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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, 2002
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
(Registrant's Telephone Number, Including Area Code)
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Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, PAR VALUE $.01 PER SHARE
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES X NO
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2).
YES X NO
--- ---
The aggregate market value of the voting stock held by non-affiliates of the
registrant as of June 28, 2002, based on the closing price of the common stock
on June 28, 2002 as reported on the Nasdaq National Market, was approximately
$82,905,660.
The number of shares outstanding of the registrant's common stock as of March
12, 2003 was 22,698,171.
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 29, 2003 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, 2002
TABLE OF CONTENTS
PART I
Item 1. Description of the Business............................................................... 3
Item 2. Properties................................................................................ 9
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 7A. Quantitative and Qualitative Disclosures About Market Risk................................ 24
Item 8. Consolidated Financial Statements and Supplementary Data.................................. 25
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure................................................................................ 43
PART III
Item 10. Directors and Executive Officers of the Registrant........................................ 43
Item 11. Executive Compensation.................................................................... 44
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters................................................................................... 44
Item 13. Certain Relationships and Related Transactions............................................ 44
Item 14. Controls and Procedures................................................................... 45
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.......................... 46
Signatures............................................................................................... 47
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. 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 and 2002, approximately 78% and 64%, respectively, of our revenue
came from licensing ADSL intellectual property. We license our intellectual
property worldwide through our direct sales force. Our largest semiconductor
customers in 2002 were 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 include board-level products that allow
customers to make products that require ADSL connectivity, such as ADSL test
equipment. Our hardware products also include system-level products that enable
our customers to 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 120 people at December 31, 2002. Our stock is traded on the
Nasdaq National Market under the symbol AWRE.
Our website provides a link to a third-party website through which our annual,
quarterly and current reports, and amendments to those reports, are available
free of charge. We believe these reports are made available as soon as
reasonably practicable after we electronically file them with, or furnish them
to, the SEC. We do not maintain or provide any information directly to the
third-party website, and we do not check its accuracy.
INDUSTRY BACKGROUND
ADSL INDUSTRY BACKGROUND. ADSL technology allows telephone companies to offer
high-speed data services over their existing telephone networks by connecting
their central offices to end users' residences. Telephone companies began tests
and trials of ADSL technology in the mid 1990s. Commercial deployment of ADSL
services began in modest volumes in 1999, and during the last three years, the
rate of deployment of ADSL services accelerated dramatically, particularly
outside of the United States. According to announcements by major telephone
companies and information compiled by Point Topic Ltd., a company that provides
analysis of broadband access to the internet, approximately 5 million, 12
million, and 17 million new ADSL subscribers were added in 2000, 2001, and 2002,
respectively. As of December 31, 2002, there were approximately 36 million
global ADSL subscribers of which approximately 6 million were in the United
States and approximately 30 million were in other countries.
Some of the largest suppliers of ADSL service in North America are SBC, Verizon,
Bell South, Qwest, Bell Canada, and Telus. In Europe, some of the largest
providers are Deutsche Telekom, France Telecom, Belgacom, British Telecom,
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Telephonica, Telecom Italia, and Telia. Large Asian providers include Korea
Telecom and Hanaro in Korea; NTT and Yahoo Broadband in Japan; Chunghwa in
Taiwan; and China Telecom in China.
In order to enable ADSL service, ADSL equipment must be installed in the central
offices of telephone companies and in end users' premises. ADSL central office
equipment and customer premises modems are available from numerous
telecommunications equipment suppliers. Some of the leading suppliers of ADSL
equipment include Alcatel Alsthom S.A. ("Alcatel"), ECI Telecom, LTD's Inovia
business unit ("Inovia"), Lucent Technologies, Inc., NEC Corporation, Samsung
Corporation, Siemens AG, Sumitomo Corporation, UT Starcom, Westell Technologies,
Inc., and Comtrend and other Taiwanese modem manufacturers.
Telecommunications equipment suppliers are able to purchase ADSL chipsets from a
number of suppliers, including Analog Devices Inc. ("ADI"), Broadcom Corporation
("Broadcom"), Centillium Communications, Inc. ("Centillium"), Conexant Systems,
Inc. ("Conexant"), GlobespanVirata, Inc. ("GlobespanVirata"), Infineon
Technologies AG (`Infineon"), ST Microelectronics N.V. ("ST"), and Texas
Instruments Incorporated ("TI"). ADSL chipsets offered by these suppliers are
designed to operate in either central office equipment or customer premises
modems.
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 two principal
categories:
|X| HORIZONTAL IP consists of designs for: (i) standard chip functions,
such as timers and clocks, memory management, and hardware
controllers, (ii) configurable processors and digital signal
processors, and (iii) libraries of intellectual property that are used
during the semiconductor manufacturing process.
|X| VERTICAL IP consists of solutions for specific applications that are
usually based on standards or patents. Examples include ADSL, Code
Division Multiple Access ("CDMA"), Universal Serial Bus ("USB"),
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 Vertical 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
usable 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.
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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.
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. Full-rate ADSL can
transmit data at speeds up to 8 megabits per second ("Mbps") downstream and up
to 640 Kbps upstream.
In 1999, the ITU also standardized a lower speed version of ADSL, known as
G.Lite or G.992.2. G.Lite can transmit data at speeds up to 1.5 Mbps downstream
and up to 512 Kbps upstream without using special filtering equipment required
by full-rate ADSL. G.Lite was intended to make the installation of ADSL faster
and less expensive for telephone companies. Notwithstanding G.Lite's ease of
installation, most ADSL service offerings today are based on full-rate ADSL.
In 2002, the ITU consented to a new set of ADSL standards known as ADSL2 or
G.992.3 and G.992.4. These standards provide numerous improvements over previous
ADSL standards, including line diagnostics, power management, power down and
power cut-back, reduced framing and on-line configuration. In February 2003, the
ITU consented to a new standard known as ADSL2+ or G.992.5. ADSL2+ builds upon
the ADSL2 standard by increasing achievable data rates to speeds of up to 24
Mbps upstream on phone lines as long as 3,000 feet (20 Mbps out to 5,000 feet).
We license a technology package that includes a complete implementation of the
ITU standards for ADSL, ADSL2 and ADSL2+. Our intellectual property offering
includes chip designs, in the form of RTL, and software for operating the chip.
In January 2003, we announced that we had developed and manufactured a physical
chip named StratiPHY(TM) that represents our intellectual property designs. The
addition of StratiPHY to Aware's intellectual property offering provides our
customers with access to working silicon along with a complete turnkey package
of RTL and firmware. We believe the addition of a physical chip to our
intellectual property offerings has the potential of further reducing our
customers' development costs and time-to-market.
Customers can integrate our technology into their own or third party
manufacturing processes to develop monolithic chips or packaged solutions. We
also license patent rights and offer engineering services to our customers.
We have complemented our core ADSL offerings with technologies aimed at
enhancing the value proposition of ADSL for telephone companies. An important
innovation we have developed is our Dr. DSL(R) diagnostic testing technology.
Dr. DSL is designed to assist service providers with provisioning, monitoring,
and maintaining their DSL services by enabling them to collect important
information about their copper loop plant and the access network. Dr. DSL also
has the potential of providing subscribers with tools they can use to assist
with provisioning and maintenance. The primary goal of Dr. DSL is to reduce the
costs associated with service turn-on and maintenance by reducing customer
complaints and technician visits 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 have also developed channelized voice technology, named
voice-enabled DSL (VeDSL(TM)), which allows service providers to bundle new,
profitable voice-over-DSL services to their residential subscribers, enabling
ADSL to evolve from a data-centric technology to a complete residential voice
and data solution.
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;
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|X| provide multiple and flexible technology solutions for numerous silicon and
equipment architectures;
|X| offer systems-level, vertical 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.
AWARE ADSL HARDWARE PRODUCTS
In addition to our intellectual property licensing business, we sell
ADSL-related hardware products. Our principal hardware products include:
o ADSL MODULES - Modules are board-level products that contain all of the
components of an ADSL system. Customers, such as ADSL test equipment
companies, can integrate ADSL connectivity into their equipment-based
products using our ADSL modules;
o ADSL DEVELOPMENT SYSTEMS - Development systems are system-level products
that are designed to help our customers build ADSL chipsets by providing
them with a means to conduct performance and interoperability testing
during product development; and
o ADSL TEST SYSTEMS - Test systems are systems-level products that are
designed to help ADSL modem manufacturers test their products during
production without requiring them to purchase expensive central office
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, ACCUPRINT BY AWARE, AND ACCUSCAN 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| 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 that we are developing technology for diagnostics and testing
(Dr. DSL), G.SHDSL (ITU standard G.991.2), and wireless local area networking.
As of December 31, 2002, we had an engineering staff of 89 employees,
representing 74% of our total employee staff. During the years ended December
31, 2002, 2001, and 2000, research and development expenses charged to
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operations were $14.0 million, $10.1 million, and $5.9 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 senior management to key employees at prospective
customers. As of December 31, 2002, we had twelve 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"),
Metanoia Technologies (formerly a division of Sigmatel, Inc.), and 3COM/US
Robotics.
In 2002, we derived approximately 32%, 15%, and 12% of our total revenue from
ADI, Infineon, and Intel, respectively. 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. All revenue in 2002,
2001, and 2000 was derived from unaffiliated customers.
We sell our software-based compression products primarily through OEMs and
systems integrators. As of December 31, 2002, there were three people in our
compression software sales organization.
COMPETITION
We 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| rapid 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
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 for DSL and wireless local
area networking.
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
Broadcom, Centillium, Conexant, GlobespanVirata, ST and TI.
ADSL services compete with alternative DSL technologies that can also transport
high-speed data over telephone lines. These technologies include symmetric high
speed DSL (also known as HDSL, SDSL and G.SHDSL), and
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very high speed DSL, also known as VDSL. We cannot assure you that these
alternative broadband technologies will not be more successful than ADSL or that
we will be able to participate in markets involving these alternative broadband
technologies.
ADSL services also compete with broadband technologies that use other network
architectures to provide high-speed data service. These technologies include
cable modems using cable networks, and wireless solutions using wireless
networks. To date, ADSL services have been more successful than high-speed cable
services outside of the United States; however cable services serve a larger
number of broadband subscribers than ADSL inside the United States. We cannot
assure you that these alternative network architectures 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 Broadcom,
Conexant, GlobespanVirata, ST 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.
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, 2002,
we had 18 issued patents and 45 pending patent applications pertaining to
telecommunications and signal processing technology. We also had 12 issued
patents and 3 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. In the past, we have
received letters from third parties suggesting that we may be obligated to
license such intellectual property rights. If we were found to have infringed
any third party's patents, we could be subject to substantial damages and an
injunction preventing us from conducting our business.
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 ADI, we believe that other components for our
equipment-based products are available from a number of suppliers.
EMPLOYEES
At December 31, 2002, we employed 120 people, including 89 in engineering, 15 in
sales and marketing, 3 in manufacturing and 13 in finance and administration. Of
these employees, 118 were based in Massachusetts. None of our employees is
represented by a labor union. We consider our employee relations to be good.
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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 retain
highly qualified technical, sales and marketing and managerial personnel. In
October 2002 we terminated approximately 22 percent of our workforce as part of
an effort to reduce operating expenses. Our workforce reduction may yield
unanticipated consequences, such as attrition beyond our planned reduction in
workforce. Further, the reduction in force may reduce employee morale and may
create concern among existing employees about job security, which may lead to
increased attrition or turnover. As a result of these factors, our remaining
personnel may decide to seek employment with more established companies, and we
may have difficulty attracting new personnel that we might wish to hire in the
future. 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:
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, 2002.
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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, 2001 to December 31, 2002.
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
----------------------- ----------- ----------- ----------- -----------
2002
High............... $9.79 $6.50 $3.94 $3.05
Low................ 5.92 3.25 1.95 2.01
2001
High............... $21.00 $10.50 $9.05 $8.63
Low................ 8.50 7.30 3.17 3.76
As of March 12, 2003, we had approximately 160 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, 2002.
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, 2002, 2001, 2000, 1999, and 1998. 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, 2002 2001 2000 1999 1998
- ------------------------------------------------------------------------------------------------------
(in thousands, except per share data)
STATEMENTS OF OPERATIONS DATA
Revenue.................................. $13,844 $18,547 $30,667 $20,527 $11,796
Income (loss) from operations............ (12,529) (4,823) 9,490 3,321 (3,951)
Cumulative effect of change in
accounting principle (1)............. - - (1,618) - -
Net income (loss)........................ (18,728) (2,520) 13,414 4,898 (2,249)
Net income (loss) per share - basic...... ($0.83) ($0.11) $0.60 $0.23 ($0.11)
Net income (loss) per share - diluted.... ($0.83) ($0.11) $0.56 $0.21 ($0.11)
BALANCE SHEET DATA
Cash and short-term investments.......... $33,302 $57,284 $57,503 $36,265 $26,567
Working capital.......................... 33,481 59,608 67,146 41,348 28,813
Total assets............................. 59,237 78,103 81,450 54,482 40,162
Total liabilities........................ 1,659 1,947 3,117 1,514 1,028
Total stockholders' equity............... 57,578 76,156 78,333 52,968 39,133
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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.
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,
---------------------------------------------------
2002 2001 2000
---------------------------------------------------
Revenue:
Product sales....................................... 33 % 21 % 15 %
Contract revenue.................................... 49 44 40
Royalties........................................... 18 35 45
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Total revenue..................................... 100 100 100
Costs and expenses:
Cost of product sales............................... 7 3 3
Cost of contract revenue............................ 35 37 29
Research and development............................ 101 54 19
Selling and marketing............................... 21 16 8
General and administrative.......................... 26 16 10
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Total costs and expenses......................... 190 126 69
Income (loss) from operations.......................... (90) (26) 31
Interest income........................................ 6 12 9
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Income (loss) before benefit from (provision for)
income taxes and cumulative effect of change in
accounting principle ............................... (84) (14) 40
Benefit from (provision for) income taxes.............. (51) - 9
---------------------------------------------------
Income (loss) before cumulative effect of change in
accounting principle................................ (135) (14) 49
---------------------------------------------------
Cumulative effect of change in accounting principle.... - - (5)
---------------------------------------------------
Net income (loss)...................................... (135) % (14) % 44 %
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PRODUCT SALES
Product sales consist primarily of revenue from the sale of hardware products
and compression software. Hardware products primarily include ADSL test and
development systems, modules, and modems. Compression software consists of
standard off-the-shelf software products that are sold to OEM customers that
integrate our software into their equipment-based products.
Product sales increased 19% from $3.8 million in 2001 to $4.5 million in 2002.
As a percentage of total revenue, product sales increased from 21% in 2001 to
33% in 2002. The dollar increase was primarily due to higher unit volume sales
of modules and compression software, which was partially offset by a decrease in
revenue from the sale of test and development systems. Module sales were higher
primarily due to sales to a customer that is using them in
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ADSL test equipment. Compression software revenue increased primarily due to
higher demand for our electronic identification products. Test and development
system revenue decreased primarily due to lower demand from our semiconductor
and equipment customers, which was the result of continued difficult economic
conditions in the semiconductor and telecommunications industries.
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 product development activities beginning in 2001 as a result
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.
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 18% from $8.3 million in 2001 to $6.8 million in
2002. As a percentage of total revenue, contract revenue increased from 44% in
2001 to 49% in 2002. 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 decreases in contract revenue in 2002 and 2001 were primarily due to
a difficult environment for licensing intellectual property for communications
integrated circuits. Both existing and prospective ADSL chipset licensees were
reluctant to begin new development projects given: (i) generally weak worldwide
economic conditions, (ii) a difficult and uncertain environment in the
semiconductor and telecommunications industries, and (iii) intense ADSL chipset
competition and falling chipset prices. During the last two years, customers and
potential customers cautiously evaluated new chipset projects or delayed or
cancelled projects in the face of such conditions. We are uncertain when the
economic and market conditions we faced in 2002 and 2001 will improve.
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 61% from $6.5 million in 2001 to $2.5 million in 2002. As a
percentage of total revenue, royalties decreased from 35% in 2001 to 18% in
2002. The decrease in royalties was primarily due to a decrease in ADSL chipset
sales by our largest customer, ADI. We believe that ADI's chipset sales declined
primarily due to falling ADSL chipset pricing and a potential loss of market
share. Despite strong growth of worldwide ADSL subscribers in 2002, the
availability of ADSL chipsets from a number of suppliers and intense competition
among those suppliers has caused chipset prices to drop sharply over the last
two years. Additionally, deployments of ADSL service in geographic areas where
chipsets based upon our technology have been sold, leveled off or declined in
2002. We are uncertain when ADSL chipset pricing will improve, whether ADI will
be able to grow its presence or whether our other licensees will contribute
meaningful royalty revenue.
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 were two principal factors
behind the decline in ADI's chipset sales in 2001. 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.
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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
increased 52% from $0.6 million in 2001 to $1.0 million in 2002. As a percentage
of product sales, cost of product sales increased from 16% in 2001 to 21% in
2002. The increase in cost of product sales was primarily due to a greater
proportion of module sales in the sales mix. Modules have higher cost of sales
than the other products that comprise our product revenue.
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.
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.
Cost of contract revenue decreased 28% from $6.8 million in 2001 to $4.9 million
in 2002. As a percentage of contract revenue, cost of contract revenue decreased
from 83% in 2001 to 72% in 2002. 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.
The dollar decrease in cost of contract revenue in 2002 and 2001 was primarily
due to fewer customer contracts. Since our cost of contract revenue is based on
the level of effort we expend on customer projects and the number of customer
projects declined in 2002 and 2001, cost of contract revenue declined as well.
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 38% from $10.1 million in 2001 to
$14.0 million in 2002. As a percentage of total revenue, research and
development expense increased from 54% in 2001 to 101% in 2002. The dollar
increase in research and development spending was primarily due to the following
factors:
(i) spending in 2002 includes the full year effect of a number of new
engineers hired in 2001. Spending in 2001 only reflects that
portion of the year that these employees were employed by us;
(ii) as the number of customer projects decreased over the past year, we
shifted engineers who were working on these projects to internal
research and development projects; and
(iii) we incurred additional research and development spending in 2002 to
design and manufacture an ADSL/ADSL2 chip that we have named
StratiPHY.
Our research and development spending is principally focused on projects related
to core ADSL technology, including our StratiPHY chip, as well as for Dr. DSL,
G.SHDSL, wireless local area network communications, and other development
projects.
In October 2002, we terminated 35 employees to reduce our operating costs. Of
the 35 employees who were terminated, 32 were engineers. The cost of severance
and other employee benefits for terminated employees was approximately $700,000.
The cost was recorded in the fourth quarter of 2002, and it approximates our
historical quarterly costs for these employees as if they were active employees.
Therefore, the reduction in force had a minimal effect on research and
development spending in 2002. As of December 31, 2002, accrued severance costs
were approximately $140,000, and are expected to be paid in the first half of
2003.
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In connection with the October reduction in force, we informed remaining
employees that effective January 1, 2003 their salaries would be reduced by 5%
and that senior management's salaries would be reduced by 10%. We anticipate
that the reduction in force and salary reductions will lower total 2003
engineering expenses by approximately $3.7 million annually, and will lower
total 2003 company expenses by $4.1 million annually. Total engineering expenses
include cost of contract revenue and research and development expense.
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.
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 2% from $2.9 million
in 2001 to $3.0 million in 2002. As a percentage of total revenue, sales and
marketing expense increased from 16% in 2001 to 21% in 2002. The dollar increase
was primarily due to increased spending on sales staff and higher commissions
for product sales, which was partially offset by lower advertising and tradeshow
expenses.
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.
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 increased 24% from $2.9
million in 2001 to $3.6 million in 2002. As a percentage of total revenue,
general and administrative expense increased from 16% in 2001 to 26% in 2002.
The dollar increase was primarily due to higher provisions for bad debts. In the
fourth quarter of 2002, we increased our allowance for doubtful accounts by $0.7
million for an accounts receivable balance that we considered uncollectible.
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.
INTEREST INCOME
Interest income decreased 61% from $2.3 million in 2001 to $0.9 million in 2002.
The dollar decrease was primarily due to lower interest rates earned on our cash
balances and lower cash balances.
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.
INCOME TAXES
We evaluate, on a quarterly basis, the positive and negative evidence affecting
the realizability of our deferred tax assets. In 2002, we determined that due to
our continuing operating losses in 2001 and 2002 as well as the uncertainty of
the timing of profitability in future periods, we should fully reserve our
deferred tax assets. As a result, we recorded a tax provision of $7.1 million in
2002 to reserve for our remaining deferred tax assets.
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We made no provision for income taxes in 2001 because we had a net loss. In
2000, we determined that based on our expected future profitability at that
time, 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.
At December 31, 2002, we had federal net operating loss carryforwards of
approximately $48.2 million, which begin to expire in 2007, and federal research
and development credit carryforwards of approximately $7.9 million, which begin
to expire in 2003. At December 31, 2002, we also had available state net
operating loss carryforwards of approximately $48.3 million, which begin to
expire in 2003, and state research and development and investment tax credit
carryforwards of approximately $4.0 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 $24.5
million is 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 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, 2002, 2001 and 2000,
we received net proceeds from the issuance of stock under employee stock plans
of $0.2 million, $0.3 million and $7.6 million, respectively. Our operating
activities used net cash of $9.5 million in 2002. Cash used in our operating
activities was primarily the result of operating losses and working capital
requirements. Operating activities provided net cash of $1.2 million and $14.5
million in the years ended December 31, 2001 and 2000, 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 was primarily due to our
profitability in that year.
In the years ended December 31, 2002, 2001, and 2000, we made capital
expenditures of $0.8 million, $1.4 million, and $1.3 million, respectively.
Capital expenditures in all three years primarily consisted of spending on
computer hardware and software, laboratory equipment, and furniture used
principally in engineering activities. We have no material commitments for
capital expenditures.
At December 31, 2002, we had cash, cash equivalents, short-term investments and
investments of $47.1 million. While we can not assure you that we will not
require additional financing, or that such financing will be available to us, we
believe that our cash, cash equivalents, short-term investments and investments
will be sufficient to fund our operations for at least the next twelve months.
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CRITICAL ACCOUNTING POLICIES
We consider certain accounting policies related to revenue recognition, income
taxes and the allowance for doubtful accounts to be critical 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. We also apply the
principles set forth in AICPA Statement of Position No. 97-2, Software Revenue
Recognition, when recognizing compression software revenue. Our revenue
recognition policies are described more fully in Note 2, Summary of Significant
Accounting Policies, in the Notes to our Consolidated Financial Statements
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.
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.
INCOME TAXES. As part of the process of preparing our consolidated financial
statements we are required to estimate our actual 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 and liabilities, 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.
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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, 2002, we had a total of
$38.1 million of deferred tax assets for which we had recorded a full valuation
allowance.
Of the total valuation allowance, approximately $24.5 million 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.
ALLOWANCE FOR DOUBTFUL ACCOUNTS. We make judgments as to our ability to collect
outstanding receivables and provide allowances for receivables when collection
becomes doubtful. Provisions are made based upon a specific review of all
significant outstanding invoices. If the judgments we make to determine the
allowance for doubtful accounts do not reflect the future ability to collect
outstanding receivables, additional provisions for doubtful accounts may be
required.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2002, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 146 ("SFAS 146"), "Accounting for Costs
Associated with Exit or Disposal Activities" ("SFAS 146"). This statement
addresses financial accounting and reporting for costs associated with exit or
disposal activities and supercedes EITF Issue No. 94-3, "Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)" ("EITF 94-3"). SFAS 146
requires that a liability for a cost associated with an exit or disposal
activity be recognized when the liability is incurred. EITF 94-3 allowed for an
exit cost liability to be recognized at the date of an entity's commitment to an
exit plan. SFAS 146 also requires that liabilities recorded in connection with
exit plans be initially measured at fair value. The provisions of SFAS 146 are
effective for exit or disposal activities that are initiated after December 31,
2002, with early adoption encouraged. We do not expect the adoption of SFAS 146
will have a material impact on our financial position or results of operations.
In December 2002, the FASB issued SFAS 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure - An Amendment of SFAS No. 123." SFAS 148
amends SFAS 123, "Accounting for Stock-Based Compensation" to provide
alternative methods of transition for those companies who voluntarily change to
the fair value based method of accounting for stock-based employee compensation.
In addition, this Statement amends the disclosure requirements of SFAS 123 to
require prominent disclosures in both the annual and interim financial
statements about the method of accounting for stock-based employee compensation
and the effect of the method used on reported results. The transition and annual
disclosure provisions of SFAS 148 are effective for fiscal years ending after
December 15, 2002. We have not adopted the fair value method of accounting for
stock-based compensation, and will continue to apply APB 25 for our stock-based
compensation plans. We have adopted the disclosure requirements of SFAS 148 in
this Form 10-K, which is included in the "Summary of Significant Accounting
Policies" footnote of our consolidated financial statements.
In November 2002, the FASB issued FASB Interpretation No. 45 ("FIN 45"),
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others." This interpretation elaborates
on the disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it has issued. It
also clarifies that a guarantor is required to recognize, at the inception of a
guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. This interpretation does not prescribe a specific
approach for subsequently measuring the guarantor's recognized liability over
the term of the related guarantee. This interpretation also incorporates,
without change, the guidance in FASB Interpretation No. 34, "Disclosure of
Indirect Guarantees of Indebtedness of Others," which is being superseded. The
disclosure requirements of this interpretation are effective for interim and
annual periods ending after December 15, 2002. Recognition and measurement
provisions of FIN 45 become effective for
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guarantees issued or modified on or after January 1, 2003. We are currently
assessing the impact of adopting the recognition and initial measurement
provisions of this new interpretation.
In November 2002, the EITF issued No. 00-21, "Accounting for Revenue
Arrangements with Multiple Deliverables." EITF Issue No. 00-21 addresses certain
aspects of the accounting by a vendor for arrangements under which it will
perform multiple revenue-generating activities. EITF Issue No. 00-21 establishes
three principles: revenue should be recognized separately for separate units of
accounting, revenue for a separate unit of accounting should be recognized only
when the arrangement consideration is reliably measurable and the earnings
process is substantially complete, and consideration should be allocated among
the separate units of accounting in an arrangement based on their relative fair
values. EITF Issue No. 00-21 is effective for all revenue arrangements entered
into in fiscal periods beginning after June 15, 2003, with early adoption
permitted. We are currently determining the impact, if any, EITF Issue No. 00-21
will have on our financial position and results of operations.
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, or by the termination of a contract. 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;
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|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;
|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 EXPERIENCED NET LOSSES. We had net losses in 2002 and 2001. We expect
that we will have a net loss during the first quarter of 2003. We may continue
to experience losses in the future if:
|X| the semiconductor and telecommunications markets do not recover from
the downturn that began in 2001;
|X| our existing customers do not increase their revenues from sales of
chipsets with our technology; or
|X| new and existing customers do not choose to license our intellectual
property for new chipset products.
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
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|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.
THERE HAS BEEN AND MAY CONTINUE TO BE AN OVERSUPPLY OF ADSL CHIPSETS, WHICH HAS
CAUSED OUR ROYALTY REVENUE TO DECLINE. The royalties we receive are influenced
by many of the risks faced by the ADSL market in general; including reduced
average selling prices ("ASPs") for ADSL chipsets during periods of surplus.
Since late 2000, the ADSL industry has experienced an oversupply of ADSL
chipsets and central office equipment. Excessive inventory levels led to soft
chipset demand, which in turn led to declining ASPs. As a result of the soft
demand and declining ASPs for ADSL chipsets, our royalty revenue has decreased
substantially from the levels we achieved in 2000. Price decreases for ADSL
chipsets, and the corresponding decreases in per unit royalties received by us,
can be sudden and dramatic. Pricing pressures may continue during the first
quarter of 2003 and beyond. Our royalty revenue may continue to decline.
WE DEPEND SUBSTANTIALLY UPON A LIMITED NUMBER OF LICENSEES. There is a
relatively limited number of semiconductor and equipment companies to which we
can license our broadband technology in a manner consistent 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 are less certain than we have been in the past
that one of our large customers, Intel, will field ADSL products based upon
licensed technology from Aware. Over the course of 2002, our confidence that
Intel will be a large source of revenue for us in the near future has
diminished. In addition, our prospective customers may use their superior size
and bargaining power to demand license terms that are unfavorable to us and
prospective customers may not elect to license from us.
WE DERIVE A SIGNIFICANT AMOUNT OF REVENUE FROM ONE CUSTOMER. In 2001 and 2002,
we derived 52% and 32%, 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. Our royalty 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' decisions whether to purchase integrated circuits that
incorporates our technology is limited.
20
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, their products may not 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.
If telephone companies do not install ADSL service in significant volumes, or if
telephone companies install ADSL service based on other technology, our business
will be seriously harmed.
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, the steps we have taken may be inadequate 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, our competitors may 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.
21
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 patent, copyright
and other intellectual property rights to technologies that are important to our
business. In the past, we have received claims from other companies that our
technology infringes their patent rights. Intellectual property rights can be
uncertain and can involve complex legal and factual questions. We may infringe
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, 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.
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 ADSL
and wireless local area networking.
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
Broadcom, Centillium, Conexant, GlobespanVirata, ST, 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
22
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. These
alternative broadband technologies may be more successful than ADSL and we may
not be able to participate in the markets involving these alternative
technologies.
Many of our current and prospective ADSL licensees, as well as chipset
competitors that compete with our semiconductor licensees, including Broadcom,
Conexant, GlobespanVirata, ST, and TI have significantly greater financial,
technological, manufacturing, marketing and personnel resources than we do. We
may be unable to compete successfully, and competitive pressures could seriously
harm our business.
OUR RECENT REDUCTION IN WORKFORCE MAY ADVERSELY AFFECT THE MORALE AND
PERFORMANCE OF OUR PERSONNEL, OUR ABILITY TO HIRE NEW PERSONNEL AND OUR
OPERATIONS. In October 2002, as part of an effort to reduce operating expenses,
we terminated 35 employees, which constituted approximately 22 percent of our
workforce. As a result of that workforce reduction, we have incurred costs
related to severance and other employee-related costs. Our workforce reduction
may also subject us to litigation risks and expenses. In addition, our
restructuring plan may yield unanticipated consequences, such as attrition
beyond our planned reduction in workforce. As a result of these reductions, our
ability to respond to unexpected challenges may be impaired, and we may be
unable to take advantage of new opportunities. Further, the reduction in force
may reduce employee morale and may create concern among existing employees about
job security, which may lead to increased attrition or turnover. As a result of
these factors, our remaining personnel may decide to seek employment with more
established companies, and we may have difficulty attracting new personnel that
we might wish to hire in the future.
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
23
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.
ITEM 7A. 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, 2002, we had invested $33.3 million in cash, cash
equivalents and short-term investments that matured in twelve months or less.
Due to the short duration of these financial instruments, we do not expect that
an increase in interest rates would result in any material loss to our
investment portfolio.
As of December 31, 2002, we had invested $13.8 million in long-term investments
that matured in one to three years. These long-term securities are invested in
high quality corporate securities and U.S. government securities. Despite the
high quality of these securities, they may be subject to interest rate risk.
This means that if interest rates increase, the principal amount of our
investment would probably decline. A large increase in interest rates may cause
a material loss to our long-term investments. The following table (dollars in
thousands) presents hypothetical changes in the fair value of our long-term
investments at December 31, 2002. The modeling technique measures the change in
fair value arising from selected potential changes in interest rates. Movements
in interest rates of plus or minus 50 basis points (BP) and 100 BP reflect
immediate hypothetical shifts in the fair value of these investments.
VALUATION OF SECURITIES VALUATION OF SECURITIES
GIVEN AN INTEREST RATE GIVEN AN INTEREST RATE
DECREASE OF NO CHANGE INCREASE OF
------------------------- IN INTEREST -------------------------
Type of security (100BP) (50 BP) RATES 100 BP 50 BP
- ---------------------------------------------------------------------------------------------------------------
Long-term investments with
maturities of one to three years $14,037 $13,926 $13,816 $13,599 $13,707
24
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..................................................... 26
Consolidated Balance Sheets as of December 31, 2002 and 2001.......................... 27
Consolidated Statements of Operations for each of the three
years in the period ended December 31, 2002....................................... 28
Consolidated Statements of Cash Flows for each of the
three years in the period ended December 31, 2002................................ 29
Consolidated Statements of Stockholders' Equity for each of
the three years in the period ended December 31, 2002........................... 30
Notes to Consolidated Financial Statements........................................... 31
FINANCIAL STATEMENT SCHEDULE:
Page
----
Schedule II - Valuation and Qualifying Accounts....................................... 42
25
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, 2002 and 2001, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2002 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
February 4, 2003, except for the
information described in the last
paragraph of Note 6, for which
the date is March 3, 2003
26
AWARE, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
DECEMBER 31,
-----------------------------------
2002 2001
---------------- ---------------
ASSETS
Current assets:
Cash and cash equivalents............................................. $25,268 $36,056
Short-term investments................................................ 8,034 21,228
Accounts receivable (less allowance for doubtful......................
accounts of $1,077 in 2002 and $380 in 2001) 1,258 1,383
Inventories........................................................... 50 282
Deferred tax assets................................................... - 1,811
Prepaid expenses and other current assets............................. 530 795
---------------- ---------------
Total current assets............................................ 35,140 61,555
---------------- ---------------
Property and equipment, net................................................ 10,038 10,937
Deferred tax assets........................................................ - 5,282
Investments................................................................ 13,816 -
Other assets, net.......................................................... 243 329
---------------- ---------------
Total assets.................................................... $59,237 $78,103
================ ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable...................................................... $274 $353
Accrued expenses...................................................... 213 521
Accrued compensation.................................................. 965 948
Accrued professional.................................................. 65 125
Deferred revenue...................................................... 142 -
---------------- ---------------
Total current liabilities..................................... 1,659 1,947
---------------- ---------------
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; shares authorized,
70,000,000 in 2002 and 30,000,000 in 2001; issued
and outstanding, 22,698,171 in 2002 and 22,657,741 in 2001.... 227 227
Additional paid-in capital........................................... 77,301 77,151
Retained earnings (accumulated deficit).............................. (19,950) (1,222)
---------------- ---------------
Total stockholders' equity.................................... 57,578 76,156
---------------- ---------------
Total liabilities and stockholders' equity.................... $59,237 $78,103
================ ===============
The accompanying notes are an integral part of the financial statements.
27
AWARE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
YEARS ENDED DECEMBER 31,
-----------------------------------------------
2002 2001 2000
-----------------------------------------------
Revenue:
Product sales....................................... $4,530 $3,817 $4,655
Contract revenue.................................... 6,797 8,253 12,152
Royalties........................................... 2,517 6,477 13,860
-----------------------------------------------
Total revenue................................... 13,844 18,547 30,667
-----------------------------------------------
Costs and expenses:
Cost of product sales............................... 955 629 831
Cost of contract revenue............................ 4,889 6,822 8,800
Research and development............................ 13,956 10,104 5,915
Selling and marketing............................... 2,966 2,916 2,533
General and administrative.......................... 3,607 2,899 3,098
-----------------------------------------------
Total costs and expenses....................... 26,373 23,370 21,177
-----------------------------------------------
Income (loss) from operations........................... (12,529) (4,823) 9,490
Interest income......................................... 894 2,303 2,826
-----------------------------------------------
Income (loss) before benefit from (provision for) income
taxes and cumulative effect of change in accounting
principle............................................ (11,635) (2,520) 12,316
Benefit from (provision for) income taxes............... (7,093) - 2,716
-----------------------------------------------
Income (loss) before cumulative effect of change in
accounting principle................................. (18,728) (2,520) 15,032
Cumulative effect of change in accounting
principle (Note 2)................................... - - (1,618)
-----------------------------------------------
Net income (loss)....................................... ($18,728) ($2,520) $13,414
===============================================
Basic net income (loss) per share:
Income (loss) before cumulative effect of change in
accounting principle............................. ($0.83) ($0.11) $0.67
Cumulative effect of change in accounting principle . - - ($0.07)
-----------------------------------------------
Net income (loss) per share.......................... ($0.83) ($0.11) $0.60
===============================================
Diluted net income (loss) per share:
Income (loss) before cumulative effect of change in
accounting principle............................. ($0.83) ($0.11) $0.63
Cumulative effect of change in accounting principle.. - - ($0.07)
-----------------------------------------------
Net income (loss) per share.......................... ($0.83) ($0.11) $0.56
===============================================
Weighted average shares - basic......................... 22,679 22,631 22,454
Weighted average shares - diluted....................... 22,679 22,631 23,807
The accompanying notes are an integral part of the financial statements.
28
AWARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEARS ENDED DECEMBER 31,
--------------------------------------------------
2002 2001 2000
--------------------------------------------------
Cash flows from operating activities:
Net income (loss)......................................... ($18,728) ($2,520) $13,414
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization.......................... 1,844 1,720 1,738
Provision for doubtful accounts....................... 707 25 325
Increase (decrease) from changes in assets and
liabilities:
Accounts receivable.................................... (582) 3,792 181
Inventories............................................ 232 (115) (45)
Deferred tax assets.................................... 7,093 - (2,716)
Prepaid expenses and other current assets.............. 265 (495) (31)
Accounts payable....................................... (79) (130) (305)
Accrued expenses....................................... (351) 429 439
Deferred revenue....................................... 142 (1,469) 1,469
--------------------------------------------------
Net cash provided by (used in) operating activities (9,457) 1,237 14,469
--------------------------------------------------
Cash flows from investing activities:
Purchases of property and equipment...................... (807) (1,424) (1,305)
Other assets............................................. (52) (375) 500
Net sales (purchases) of short-term investments.......... 13,194 (15,387) (4,824)
Net purchases of investments............................. (13,816) - -
--------------------------------------------------
Net cash used in investing activities............. (1,481) (17,186) (5,629)
--------------------------------------------------
Cash flows from financing activities:
Proceeds from issuance of common stock .................. 150 343 7,574
--------------------------------------------------
Net cash provided by financing activities......... 150 343 7,574
--------------------------------------------------
Increase (decrease) in cash and cash equivalents............. (10,788) (15,606) 16,414
Cash and cash equivalents, beginning of year................. 36,056 51,662 35,248
--------------------------------------------------
Cash and cash equivalents, end of year ...................... $25,268 $36,056 $51,662
==================================================
The accompanying notes are an integral part of the financial statements.
29
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, 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
Exercise of common stock options ..... 10 - 63 63
Issuance of common stock under
employee stock purchase plan....... 30 - 87 87
Net loss.............................. (18,728) (18,728)
------------ ------------- ------------- ------------- -------------
Balance at December 31, 2002.............. 22,698 $227 $77,301 ($19,950) $57,578
============ ============= ============= ============= =============
The accompanying notes are an integral part of the financial statements.
30
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.
INVESTMENTS - At December 31, 2002 and 2001, 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, 2002 and 2001,
unrealized gains and losses were not material.
The amortized cost of securities, which approximates fair value, consists
of the following at December 31, 2002 and 2001 (in thousands):
Short-term Investments 2002 2001
---------------------- ------------ ------------
Corporate debt securities.......... $3,185 $6,869
U.S. agency securities............. 4,849 14,359
------------ ------------
Total............................ $8,034 $21,228
============ ============
Investments 2002 2001
----------- ------------ ------------
Corporate debt securities.......... $1,030 -
U.S. agency securities............. 12,786 -
------------ ------------
Total............................ $13,816 -
============ ============
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 $707,000, $25,000, and
$325,000 for 2002, 2001, and 2000, respectively.
INVENTORIES - Inventories are stated at the lower of cost or market with
cost being determined by the first-in, first-out ("FIFO") method.
31
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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
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, 2002.
REVENUE RECOGNITION. Effective January 1, 2000, we adopted Securities and
Exchange Commission Staff Accounting Bulletin No. 101, Revenue Recognition
in Financial Statements ("SAB 101"). Accordingly, our general revenue
recognition policy is to 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.
We derive our revenue from three sources (i) product revenue, which
includes revenue from the sale of ADSL equipment products 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. In addition to
the general revenue recognition principles prescribed by SAB 101, our
specific revenue recognition policies for each revenue source are more
fully described below.
PRODUCT SALES. Product sales consist primarily of revenue from the sale of:
(i) hardware products, and (ii) compression software.
o Hardware products, including ADSL transceiver modules and test
and development systems are standalone products that are sold
independently of our technology licensing business. The terms of
sales generally do not contain provisions that obligate us to
provide additional products or services after shipment.
Additionally, we do not grant return rights other than normal
warranty rights of return. We recognize revenue: (i) upon
shipment when products are shipped FOB shipping point, and (ii)
upon delivery at the customer's location when products are
shipped FOB destination.
o Compression software consists of standard off-the-shelf software
products that are sold to OEM customers that integrate our
software into their equipment-based products. The terms of sale
generally do not contain provisions that obligate us to provide
additional products or services after shipment, other than
technical telephone support for a brief period of time post sale.
The cost of providing technical support is inconsequential
because of the limited scope of the support. Additionally, we do
not grant return rights other than normal warranty rights of
return, and we generally do not customize software for customers.
Occasionally, we sell maintenance contracts that entitle
customers to product updates.
We recognize compression software revenue by applying the
principles set forth in SAB 101 and American Institute of
Certified Public Accountants ("AICPA") Statement of Position No.
97-2, Software Revenue Recognition. Accordingly, we recognize
revenue for software licenses: (i) upon shipment when products
are shipped FOB shipping point, and (ii) upon delivery at the
customer's
32
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
location when products are shipped FOB destination. We recognize
revenue for maintenance contracts ratably over the related
contract period.
CONTRACT REVENUE. We enter into nonexclusive technology licensing
agreements with semiconductor licensees that contain terms and conditions
that have historically varied by licensee. Such agreements generally
require us to provide: (i) intellectual property, which consists primarily
of integrated circuit designs; (ii) engineering services; and (iii) the
right to incorporate our intellectual property components and patented
technology into our customers' products. Generally our licensing agreements
include one or more of the following elements of financial consideration to
us: (i) technology license fees; (ii) engineering service fees, and (iii)
royalty payments. We classify license and engineering service fees received
under licensing agreements as contract revenue.
Technology license fees and engineering service fees are paid during
product development and royalties are paid once customers begin shipping
products that incorporate our technology. License fees are typically
payable on an upfront basis or in lump sums at various points during a
development project. Engineering services fees are typically paid on a more
uniform basis throughout the project to reflect the level of engineering
services being performed. In addition, customers may engage us to provide
on-going engineering services or support after a project has been
completed.
Revenue recognition for contract revenue is based on whether a licensing
agreement contains a single element of either license fees or engineering
service fees, or whether a licensing agreement contains multiple elements
of both license fees and engineering service fees. Our revenue recognition
policy for each type of licensing agreement is described as follows:
SINGLE ELEMENT LICENSING AGREEMENTS. To the extent that the single
element contained in a licensing agreement is for technology only,
then technology license fees are recognized as revenue when technology
transfers have been effected and no contingent factors are present. To
the extent that the single element contained in a licensing agreement
is for engineering services only, then 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.
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. Based on our
multiple element licensing agreements, we believe that the
straight-line method represents the appropriate systematic method for
revenue recognition.
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
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.
33
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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, 2002, 2001 and 2000, 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, 2002 and 2001, we had cash
and investments, in excess of federally insured deposit limits of
approximately $47.0 million and $57.2 million, respectively.
Concentration of credit risk with respect to net accounts receivable
consists of $0.6 million, $0.4 million, and $0.2 million with three
customers at December 31, 2002 and $0.7 million, $0.3 million, $0.2
million, and $0.1 million with four customers at December 31, 2001.
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.
At December 31, 2002, we have four stock-based employee compensation plans,
which are described more fully in Note 6. No stock-based employee
compensation cost is reflected in net income, as all options granted under
those plans had an exercise price equal to the fair market value of the
underlying common stock on the date of grant. The following table
illustrates the pro forma effect on net income (loss) and earnings per
share if we had applied the fair value recognition provisions of SFAS No.
123 and SFAS No. 148 to stock-based employee compensation (in thousands,
except per share data):
Year ended December 31,
----------------------------------------------------
2002 2001 2000
----------------- ---------------- -----------------
Net income (loss) - as reported........................ ($18,728) ($2,520) $13,414
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards....................................... 21,207 25,253 17,247
----------------- ---------------- -----------------
Net loss - pro forma................................... ($39,935) ($27,773) ($3,833)
Basic earnings (loss) per share - as reported.......... ($0.83) ($0.11) $0.60
Basic earnings (loss) per share - pro forma............ ($1.76) ($1.23) ($0.17)
Diluted earnings (loss) per share - as reported........ ($0.83) ($0.11) $0.56
Diluted earnings (loss) per share - pro forma.......... ($1.76) ($1.23) ($0.17)
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,
------------------------------------------------------
2002 2001 2000
--------------- --------------- ---------------
Average risk-free interest rate............. 3.82% 4.55% 6.15%
Expected life of option grants.............. 5 years 5 years 5 years
Expected volatility of underlying stock..... 99% 104% 106%
Expected dividend yield..................... - - -
34
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 (LOSS) - Comprehensive income (loss) 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
foreign currency translation adjustments and unrealized gains and losses on
marketable securities. For the years ended December 31, 2002, 2001 and
2000, comprehensive income (loss) was not materially different from net
income (loss).
RECENT ACCOUNTING PRONOUNCEMENTS - In June 2002, the FASB issued SFAS No.
146, "Accounting for Costs Associated with Exit or Disposal Activities"
("SFAS 146"). This statement addresses financial accounting and reporting
for costs associated with exit or disposal activities and supercedes EITF
Issue No. 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs
Incurred in a Restructuring)" ("EITF 94-3"). SFAS 146 requires that a
liability for a cost associated with an exit or disposal activity be
recognized when the liability is incurred. EITF 94-3 allowed for an exit
cost liability to be recognized at the date of an entity's commitment to an
exit plan. SFAS 146 also requires that liabilities recorded in connection
with exit plans be initially measured at fair value. The provisions of SFAS
146 are effective for exit or disposal activities that are initiated after
December 31, 2002, with early adoption encouraged. We do not expect the
adoption of SFAS 146 will have a material impact on our financial position
or results of operations.
In December 2002, the FASB issued SFAS 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure - An Amendment of SFAS No. 123."
SFAS 148 amends SFAS 123, "Accounting for Stock-Based Compensation" to
provide alternative methods of transition for those companies who
voluntarily change to the fair value based method of accounting for
stock-based employee compensation. In addition, this Statement amends the
disclosure requirements of SFAS 123 to require prominent disclosures in
both the annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the
method used on reported results. The transition and annual disclosure
provisions of SFAS 148 are effective for fiscal years ending after December
15, 2002. We have not adopted the fair value method of accounting for
stock-based compensation, and will continue to apply APB 25 for our
stock-based compensation plans. We have adopted the disclosure requirements
of SFAS 148 in this Form 10-K, which is included in the "Summary of
Significant Accounting Policies" footnote of our consolidated financial
statements.
In November 2002, the FASB issued FASB Interpretation No. 45 ("FIN 45"),
"Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others." This
interpretation elaborates on the disclosures to be made by a guarantor in
its interim and annual financial statements about its obligations under
certain guarantees that it has issued. It also clarifies that a guarantor
is required to recognize, at the inception of a guarantee, a liability for
the fair value of the obligation undertaken
35
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
in issuing the guarantee. This interpretation does not prescribe a specific
approach for subsequently measuring the guarantor's recognized liability
over the term of the related guarantee. This interpretation also
incorporates, without change, the guidance in FASB Interpretation No. 34,
"Disclosure of Indirect Guarantees of Indebtedness of Others," which is
being superseded. The disclosure requirements of this interpretation are
effective for interim and annual periods ending after December 15, 2002.
Recognition and measurement provisions of FIN 45 become effective for
guarantees issued or modified on or after January 1, 2003. We are currently
assessing the impact of adopting the recognition and initial measurement
provisions of this new interpretation.
In November 2002, the EITF issued No. 00-21, "Accounting for Revenue
Arrangements with Multiple Deliverables." EITF Issue No. 00-21 addresses
certain aspects of the accounting by a vendor for arrangements under which
it will perform multiple revenue-generating activities. EITF Issue No.
00-21 establishes three principles: revenue should be recognized separately
for separate units of accounting, revenue for a separate unit of accounting
should be recognized only when the arrangement consideration is reliably
measurable and the earnings process is substantially complete, and
consideration should be allocated among the separate units of accounting in
an arrangement based on their relative fair values. EITF Issue No. 00-21 is
effective for all revenue arrangements entered into in fiscal periods
beginning after June 15, 2003, with early adoption permitted. We are
currently determining the impact, if any, EITF Issue No. 00-21 will have on
our financial position and results of operations.
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):
2002 2001
--------------- --------------
Raw materials.................... $46 $146
Finished goods................... 4 136
--------------- --------------
Total........................ $50 $282
=============== ==============
4. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following at December 31 (in
thousands):
2002 2001
--------------- ----------------
Land............................................... $1,080 $1,080
Building and improvements.......................... 8,784 8,757
Computer equipment................................. 5,568 5,272
Purchased software................................. 2,818 2,343
Furniture and fixtures............................. 928 923
Office equipment................................... 346 342
Manufacturing equipment............................ 268 268
--------------- ----------------
Total........................................... 19,792 18,985
Less accumulated depreciation and amortization..... (9,754) (8,048)
--------------- ----------------
Property and equipment, net..................... $10,038 $10,937
=============== ================
Depreciation expense amounted to $1.7 million in each of the years ended
December 31, 2002, 2001, and 2000, respectively.
36
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. INCOME TAXES
Deferred tax assets are attributable to the following at December 31 (in
thousands):
2002 2001
-------------- --------------
Federal net operating loss carryforwards........................ $16,370 $19,073
Research and development and other tax credit carryforwards..... 10,533 10,575
State net operating loss carryforwards.......................... 3,042 3,385
Capitalized research and development costs...................... 6,932 -
Other .......................................................... 1,228 791
-------------- --------------
Total........................................................ 38,105 33,824
Less valuation allowance........................................ (38,105) (26,731)
-------------- --------------
Deferred tax assets, net..................................... $ - $ 7,093
============== ==============
A reconciliation of the U.S. federal statutory rate to the effective tax
rate is as follows:
Year ended December 31,
-----------------------------------------------
2002 2001 2000
------------- ------------ -------------
Federal statutory rate..................................... (34%) (34%) 34%
State rate, net of federal benefit......................... (6) (6) 6
Tax credits................................................ (14) (60) (9)
Change in valuation allowance.............................. 111 100 (58)
Other 4 - 5
------------- ------------ -------------
Effective tax rate...................................... 61% -% (22)%
============= ============ =============
We have evaluated the positive and negative evidence affecting the
realizability of our deferred tax assets. As of December 31, 2002, based on
the weight of the available evidence, we determined that it is more likely
than not that all of our deferred tax assets will not be realized, and
fully reserved our deferred tax assets. 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, 2002, we had federal net operating loss carryforwards of
approximately $48.2 million, which begin to expire in 2007, and federal
research and development credit carryforwards of approximately $7.9
million, which begin to expire in 2003. At December 31, 2002, we also had
available state net operating loss carryforwards of approximately $48.3
million, which begin to expire in 2003, and state research and development
and investment tax credit carryforwards of approximately $4.0 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
$24.5 million is 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, 2002, we have four stock-based compensation plans, which
are described below.
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 8,000,000 shares of
37
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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,
2002, there were 4,573,925 shares available for grant under the 2001 Plan,
678,740 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, 2002, 2001, and 2000 are presented below:
2002 2001 2000
-------------------------- --------------------------- -------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
-------------------------- --------------------------- -------------------------
Outstanding at beginning of year... 6,268,208 $20.63 4,083,683 $29.52 3,538,687 $22.05
Granted............................ 1,521,100 3.50 2,407,423 6.42 1,631,350 37.86
Exercised.......................... (9,736) 6.48 (23,731) 7.60 (680,413) 10.89
Forfeited or cancelled............. (937,026) 16.00 (199,167) 32.73 (405,941) 29.10
-------------------------- --------------------------- -------------------------
Outstanding at end of year......... 6,842,546 $17.47 6,268,208 $20.63 4,083,683 $29.52
========================== =========================== =========================
Options exercisable at year end.... 4,265,956 $21.01 3,358,403 $21.28 1,711,351 $23.79
The weighted average grant date fair values of options granted during the
years ended December 31, 2002, 2001 and 2000 were $2.65, $5.01 and $30.30,
respectively.
The following table summarizes information about stock options outstanding
at December 31, 2002:
Options Outstanding Options Exercisable
----------------------------------------------------------- -------------------------------------
Number Weighted-Avg. Number
Range of Outstanding at Remaining Weighted-Avg. Exercisable Weighted-Avg.
Exercise Prices 12/31/02 Contractual Life Exercise Price At 12/31/02 Exercise Price
--------------- ----------------------------------------------------------- -------------------------------------
$0 to 10.......... 3,714,944 8.6 years $5.26 1,687,331 $6.48
10 to 20.......... 737,432 4.9 $11.81 725,941 $11.82
20 to 30.......... 609,730 6.7 $23.73 503,955 $24.43
30 to 40.......... 512,350 7.0 $31.97 393,631 $31.96
40 to 50.......... 1,258,090 6.9 $47.55 946,348 $47.26
50 to 70.......... 10,000 6.8 $58.06 8,750 $57.36
----------------------------------------------------------- -------------------------------------
6,842,546 7.6 $17.47 4,265,956 $21.01
=========================================================== =====================================
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, 2002
there were 20,303 shares available for future issuance under the ESPP Plan.
We issued 30,694, 27,733 and 7,808 common shares under the ESPP Plan in
2002, 2001 and 2000, 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
38
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
EMPLOYEE STOCK OPTION EXCHANGE PROGRAM - On March 3, 2003, we commenced an
offer to exchange outstanding stock options with eligible employees. Under
the terms of the program, eligible employees have the right to tender for
cancellation all stock options that they hold with an exercise price above
$3.00 per share. Employees electing to participate must tender all such
outstanding stock options held by them by the end of the day on April 1,
2003. In return, employees will receive replacement stock options that will
be granted between October 2, 2003 and November 13, 2003. Employees will
receive replacement options based on a formula that allows them to purchase
one share of common stock for every two option shares surrendered by them.
Replacement grants will be priced at the current market value of our stock
on the replacement grant date.
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 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 (in
thousands):
YEAR ENDED DECEMBER 31,
-----------------------
2003..................................... 44
2004..................................... 30
-----------
Total minimum lease payments.......... $74
===========
Rental expense was approximately $44,000, $36,000 and $105,000 in 2002,
2001 and 2000, 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.
GUARANTEES AND INDEMNIFICATION OBLIGATIONS - We enter into licensing
agreements in the ordinary course of business that requires us: i)to
perform under the terms of the contracts, ii) to protect the
confidentiality of our customers' intellectual property, and iii) to
indemnify customers, including indemnification against third party claims
alleging infringement of intellectual property rights. We also have
agreements with each of our directors and executive officers to indemnify
such directors or executive officers, to the extent legally permissable,
against all liabilities reasonably incurred in connection with any action
in which such individual may be involved by reason of such individual being
or having been a director or officer of Aware.
Given the nature of the above obligations and agreements, we are unable to
make a reasonable estimate of the maximum potential amount that we could be
required to pay. Historically, we have not made any significant payments on
the above guarantees and indemnifications and no amount has been accrued in
the accompanying consolidated financial statements with respect to these
guarantees and indemnifications.
39
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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,
----------------------------------------------------
2002 2001 2000
--------------- -------------- --------------
United States................................... $11,045 $17,092 $26,606
Europe.......................................... 2,438 717 2,231
Asia/Pacific.................................... 225 627 1,567
Rest of world................................... 136 111 263
--------------- -------------- --------------
$13,844 $18,547 $30,667
=============== ============== ==============
The portion of total revenue that was derived from major customers was as
follows:
Year ended December 31,
----------------------------------------------------
2002 2001 2000
--------------- -------------- --------------
Customer A................................. 32% 52% 51%
Customer B................................... 15% 14% 9%
Customer C................................ 12% 2% 7%
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 $340,000, $313,000 and $166,000
in 2002, 2001 and 2000, 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,
-----------------------------------------------------
2002 2001 2000
------------- --------------- ----------------
Net income (loss)................................... ($18,728) ($2,520) $13,414
Weighted average common shares outstanding........ 22,679 22,631 22,454
Additional dilutive common stock equivalents ..... - - 1,353
------------- --------------- ----------------
Diluted shares outstanding ....................... 22,679 22,631 23,807
============= =============== ================
Net income (loss) per share - basic................. ($0.83) ($0.11) $0.60
Net income (loss) per share - diluted............... ($0.83) ($0.11) $0.56
For the year ended December 31, 2002 and 2001, potential common stock
equivalents of 226,303 and 285,427, respectively, 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, 2002, 2001 and 2000, options to purchase 4,770,052, 3,488,215
and 1,508,194 shares of common stock at average weighted prices of $23.54,
$31.95 and $47.53 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.
40
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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, 2002 (in
thousands, except per share data):
2002 Quarters Ended
-----------------------------------------------------------------
March 31 June 30 September 30 December 31
-----------------------------------------------------------------
Revenue................................. $3,576 $4,012 $3,953 $2,303
Loss from operations.................... (2,815) (2,362) (2,812) (4,540)
Net loss................................ (2,576) (2,130) (9,681) (4,341)
Net loss per share - basic.............. ($0.11) ($0.09) ($0.43) ($0.19)
Net loss per share - diluted ........... ($0.11) ($0.09) ($0.43) ($0.19)
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)
41
FINANCIAL STATEMENT SCHEDULE
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS - YEARS ENDED DECEMBER 31,2002, 2001, AND 2000
(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:
2002................. $380 $707 - $10 $1,077
2001................. $402 $25 - $47 $380
2000................. $175 $325 - $98 $402
Allowance for sales returns and allowances:
2002................. - - - - -
2001................. $125 - ($125) - -
2000................. $35 - $90 - $125
Inventory reserves:
2002................. $284 - - - $284
2001................. $209 $75 - - $284
2000................. $159 $50 - - $209
42
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, 2003 are as
follows:
NAME AGE POSITION
---- --- --------
Michael A. Tzannes............. 41 Chief Executive Officer and Director
Edmund C. Reiter............... 39 President and Director
Richard P. Moberg.............. 48 Chief Financial Officer and Treasurer
Richard W. Gross............... 45 Senior Vice President - Engineering
John K. Kerr .................. 65 Chairman of the Board of Directors
David Ehreth .................. 53 Director
G. David Forney, Jr. .......... 62 Director
Frederick D. D'Alessio......... 54 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 - engineering 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.
43
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 chairman of Westwave Communications, Inc., a
telecommunications software company. From April 1998 to July 2002, Mr. Ehreth
also served as president and chief executive officer of Westwave. 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.
FREDERICK D. D'ALESSIO has served as a director of Aware since December 2002.
Mr. D'Alessio is currently a general partner at Capitol Management Partners, a
business advisory partnership. Mr. D'Alessio served as president for the
Advanced Services Group for Verizon Communications from July 2000 to November
2001. The Advanced Services Group included Verizon's Long Distance, DSL and
Internet Service Provider Businesses. From December 1998 to June 2000, Mr.
D'Alessio served as group president consumer services for Bell Atlantic
Communications, responsible for all aspects of Residential Services. From April
1995 to November 1998 Mr. D'Alessio served as president-consumer sales and
services for Bell Atlantic. Mr. D'Alessio received a B.S.E.E. and M.S. degree
from New Jersey Institute of Technology and a Masters of Business Administration
from Rutgers 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 29, 2003 Annual Meeting of
Shareholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
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 AND RELATED STOCKHOLDER MATTERS" in the
Proxy Statement that will be delivered to our shareholders in connection with
our May 29, 2003 Annual Meeting of Shareholders.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Not applicable.
44
ITEM 14. CONTROLS AND PROCEDURES
(a) DISCLOSURE CONTROLS AND PROCEDURES. Within 90 days before filing this
report, we evaluated the effectiveness of the design and operation of our
disclosure controls and procedures. Our disclosure controls and procedures are
the controls and other procedures that we designed to ensure that we record,
process, summarize and report in a timely manner the information we must
disclose in reports that we file with or submit to the SEC. Our disclosure
controls and procedures include a significant portion of our internal controls.
Michael A. Tzannes, our Chief Executive Officer, and Richard P. Moberg, our Vice
President and Chief Financial Officer, supervised and participated in this
evaluation. Based on this evaluation, Mr. Tzannes and Mr. Moberg concluded that,
as of the date of their evaluation, our disclosure controls and procedures were
effective.
(b) INTERNAL CONTROLS. Since the date of the evaluation described above, there
have not been any significant changes in our internal controls or in other
factors that could significantly affect those controls.
45
PART IV
ITEM 15. 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.
Our chief executive officer and chief financial officer have furnished to
the SEC the certification with respect to this Report that is required by
Section 906 of the Sarbanes-Oxley Act of 2002.
(B) There were no reports on Form 8-K filed during the fourth quarter ended
December 31, 2002.
(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 Articles of Amendment to the Articles of Organization (filed as Exhibit 3.3 to the
Company's Form 10-Q for the quarter ended September 30, 2002 and incorporated herein
by reference).
3.3 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 and Officer Indemnification Agreement.
10.5 2001 Nonqualified Stock Plan (filed as Exhibit 99(d)(4) to the Company's Schedule TO
filed with the Securities and Exchange Commission on March 3, 2003 and incorporated
herein by reference).
21.1 * Subsidiaries of Registrant.
23.1 * Consent of PricewaterhouseCoopers LLP.
99.1 * Certification of Chief Executive Officer pursuant to 18 U.S.C. 1350
99.2 * Certification of Chief Financial Officer pursuant to 18 U.S.C. 1350
* Filed herewith
46
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 26, 2003
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 26th day of March 2003.
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
/s/ Frederick D. D'Alessio Director
- --------------------------------
Frederick D. D'Alessio
47