263
---------------- ---------------
Property and equipment, net................................................ 10,937 11,187
Deferred tax assets........................................................ 5,282 -
Other assets, net.......................................................... 329 -
---------------- ---------------
Total assets.................................................... $78,103 $81,450
================ ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable...................................................... $353 $483
Accrued expenses...................................................... 521 332
Accrued compensation.................................................. 948 664
Accrued professional.................................................. 125 169
Deferred revenue...................................................... - 1,469
---------------- ---------------
Total current liabilities..................................... 1,947 3,117
---------------- ---------------
Commitments and contingent liabilities (Note 7)
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, 22,657,741 in 2001 and 22,606,277 in 2000.... 227 226
Additional paid-in capital........................................... 77,151 76,809
Retained earnings (accumulated deficit).............................. (1,222) 1,298
---------------- ---------------
Total stockholders' equity.................................... 76,156 78,333
---------------- ---------------
Total liabilities and stockholders' equity.................... $78,103 $81,450
================ ===============
The accompanying notes are an integral part of the financial statements.
26
AWARE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
YEARS ENDED DECEMBER 31,
-----------------------------------------------
2001 2000 1999
-----------------------------------------------
Revenue:
Product sales....................................... $3,817 $4,655 $5,535
Contract revenue.................................... 8,253 12,152 10,594
Royalties........................................... 6,477 13,860 4,398
-------------------------------------------
Total revenue................................... 18,547 30,667 20,527
-------------------------------------------
Costs and expenses:
Cost of product sales............................... 629 831 1,363
Cost of contract revenue............................ 6,822 8,800 7,053
Research and development............................ 10,104 5,915 3,636
Selling and marketing............................... 2,916 2,533 2,574
General and administrative.......................... 2,899 3,098 2,580
-------------------------------------------
Total costs and expenses....................... 23,370 21,177 17,206
-------------------------------------------
Income (loss) from operations........................... (4,823) 9,490 3,321
Interest income......................................... 2,303 2,826 1,577
-------------------------------------------
Income (loss) before benefit from income taxes and
cumulative effect of change in accounting principle.. (2,520) 12,316 4,898
Benefit from income taxes............................... - 2,716 -
-------------------------------------------
Income (loss) before cumulative effect of change in
accounting principle................................. (2,520) 15,032 4,898
Cumulative effect of change in accounting
principle (Note 2)................................... - (1,618) -
-------------------------------------------
Net income (loss)....................................... ($2,520) $13,414 $4,898
===========================================
Basic net income (loss) per share:
Income (loss) before cumulative effect of change in
accounting principle............................. ($0.11) $0.67 $0.23
Cumulative effect of change in accounting principle . - ($0.07) -
-------------------------------------------
Net income (loss) per share.......................... ($0.11) $0.60 $0.23
==========================================
Diluted net income (loss) per share:
Income (loss) before cumulative effect of change in
accounting principle............................. ($0.11) $0.63 $0.21
Cumulative effect of change in accounting principle.. - ($0.07) -
-------------------------------------------
Net income (loss) per share.......................... ($0.11) $0.56 $0.21
===========================================
Weighted average shares - basic......................... 22,631 22,454 21,497
Weighted average shares - diluted....................... 22,631 23,807 23,585
The accompanying notes are an integral part of the financial statements.
27
AWARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEARS ENDED DECEMBER 31,
------------------------------------------------
2001 2000 1999
------------------------------------------------
Cash flows from operating activities:
Net income (loss)......................................... ($2,520) $13,414 $4,898
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization.......................... 1,720 1,738 1,775
Provision for doubtful accounts....................... 25 325 100
Increase (decrease) from changes in assets and
liabilities:
Accounts receivable.................................... 3,792 181 (2,904)
Inventories............................................ (115) (45) (1)
Deferred tax assets.................................... - (2,716) -
Prepaid expenses and other current assets.............. (495) (31) (17)
Accounts payable....................................... (130) (305) 308
Accrued expenses....................................... 429 439 190
Deferred revenue....................................... (1,469) 1,469 (13)
------------------------------------------------
Net cash provided by operating activities......... 1,237 14,469 4,336
------------------------------------------------
Cash flows from investing activities:
Purchases of property and equipment....................... (1,424) (1,305) (3,075)
Other assets.............................................. (375) 500 (500)
Net sales (purchases) of short-term investments........... (15,387) (4,824) 2,038
------------------------------------------------
Net cash used in investing activities............. (17,186) (5,629) (1,537)
------------------------------------------------
Cash flows from financing activities:
Proceeds from issuance of common stock .................. 343 7,574 8,937
------------------------------------------------
Net cash provided by financing activities......... 343 7,574 8,937
------------------------------------------------
Increase (decrease) in cash and cash equivalents............. (15,606) 16,414 11,736
Cash and cash equivalents, beginning of year................. 51,662 35,248 23,512
------------------------------------------------
Cash and cash equivalents, end of year ...................... $36,056 $51,662 $35,248
================================================
The accompanying notes are an integral part of the financial statements.
28
AWARE, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
Retained
Common Stock Additional Earnings Total
-------------------------- Paid-In (Accumulated Stockholders'
Shares Amount Capital Deficit) Equity
--------------------------------------------------------------------
Balance at December 31, 1998.............. 20,911 $209 $55,938 ($17,014) $39,133
Exercise of common stock options ..... 1,001 10 8,785 8,795
Issuance of common stock under
employee stock purchase plan....... 6 - 142 142
Net income............................ 4,898 4,898
--------------------------------------------------------------------
Balance at December 31, 1999.............. 21,918 219 64,865 (12,116) 52,968
Exercise of common stock options ..... 680 7 7,405 7,412
Issuance of common stock under
employee stock purchase plan....... 8 - 162 162
Tax benefit of stock option exercises. 4,377 4,377
Net income............................ 13,414 13,414
--------------------------------------------------------------------
Balance at December 31, 2000.............. 22,606 226 76,809 1,298 78,333
Exercise of common stock options ..... 24 - 180 180
Issuance of common stock under
employee stock purchase plan....... 28 1 162 163
Net loss.............................. (2,520) (2,520)
--------------------------------------------------------------------
Balance at December 31, 2001.............. 22,658 $227 $77,151 ($1,222) $76,156
====================================================================
The accompanying notes are an integral part of the financial statements.
29
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF BUSINESS
We are a leader in the development and marketing of intellectual property
for broadband communications. Our principal offering to date has been
Asymmetric Digital Subscriber Line ("ADSL") technology for the
telecommunications industry. ADSL enables telephone companies to use their
existing copper telephone lines to offer broadband services. We have
adopted an intellectual property business model in which we neither
manufacture nor sell integrated circuits incorporating our technology. We
license our broadband technology on a nonexclusive and worldwide basis to
semiconductor companies that manufacture and sell products that
incorporate our technology. Our licensees sell integrated circuits to
equipment companies who incorporate those integrated circuits into their
products. We also offer ADSL hardware products and 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 - At December 31, 2001 and 2000, we categorized all
securities as "available-for-sale," since we may liquidate these
investments currently. In calculating realized gains and losses, cost is
determined using specific identification. Unrealized gains and losses on
available-for-sale securities are excluded from earnings and reported in a
separate component of stockholders' equity. At December 31, 2001 and 2000,
unrealized gains and losses were not material.
The amortized cost of securities, which approximates fair value, consists
of the following at December 31, 2001 and 2000 (in thousands):
Type of Security 2001 2000
---------------- ------------ ------------
Corporate debt securities.......... $ 6,869 $ -
U.S. agency securities............. 14,359 5,841
------------ ------------
Total............................ $21,228 $5,841
============ ============
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 $25,000,
$325,000, and $100,000 for 2001, 2000, and 1999, 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.
Upon retirement or sale, the costs of the assets disposed of and the
related accumulated depreciation are removed from the accounts and any
resulting gain or loss is included in the determination of income or loss.
The estimated useful lives of assets used by us are:
Building and improvements.......................... 30 years
Furniture and fixtures and office equipment........ 5 years
Computer & manufacturing equipment................. 3 years
Purchased software................................. 3 years
30
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
IMPAIRMENT OF LONG-LIVED ASSETS - We review long-lived assets for
impairment whenever events or changes in business circumstances indicate
that the carrying amount of the assets may not be fully recoverable or
that the useful lives of these assets are no longer appropriate. Each
impairment test is based on a comparison of the undiscounted cash flows to
the recorded value of the asset. If an impairment is indicated, the asset
is written down to its estimated fair value on a discounted cash flow
basis. The cash flow estimates used to determine the impairment, if any,
reflect our best estimates using appropriate assumptions and projections
at that time. We believe that no significant impairment of our long-lived
assets has occurred as of December 31, 2001.
REVENUE RECOGNITION - Effective January 1, 2000, we adopted Securities and
Exchange Commission Staff Accounting Bulletin No. 101, Revenue Recognition
in Financial Statements ("SAB 101"). We recognize revenue when there is
persuasive evidence of an arrangement, the sales price is fixed or
determinable, collection of the related receivable is reasonably assured,
and delivery has occurred or services have been rendered as more fully
described below.
PRODUCT SALES. Product sales consist primarily of revenue from the sale of
transceiver modules, test and development systems, and compression
software. Product sales are recognized upon shipment.
CONTRACT REVENUE. We enter into nonexclusive technology licensing
agreements with semiconductor licensees that provide for us to receive
fees for: (i) the transfer of intellectual property components and/or (ii)
the performance of engineering services to customer specifications.
Technology licensing agreements also provide licensees with the right to
incorporate our intellectual property components in their products with
terms and conditions that have historically varied by licensee. Generally
licensing agreements include one or more of the following elements: i)
technology license fees; which are payable upon the transfer of
intellectual property, ii) engineering service fees, which generally are
payable upon our achievement of defined milestones, and iii) royalty
payments, which are generally payable when licensees use our intellectual
property in their products. We classify license and engineering service
fees received under licensing agreements as contract revenue.
Our revenue recognition methodology for contract revenue classifies
licensing agreements between those contracts that contain multiple
elements of license and engineering service fees and those contracts that
contain a single element.
MULTIPLE ELEMENT LICENSING AGREEMENTS. Contract revenue under multiple
element agreements is recognized by recording total license and
engineering fees for the entire contract on a straight-line basis over
the estimated contract performance period, subject to the limitation
that cumulative revenue through the end of any period may not exceed
cumulative contract payments through that same period.
SINGLE ELEMENT LICENSING AGREEMENTS. Technology license fees are
recognized as revenue when technology transfers have been effected and
no contingent factors are present. Engineering services are recognized
as revenue when the defined milestones are completed. Engineering
milestones have historically been formulated to correlate with the
estimated level of effort and related costs.
ROYALTY REVENUE. Royalty revenue is generally recognized in the quarter in
which a report is received from a licensee detailing the shipments of
products incorporating our intellectual property components (i.e., in the
quarter following the sales of the licensed product by the licensee). The
terms of our licensing agreements generally require licensees to give
notification to us and to pay royalties within 45 to 60 days of the end of
the quarter during which sales of licensed products take place.
CHANGE IN ACCOUNTING PRINCIPLE - Effective January 1, 2000 we changed our
method of revenue recognition in accordance with Securities and Exchange
Commission Staff Accounting Bulletin No. 101, Revenue Recognition in
Financial Statements. Previously, we recognized contract revenue under
multiple element agreements upon completion of contract milestones or upon
transfer of intellectual property. Under the accounting method we adopted
retroactive to January 1, 2000, we now recognize contract revenue under
multiple element agreements by recording total license and engineering
fees for the entire contract on a straight-line basis over the estimated
contract performance period, subject to the limitation that cumulative
revenue through the end of any period may not exceed cumulative contract
payments through that same period. The cumulative effect of the change on
prior years resulted in a charge to income of $1.6 million for the year
31
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
ended December 31, 2000. For the years ended December 31, 2001 and 2000,
we recognized $0.9 million and $0.7 million in revenue, respectively, that
was included in the cumulative effect adjustment as of January 1, 2000.
In 1999, the pro forma effect of retroactive application of SAB 101 would
have resulted in net income of $3.280 million and net income per share,
basic and diluted, of $0.15 and $0.14, respectively.
INCOME TAXES - We compute deferred income taxes based on 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. We must establish a valuation allowance to offset
temporary deductible differences, net operating loss carryforwards and tax
credits when it is more likely than not that the deferred tax assets will
not be realized.
CAPITALIZATION OF SOFTWARE COSTS - We capitalize certain internally
generated software development costs after technological feasibility of
the product has been established. No software costs were capitalized for
the years ended December 31, 2001, 2000 and 1999, because such costs
incurred subsequent to the establishment of technological feasibility, but
prior to commercial availability, were immaterial.
CONCENTRATION OF CREDIT RISK - At December 31, 2001 and 2000, we had cash
and investments, in excess of federally insured deposit limits of
approximately $57.2 million and $57.4 million, respectively.
Concentration of credit risk with respect to accounts receivable consists
of $0.7 million, $0.3 million, $0.2 million, and $0.1 million with four
customers at December 31, 2001 and of $3.4 million, $0.6 million, $0.5
million, and $0.5 million with four customers at December 31, 2000.
STOCK-BASED COMPENSATION - We grant stock options to our employees and
directors. Such grants are for a fixed number of shares 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", we
account for stock option grants in accordance with Accounting Principles
Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees"
and FASB Interpretation No. 44 ("FIN 44"), "Accounting for Certain
Transactions Involving Stock Compensation." Accordingly, we have adopted
the provisions of SFAS No. 123 through disclosure only (Note 6).
COMPUTATION OF EARNINGS PER SHARE - Basic earnings per share is computed
by dividing income available to common shareholders by the weighted
average number of common shares outstanding. Diluted earnings per share is
computed by dividing income available to common shareholders by the
weighted average number of common shares outstanding plus additional
common shares that would have been outstanding if dilutive potential
common shares had been issued. For the purposes of this calculation, stock
options are considered common stock equivalents in periods in which they
have a dilutive effect. Stock options that are antidilutive are excluded
from the calculation.
USE OF ESTIMATES - The preparation of our financial statements in
conformity with generally accepted accounting principles requires us to
make estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amount of revenues and
expenses during the reporting period. Significant estimates include
revenue recognition, 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
could differ from those 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.
COMPREHENSIVE INCOME - Comprehensive income is defined as the change in
equity of a business enterprise during a period from transactions and
other events and circumstances from non-owner sources, including
32
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
foreign currency translation adjustments and unrealized gains and losses
on marketable securities. For the years ended December 31, 2001, 2000 and
1999, comprehensive income (loss) was not materially different from net
income (loss).
RECENT ACCOUNTING PRONOUNCEMENTS - In August 2001, the FASB issued
Statement of Financial Accounting Standards No. 144 ("SFAS 144"),
"Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS 144
supercedes FASB Statement No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long Lived Assets to Be Disposed Of." SFAS 144
applies to all long-lived assets (including discontinued operations) and
consequently amends Accounting Principles Board Opinion No. 30, "Reporting
Results of Operations - Reporting the Effects of Disposal of a Segment of
a Business." SFAS 144 is effective for financial statements issued for
fiscal years beginning after December 15, 2001. We will adopt SFAS 144 in
the first quarter of 2002. We are currently determining the impact, if
any, SFAS 144 will have on our financial position and results of
operations.
RECLASSIFICATIONS - Certain prior period amounts have been reclassified to
be consistent with the current period presentation.
SEGMENTS - We organize ourselves as one segment reporting to the chief
operating decision-maker. We have sales outside of the United States,
which are described in Note 8. All long-lived assets are maintained in the
United States.
3. INVENTORIES
Inventories consisted of the following at December 31 (in thousands):
2001 2000
--------------- --------------
Raw materials.................. $146 $142
Finished goods................. 136 25
--------------- --------------
Total...................... $282 $167
=============== ==============
4. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following at December 31 (in
thousands):
2001 2000
--------------- ---------------
Land................................................ $ 1,080 $ 1,080
Building and improvements........................... 8,757 8,757
Computer equipment.................................. 5,272 4,367
Purchased software.................................. 2,343 1,907
Furniture and fixtures.............................. 923 864
Office equipment.................................... 342 319
Manufacturing equipment............................. 268 267
--------------- ---------------
Total............................................ 18,985 17,561
Less accumulated depreciation and amortization...... (8,048) (6,374)
--------------- ---------------
Property and equipment, net...................... $10,937 $11,187
=============== ===============
Deprecation expense amounted to $1.7 million, $1.7 million and $1.8
million for the years ended December 31, 2001, 2000, and 1999,
respectively.
33
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. INCOME TAXES
Deferred tax assets are attributable to the following at December 31 (in
thousands):
2001 2000
-------------- --------------
Federal net operating loss carryforwards........................ $19,073 $ 18,090
Research and development and other tax credit carryforwards..... 10,575 9,481
State net operating loss carryforwards.......................... 3,385 3,163
Deferred revenue................................................ - 355
Other .......................................................... 791 489
-------------- --------------
Total........................................................ 33,824 31,578
Less valuation allowance........................................ (26,731) (24,485)
-------------- --------------
Deferred tax assets, net..................................... $ 7,093 $ 7,093
============== ==============
A reconciliation of the U.S. federal statutory rate to the effective tax
rate is as follows:
Year ended December 31,
-----------------------------------------------
2001 2000 1999
------------- ------------ -------------
Federal statutory rate..................................... (34%) 34% 34%
State rate, net of federal benefit......................... (6) 6 4
Tax credits................................................ (60) (9) (69)
Valuation allowance........................................ 100 (58) 27
Other - 5 4
------------- ------------ -------------
Effective tax rate...................................... -% (22)% - %
============= ============ =============
As of December 31, 2001, we had net deferred tax assets of $7.1 million,
which we believed was more likely than not that we would realize based on
our projected taxable income in the next two years. The remaining deferred
tax assets were fully reserved due to the uncertainty of realization. We
will continue to evaluate, on a quarterly basis, the positive and negative
evidence affecting the realizability of our deferred tax assets.
At December 31, 2001, we had federal net operating loss carryforwards of
approximately $56.1 million, which begin to expire in 2003, and federal
research and development credit carryforwards of approximately $6.7
million, which begin to expire in 2003. At December 31, 2001, we also had
available state net operating loss carryforwards of approximately $53.7
million, which begin to expire in 2002, and state research and development
and investment tax credit carryforwards of approximately $3.9 million,
which begin to expire in 2003.
Of the total net operating loss and research and development credit
carryforwards for which a valuation allowance was recorded approximately
$3.0 million will be credited to the statement of operations as a tax
benefit, if realized in the future. The remainder of the net operating
losses and research and development credit carryforwards for which a
valuation allowance was recorded are attributable to the exercise of stock
options and the tax benefit will be credited to additional paid-in
capital, if realized in the future.
6. EQUITY AND STOCK COMPENSATION PLANS
At December 31, 2001, we have four stock-based compensation plans, which
are described below. We adopted SFAS No. 123, but, as permitted, apply APB
Opinion No. 25 and related Interpretations in accounting for options
granted to employees and directors. We have no performance-based stock
option plans. Had compensation cost for our four stock-based compensation
plans been determined based on the fair value at the grant dates as
prescribed by SFAS No. 123, our net income (loss) and basic and diluted
net income (loss) per share would have been adjusted to the pro forma
amounts indicated below (in thousands, except per share data):
34
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Year ended December 31,
----------------------------------------------------
2001 2000 1999
----------------- ---------------- -----------------
Net income (loss) - as reported........................ ($2,520) $13,414 $4,898
Net income (loss) - pro forma.......................... ($27,773) ($3,833) ($11,745)
Basic earnings (loss) per share - as reported.......... ($0.11) $0.60 $0.23
Basic earnings (loss) per share - pro forma............ ($1.23) ($0.17) ($0.55)
Diluted earnings (loss) per share - as reported........ ($0.11) $0.56 $0.21
Diluted earnings (loss) per share - pro forma.......... ($1.23) ($0.17) ($0.55)
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:
Year ended December 31,
------------------------------------------------------
2001 2000 1999
--------------- --------------- ---------------
Average risk-free interest rate............. 4.55 % 6.15 % 5.54 %
Expected life of option grants.............. 5 years 5 years 5 years
Expected volatility of underlying stock..... 104 % 106 % 98 %
Expected dividend yield..................... - - -
FIXED STOCK OPTION PLANS - We have three fixed option plans. Under the
1990 Incentive and Nonstatutory Stock Option Plan ("1990 Plan"), we may
grant incentive stock options or nonqualified stock options to our
employees and directors for up to 2,873,002 shares of common stock. Under
the 1996 Stock Option Plan ("1996 Plan"), we may grant incentive stock
options or nonqualified stock options to our employees and directors for
up to 6,100,000 shares of common stock. Under the 2001 Nonqualified Stock
Plan ("2001 Plan"), we may grant nonqualified stock options to our
employees and directors for up to 3,000,000 shares of common stock. Under
all three 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. As of December 31, 2001, there were 661,544
shares available for grant under the 2001 Plan, 175,195 shares available
for grant under the 1996 Plan, and no shares available under the 1990
Plan.
A summary of the transactions of our three fixed stock option plans for
the years ended December 31, 2001, 2000, and 1999 are presented below:
2001 2000 1999
-------------------------- --------------------------- -------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
-------------------------- --------------------------- -------------------------
Outstanding at beginning of year... 4,083,683 $29.52 3,538,687 $22.05 3,097,043 $9.24
Granted............................ 2,407,423 6.42 1,631,350 37.86 1,562,500 38.14
Exercised.......................... (23,731) 7.60 (680,413) 10.89 (1,000,399) 8.79
Forfeited or cancelled............. (199,167) 32.73 (405,941) 29.10 (120,457) 11.54
-------------------------- --------------------------- -------------------------
Outstanding at end of year......... 6,268,208 $20.63 4,083,683 $29.52 3,538,687 $22.05
========================== =========================== =========================
Options exercisable at year end.... 3,358,403 $21.28 1,711,351 $23.79 1,595,443 $16.32
The weighted average grant date fair values of options granted during the
years ended December 31, 2001, 2000 and 1999 were $5.01, $30.30 and
$29.16, respectively.
The following table summarizes information about stock options outstanding
at December 31, 2001:
35
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Options Outstanding Options Exercisable
----------------------------------------------------------- -------------------------------------
Number Weighted-Avg. Number
Range of Outstanding at Remaining Weighted-Avg. Exercisable Weighted-Avg.
Exercise Prices 12/31/01 Contractual Life Exercise Price At 12/31/01 Exercise Price
--------------- ----------------------------------------------------------- -------------------------------------
$0 to 10.......... 2,812,493 8.8 years $6.44 1,243,350 $7.27
10 to 20.......... 781,466 5.9 $11.82 628,198 $11.84
20 to 30.......... 663,305 7.8 $23.61 464,066 $24.88
30 to 40.......... 608,850 8.0 $32.18 321,069 $32.20
40 to 50.......... 1,392,094 8.0 $47.49 694,220 $47.07
50 to 70.......... 10,000 7.8 $58.06 7,500 $56.42
----------------------------------------------------------- -------------------------------------
6,268,208 8.1 $20.63 3,358,403 $21.28
=========================================================== =====================================
EMPLOYEE STOCK PURCHASE PLAN - In June 1996, we 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. A total of 100,000 shares
of common stock have been reserved for issuance. As of December 31, 2001
there were 50,997 shares available for future issuance under the ESPP
Plan. We issued 27,733, 7,808 and 6,269 common shares under the ESPP Plan
in 2001, 2000 and 1999, respectively.
STOCKHOLDER RIGHTS PLAN - In October 2001, our board of directors adopted
a stockholder rights plan and declared a dividend distribution of one
share purchase right (a "Right") for each outstanding share of our common
stock to stockholders of record at the close of business on October 15,
2001. Each share of common stock issued after that date also will carry
with it one Right, subject to certain exceptions. Each Right, when it
becomes exercisable, will entitle the record holder to purchase from us
one ten-thousandth of a share of series A preferred stock at an exercise
price of $40.00 subject to adjustment.
The Rights become exercisable upon the earliest of the following dates:
(i) the date on which we first publicly announce that a person or group
has become an acquiring person, or (ii) the date, if any, that our board
of directors may designate following the commencement of, or first public
disclosure of an intent to commence, a tender or exchange offer which
could result in the potential buyer becoming a beneficial owner of 15% or
more of our outstanding common stock. Under these circumstances, holders
of Rights will be entitled to purchase, for the exercise price, the
preferred stock equivalent of common stock having a market value of two
times the exercise price. The Rights expire on October 2, 2011, and may be
redeemed by us for $.001 per Right.
7. COMMITMENTS AND CONTINGENT LIABILITIES
LEASE COMMITMENTS - We own our principal office and research facility in
Bedford, Massachusetts, which we have occupied since November 1997. We
conduct a portion of our research and development activities in leased
facilities in Lafayette, California under a non-cancellable operating
lease that expires in 2004. The following is a schedule of future minimum
rental payments required under the California operating lease (in
thousands):
YEAR ENDED DECEMBER 31,
-----------------------
2002..................................... $42
2003..................................... 44
2004..................................... 30
-----------
Total minimum lease payments.......... $116
===========
36
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Rental expense was approximately $36,000, $105,000, and $14,000 in 2001,
2000 and 1999, respectively.
LITIGATION - There are no material pending legal proceedings to which we
are a party or to which any of our properties are subject which, either
individually or in the aggregate, are expected to have a material adverse
effect on our business, financial position or results of operations.
8. BUSINESS SEGMENTS AND MAJOR CUSTOMERS
We organize ourselves as one segment and conduct our operations in the
United States.
We sell our products and technology to domestic and international
customers. Revenues were generated from the following geographic regions
(in thousands):
Year ended December 31,
----------------------------------------------------
2001 2000 1999
--------------- -------------- --------------
United States................................... $17,092 $26,606 $14,802
Europe.......................................... 717 2,231 3,376
Asia/Pacific.................................... 627 1,567 2,169
Rest of world................................... 111 263 180
--------------- -------------- --------------
$18,547 $30,667 $20,527
=============== ============== ==============
The portion of total revenue that was derived from major customers was as
follows:
Year ended December 31,
----------------------------------------------------
2001 2000 1999
--------------- -------------- --------------
Customer A................................. 52% 51% 22%
Customer B................................... 14% 9% 11%
Customer C................................ 2% 7% 10%
Customer D................................... - 2% 12%
9. EMPLOYEE BENEFIT PLAN
In 1994, we 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. Our contributions to the Plan are at the discretion of the
Board of Directors. Our contributions were $313,000, $166,000 and $148,000
in 2001, 2000 and 1999, respectively.
10. NET INCOME (LOSS) PER SHARE
Net income (loss) per share is calculated as follows (in thousands, except
per share data):
Year ended December 31,
-----------------------------------------------------
2001 2000 1999
------------- --------------- ----------------
Net income (loss)................................... ($2,520) $13,414 $4,898
Weighted average common shares outstanding........ 22,631 22,454 21,497
Additional dilutive common stock equivalents ..... - 1,353 2,088
------------- --------------- ----------------
Diluted shares outstanding ....................... 22,631 23,807 23,585
============= =============== ================
Net income (loss) per share - basic................. ($0.11) $0.60 $0.23
Net income (loss) per share - diluted............... ($0.11) $0.56 $0.21
37
For the year ended December 31, 2001, potential common stock equivalents of
285,427 were not included in the per share calculation for diluted EPS,
because we had a net loss and the effect of their inclusion would be
anti-dilutive. For the years ended December 31, 2001, 2000 and 1999,
options to purchase 3,488,215, 1,508,194 and 897,000 shares of common stock
at average weighted prices of $31.95, $47.53 and $46.26 per share,
respectively, 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 and thus would be anti-dilutive.
11. QUARTERLY RESULTS OF OPERATIONS - UNAUDITED
The following table presents unaudited quarterly operating results for each
of our quarters in the two-year period ended December 31, 2001 (in
thousands, except per share data). As discussed in Note 2, we changed our
method of revenue recognition effective January 1, 2000. Accordingly, the
following unaudited quarterly operating results for the first three
quarters of the year ended December 31, 2000 have been adjusted to reflect
the impact of the change in accounting method as if adopted on January 1,
2000.
2001 Quarters Ended
-----------------------------------------------------------------
March 31 June 30 September 30 December 31
-----------------------------------------------------------------
Revenue................................. $8,218 $4,017 $3,108 $3,204
Income (loss) from operations........... 2,633 (1,655) (2,874) (2,927)
Net income (loss)....................... 2,056 40 (2,039) (2,577)
Net income (loss) per share - basic..... $0.09 $0.00 ($0.09) ($0.11)
Net income (loss) per share - diluted .. $0.09 $0.00 ($0.09) ($0.11)
2000 Quarters Ended
----------------------------------------------------------------
March 31 June 30 September 30 December 31
-----------------------------------------------------------------
Revenue................................ $6,563 $7,018 $8,019 $9,067
Income from operations................. 1,696 1,738 2,664 3,392
Income before cumulative effect of
change in accounting principle..... 2,266 2,408 3,421 6,937
Cumulative effect of change in
accounting principle............... (1,618) - - -
Net income............................. 648 2,408 3,421 6,937
Net income per share - basic........... $0.03 $0.11 $0.15 $0.31
Net income per share - diluted ........ $0.03 $0.10 $0.14 $0.30
38
FINANCIAL STATEMENT SCHEDULE
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS - YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
(IN THOUSANDS)
- ----------------------------- ---------------- ------------------ ------------------ ----------------- ------------------
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:
2001................. $402 $25 - $47 $380
2000................. $175 $325 - $98 $402
1999................. $100 $100 - $25 $175
Allowance for sales
returns and allowances:
2001................. $125 - ($125) - -
2000................. $35 - $90 - $125
1999................. $50 - ($15) - $35
Inventory reserves:
2001................. $209 $75 - - $284
2000................. $159 $50 - - $209
1999................. $184 ($25) - - $159
39
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Our executive officers and directors, and their ages as of March 12, 2002 are as
follows:
NAME AGE POSITION
---- --- --------
Michael A. Tzannes..................... 40 Chief Executive Officer and Director
Edmund C. Reiter....................... 38 President and Director
Richard P. Moberg...................... 47 Chief Financial Officer and Treasurer
Richard W. Gross....................... 44 Senior Vice President - Engineering
John K. Kerr .......................... 64 Chairman of the Board of Directors
David Ehreth .......................... 52 Director
G. David Forney, Jr. .................. 61 Director
MICHAEL A. TZANNES has been Aware's chief executive officer since April 1998 and
has served as a director of Aware since March 1998. Mr. Tzannes served as
Aware's president from April 1998 to March 2001. From September 1997 to April
1998, he served as Aware'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 Aware 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.
EDMUND C. REITER has served as Aware's president since March 2001 and as a
director of Aware since December 1999. Mr. Reiter served as a senior vice
president from May 1998 to March 2001, as Aware's vice president, advanced
products from August 1995 to May 1998, as 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 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.
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.
RICHARD W. GROSS was appointed Senior Vice President in July 1999. Mr. Gross
served as Vice President - Strategic Development from July 1998 to July 1999.
Prior to the Vice President position, he held various senior level engineering
positions from the time he joined Aware in September 1993 until July 1998. Prior
to joining Aware, Mr. Gross was a senior technical staff member at GTE
Laboratories from 1987 to 1993; a technical staff member at the Heinrich Hertz
Institute from 1984 to 1987; and a programmer for IBM, Federal Systems Division
from 1980 to 1984. Mr. Gross received a Ph.D. and M.S. in electrical engineering
from the University of Rhode Island and a B.A. in physics from Holy Cross
College.
40
JOHN K. KERR has been a director of Aware since 1990 and Chairman of the board
of directors since March 1999. Mr. Kerr previously served as a director of Aware
from 1988 to 1989 and as Chairman of the board of directors from November 1992
to March 1994. Mr. Kerr has been General Partner of Grove Investment Partners, a
private investment partnership, since 1990. Mr. Kerr received an M.A. and a B.A.
from Baylor University.
DAVID EHRETH has served as a director of Aware since November 1997. Since April
1998, Mr. Ehreth has served as president, chief executive officer and chairman
of Westwave Communications, Inc., a telecommunications software company. From
June 1992 to August 1998, Mr. Ehreth served as division vice president of the
access division of DSC Communications Corporation, a manufacturer of digital
switching, access, transport and private network system products for the
telecommunications industry. From 1987 to June 1992, Mr. Ehreth served as vice
president of engineering of Optilink, Inc., a manufacturer of access systems for
the telecommunications industry. Optilink, Inc. was acquired by DSC
Communications Corporation in 1990. From 1977 to 1987, Mr. Ehreth held numerous
positions in the Digital Telephone Systems division of Harris Corporation. Mr.
Ehreth received a degree in electrical engineering from College of Marin.
G. DAVID FORNEY, JR. has served as a director of Aware since May 1999. Mr.
Forney was a Vice President of Motorola, Inc. from 1977 until his retirement in
January 1999. Mr. Forney was previously a Vice President of research and
development, and a director of Codex Corporation prior to its acquisition by
Motorola in 1977. Mr. Forney is currently Bernard M. Gordon Adjunct Professor in
the Department of Electrical Engineering and Computer Sciences at the
Massachusetts Institute of Technology. Mr. Forney received an Sc.D. in
electrical engineering from Massachusetts Institute of Technology and a B.S.E.
in electrical engineering from Princeton University.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 of Form 10-K is incorporated by reference
from the information contained in the section captioned "COMPENSATION OF
DIRECTORS AND EXECUTIVE OFFICERS" in the Proxy Statement that will be delivered
to our shareholders in connection with our May 31, 2002 Annual Meeting of
Shareholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 of Form 10-K is incorporated by reference
from the information contained in the section captioned "SECURITY OWNERSHIP OF
CERTAIN BENEFICIAL OWNERS AND MANAGEMENT" in the Proxy Statement that will be
delivered to our shareholders in connection with our May 31, 2002 Annual Meeting
of Shareholders.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Not applicable.
41
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(A) See Item 8 for an index to the consolidated financial statements,
supplementary financial information, and financial statement schedule.
(B) There were no reports on Form 8-K filed during the fourth quarter ended
December 31, 2001.
(C) INDEX TO EXHIBITS
Exhibits have been filed separately with the United States Securities and
Exchange Commission in connection with this Annual Report on Form 10-K or
have been incorporated into this Report by reference. Copies of such
exhibits may be obtained from us upon request.
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).
4.1 Rights Agreement dated as of October 2, 2001 between Aware, Inc. and Equiserve Trust
Company, N.A., as Rights Agent (filed as Exhibit 4(a) to the Company's Form 8-K filed
with the Securities and Exchange Commission on October 3, 2001 and incorporated herein
by reference).
4.2 Terms of Series A Participating Cumulative Preferred Stock of Aware, Inc. (attached as
Exhibit A to the Rights Agreement filed as Exhibit 4.1 hereto).
4.3 Form of Right Certificate (attached as Exhibit B to the Rights Agreement filed as
Exhibit 4.1 hereto).
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, as amended and restated (filed as Annex A to the Company's
Definitive Proxy Statement filed with the Securities and Exchange Commission on April
11, 2000 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 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 2001 Nonqualified Stock Plan (filed as Exhibit 10.6 to the Company's Form 10-Q for the
quarter ended March 31, 2001 and incorporated herein by reference).
21.1 * Subsidiaries of Registrant.
23.1 * Consent of PricewaterhouseCoopers LLP.
* Filed herewith
42
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
Date: March 20, 2002
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 20th day of March 2002.
SIGNATURE TITLE
--------- -----
/s/ Michael A. Tzannes Chief Executive Officer and Director
- ---------------------------------------------- (Principal Executive Officer)
Michael A. Tzannes
/s/ Edmund C. Reiter President and Director
- ----------------------------------------------
Edmund C. Reiter
/s/ Richard P. Moberg Chief Financial Officer, Treasurer
- ---------------------------------------------- (Principal Financial and Accounting Officer)
Richard P. Moberg
/s/ John K. Kerr Chairman of the Board of Directors
- ----------------------------------------------
John K. Kerr
/s/ David Ehreth Director
- ----------------------------------------------
David Ehreth
/s/ G. David Forney, Jr. Director
- ----------------------------------------------
G. David Forney, Jr
43