-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Rtu6T5NnMVhQ4I4+M8PDWkmrH0xvaj7LTIOW93H4OqZQ+BxoyDAEEoD3+7lPgigD WYdl9/d1ecnnss2fqKtTJg== 0001133884-01-500731.txt : 20020410 0001133884-01-500731.hdr.sgml : 20020410 ACCESSION NUMBER: 0001133884-01-500731 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20010930 FILED AS OF DATE: 20011113 FILER: COMPANY DATA: COMPANY CONFORMED NAME: AWARE INC /MA/ CENTRAL INDEX KEY: 0001015739 STANDARD INDUSTRIAL CLASSIFICATION: SEMICONDUCTORS & RELATED DEVICES [3674] IRS NUMBER: 042911026 STATE OF INCORPORATION: MA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-21129 FILM NUMBER: 1782511 BUSINESS ADDRESS: STREET 1: 40 MIDDLESEX TURNPIKE CITY: BEDFORD STATE: MA ZIP: 01730 BUSINESS PHONE: 6172764000 MAIL ADDRESS: STREET 1: 40 MIDDLESEX TURNPIKE CITY: BEDFORD STATE: MA ZIP: 01730 10-Q 1 g10q-26288.txt ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTER ENDED SEPTEMBER 30, 2001 COMMISSION FILE NUMBER 000-21129 AWARE, INC. ------------ (Exact Name of Registrant as Specified in Its Charter) MASSACHUSETTS 04-2911026 ------------- ----------- (State or Other Jurisdiction of (I.R.S. Employer Identification No.) Incorporation or Organization) 40 MIDDLESEX TURNPIKE, BEDFORD, MASSACHUSETTS, 01730 ---------------------------------------------------- (Address of Principal Executive Offices) (Zip Code) (781) 276-4000 -------------- (Registrant's Telephone Number, Including Area Code) Indicate by check whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO ---- ---- Indicate the number of shares outstanding of the issuer's common stock as of October 26, 2001: CLASS NUMBER OF SHARES OUTSTANDING ----- ---------------------------- Common Stock, par value $0.01 per share 22,639,503 shares ================================================================================ AWARE, INC. FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2001 TABLE OF CONTENTS PAGE PART I FINANCIAL INFORMATION Item 1. Consolidated Financial Statements Consolidated Balance Sheets as of September 30, 2001 and December 31, 2000.......................... 3 Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2001 and September 30, 2000............................................ 4 Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2001 and September 30, 2000............................................ 5 Notes to Consolidated Financial Statements........................ 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............................... 9 Item 3. Quantitative and Qualitative Disclosures about Market Risk....................................................... 19 PART II OTHER INFORMATION Item 1. Legal Proceedings................................................. 20 Item 2. Changes in Securities in Use of Proceeds.......................... 20 Item 6. Exhibits and Reports on Form 8-K.................................. 21 Signatures........................................................ 21 2 PART I. FINANCIAL INFORMATION ITEM 1: CONSOLIDATED FINANCIAL STATEMENTS AWARE, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) (UNAUDITED)
SEPTEMBER 30, DECEMBER 31, 2001 2000 ----------------- ---------------- ASSETS Current assets: Cash and cash equivalents................................................ $55,149 $51,662 Short-term investments................................................... 3,020 5,841 Accounts receivable, net................................................. 2,985 5,200 Inventories.............................................................. 367 167 Deferred tax assets...................................................... 7,093 7,093 Prepaid expenses and other assets........................................ 502 300 ----------------- ---------------- Total current assets 69,116 70,263 ----------------- ---------------- Property and equipment, net................................................... 10,983 11,187 Other assets, net............................................................. 160 - ----------------- ---------------- Total assets....................................................... $80,259 $81,450 ================= ================ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable........................................................ $550 $483 Accrued expenses ........................................................ 359 332 Accrued compensation .................................................... 539 664 Accrued professional..................................................... 140 169 Deferred revenue......................................................... 18 1,469 ----------------- ---------------- Total current liabilities........................................ 1,606 3,117 ----------------- ---------------- Stockholders' equity: Preferred stock, $1.00 par value; 1,000,000 shares authorized, none outstanding................................................. - - Common stock, $.01 par value; 30,000,000 shares authorized; issued and outstanding, 22,639,503 in 2001 and 22,606,277 in 2000...... 226 226 Additional paid-in capital.............................................. 77,071 76,809 Retained earnings...................................................... 1,356 1,298 ----------------- ---------------- Total stockholders' equity...................................... 78,653 78,333 ----------------- ---------------- Total liabilities and stockholders' equity....................... $80,259 $81,450 ================= ================
The accompanying notes are an integral part of the financial statements. 3 AWARE, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------------- ------------------------------ 2001 2000 2001 2000 ------------------------------- ------------------------------ Revenue: Product sales....................................... $819 $1,184 $2,959 $3,550 Contract revenue.................................... 1,538 3,021 6,412 9,126 Royalties........................................... 751 3,814 5,972 8,924 ------------------------------- ------------------------------ Total revenue..................................... 3,108 8,019 15,343 21,600 Costs and expenses: Cost of product sales............................... 173 231 447 606 Cost of contract revenue............................ 1,376 2,342 5,516 6,518 Research and development............................ 3,007 1,414 6,917 4,167 Selling and marketing............................... 704 602 2,186 1,942 General and administrative.......................... 722 766 2,172 2,269 ------------------------------- ------------------------------ Total costs and expenses........................... 5,982 5,355 17,238 15,502 Income (loss) from operations........................... (2,874) 2,664 (1,895) 6,098 Interest income......................................... 522 757 1,953 1,997 ------------------------------- ------------------------------ Income (loss) before benefit for income taxes and cumulative effect of change in accounting principle. (2,352) 3,421 58 8,095 Benefit from income taxes............................... 313 - - - ------------------------------- ------------------------------ Income (loss) before cumulative effect of change in accounting principle................................ (2,039) 3,421 58 8,095 Cumulative effect of change in accounting principle (Note E)............................................ - - - (1,618) ------------------------------- ------------------------------ Net income (loss)....................................... ($2,039) $3,421 $58 $6,477 =============================== ============================== Basic income per share: Income (loss) before cumulative effect of change in accounting principle.............................. ($0.09) $0.15 $0.00 $0.36 Cumulative effect of change in accounting principle.. - - - ($0.07) ------------------------------- ------------------------------ Net income (loss) per share.......................... ($0.09) $0.15 $0.00 $0.29 =============================== ============================== Diluted income per share: Income (loss) before cumulative effect of change in accounting principle.............................. ($0.09) $0.14 $0.00 $0.34 Cumulative effect of change in accounting principle.. - - - ($0.07) ------------------------------- ------------------------------ Net income (loss) per share.......................... ($0.09) $0.14 $0.00 $0.27 =============================== ============================== Weighted average shares - basic......................... 22,639 22,529 22,621 22,412 Weighted average shares - diluted....................... 22,639 23,957 22,876 23,879
The accompanying notes are an integral part of the financial statements. 4 AWARE, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, ------------------------------------ 2001 2000 ---------------- ---------------- Cash flows from operating activities: Net income.................................................... $58 $6,477 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization................................ 1,249 1,345 Increase (decrease) from changes in assets and liabilities: Accounts receivable..................................... 2,215 (421) Inventories............................................. (200) (91) Prepaid expenses........................................ (202) (104) Accounts payable........................................ 67 (143) Accrued expenses........................................ (127) 72 Deferred revenue........................................ (1,451) 1,728 ---------------- ---------------- Net cash provided by operating activities............ 1,609 8,863 ---------------- ---------------- Cash flows from investing activities: Purchases of property and equipment.......................... (1,030) (963) Other assets................................................. (175) 500 Net sales of short-term investments.......................... 2,821 (2,554) ---------------- ---------------- Net cash (used in) provided by investing activities.. 1,616 (3,017) ---------------- ---------------- Cash flows from financing activities: Proceeds from issuance of common stock...................... 262 7,017 ---------------- ---------------- Net cash provided by financing activities............ 262 7,017 ---------------- ---------------- Increase in cash and cash equivalents............................ 3,487 12,863 Cash and cash equivalents, beginning of period................... 51,662 35,248 ---------------- ---------------- Cash and cash equivalents, end of period......................... $55,149 $48,111 ================ ================
The accompanying notes are an integral part of the financial statements. 5 AWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) A) BASIS OF PRESENTATION The accompanying unaudited consolidated balance sheets, statements of operations, and statements of cash flows reflect all adjustments (consisting only of normal recurring items) which are, in the opinion of management, necessary for a fair presentation of financial position at September 30, 2001, and of operations and cash flows for the interim periods ended September 30, 2001 and 2000. The accompanying unaudited consolidated financial statements have been prepared in accordance with the instructions for Form 10-Q and therefore do not include all information and footnotes necessary for a complete presentation of operations, the financial position, and cash flows of the Company, in conformity with generally accepted accounting principles. The Company filed audited financial statements which included all information and footnotes necessary for such presentation for the three years ended December 31, 2000 in conjunction with its 2000 Annual Report on Form 10-K. The results of operations for the interim period ended September 30, 2001 are not necessarily indicative of the results to be expected for the year. B) INVENTORY Inventory consists primarily of the following (in thousands): SEPTEMBER 30, DECEMBER 31, 2001 2000 --------------- --------------- Raw materials................. $355 $142 Finished goods................ 12 25 --------------- --------------- Total.................. $367 $167 =============== =============== 6 C) COMPUTATION OF EARNINGS PER SHARE Basic earnings per share is computed by dividing net income or loss by the weighted average number of common shares outstanding. Diluted earnings per share is computed by dividing net income or loss 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 anti-dilutive are excluded from the calculation. Net income or loss per share is calculated as follows (in thousands, except per share data):
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, --------------------------- --------------------------- --------------------------- --------------------------- 2001 2000 2001 2000 ------------- ------------- ------------- ------------- Net income (loss)................................. ($2,039) $3,421 $58 $6,477 Weighted average common shares outstanding........ 22,639 22,529 22,621 22,412 Additional dilutive common stock equivalents...... - 1,428 255 1,467 ------------- ------------- ------------- ------------- Diluted shares outstanding ....................... 22,639 23,957 22,876 23,879 ============= ============= ============= ============= Net income (loss) per share - basic............... ($0.09) $0.15 $0.00 $0.29 Net income (loss) per share - diluted............. ($0.09) $0.14 $0.00 $0.27
For the three month period ended September 30, 2001, common stock equivalents were not included in the computation of diluted earnings per share, because the Company had a net loss and the effect of their inclusion would have been anti-dilutive. Anti-dilutive common stock equivalents not included in per share calculations for the three months ended September 30, 2001 were 65,329. For the three and nine month periods ended September 30, 2001, options to purchase shares of the Company's common stock totaling 5,259,223 and 3,496,090 respectively, were outstanding, but were not included in the computation of diluted earnings per share as the inclusion of these shares would have been anti-dilutive due to the fact that the exercise price was in excess of the fair market value. For the three and nine month periods ended September 30, 2000, options to purchase shares of the Company's common stock totaling 621,935 and 932,309 respectively, were outstanding, but were not included in the computation of diluted earnings per share as the inclusion of these shares would have been anti-dilutive. 7 D) BUSINESS SEGMENTS The Company organizes itself as one segment and conducts its operations in the United States. The Company sells its products and technology to domestic and international customers. Revenues were generated from the following geographic regions (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ---------------------------- ---------------------------- 2001 2000 2001 2000 ------------- ------------- ------------- -------------- United States........................... $2,849 $7,521 $14,507 $18,040 Rest of World........................... 259 498 836 3,560 ------------- ------------- ------------- -------------- $3,108 $8,019 $15,343 $21,600 ============= ============= ============= ==============
E) RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS 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 ("SAB 101"). The cumulative effect of the change on prior years resulted in a charge to income of $1.6 million in the first quarter of 2000. Of this amount, $0.7 million was recognized as revenue in 2000, and $0.9 million was recognized as revenue during the first quarter of 2001. The Company has adjusted its results for the three and nine month periods ended September 30, 2000 to conform with SAB 101. In August 2001, the FASB issued Statement of Financial Accounting Standards No. 144 ("SFAS 144"), "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS 144 supercedes FASB Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long Lived Assets to Be Disposed Of." SFAS 144 applies to all long-lived assets (including discontinued operations) and consequently amends Accounting Principles Board Opinion No. 30, "Reporting Results of Operations - Reporting the Effects of Disposal of a Segment of a Business." SFAS 144 is effective for financial statements issued for fiscal years beginning after December 15, 2001. The Company is currently determining the impact, if any, SFAS 144 will have on its financial position and results of operations. 8 ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 SOME OF THE INFORMATION IN THIS FORM 10-Q 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-Q, 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-Q COULD MATERIALLY AND ADVERSELY AFFECT OUR BUSINESS. RESULTS OF OPERATIONS PRODUCT SALES. Product sales consist primarily of revenue from the sale of digital subscriber line ("DSL") equipment and compression software products. The products that comprise DSL equipment sales are primarily test and development systems and board level products known as modules. Product sales decreased 31% from $1.2 million in the third quarter of 2000 to $819,000 in the current year quarter. As a percentage of total revenue, product sales increased from 15% in the third quarter of 2000 to 26% in the current year quarter. The dollar decrease was primarily due to a decrease in revenue from the sale of test and development systems and lower revenue from the sale of compression software, which was partially offset by an increase in revenue from the sale of modules. DSL test and development system revenue decreased primarily due to a slowdown in capital spending in the telecommunications industry in 2001. Compression software revenue decreased primarily due to lower demand by our OEM customers. Module sales were higher primarily due to sales of modules to a customer that licensed our Dr. DSL(R) technology and designs. For the nine months ended September 30, product sales decreased 17% from $3.6 million in 2000 to $3.0 million in 2001. As a percentage of total revenue, product sales increased from 16% in the first nine months of 2000 to 19% in the corresponding period of 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. DSL test and development system revenue decreased primarily due to a slowdown in capital spending in the telecommunications industry in 2001. 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 asymmetric digital subscriber line ("ADSL") chipsets. 9 Contract revenue decreased 49% from $3.0 million in the third quarter of 2000 to $1.5 million in the current year quarter. As a percentage of total revenue, contract revenue increased from 38% in the third quarter of 2000 to 49% in the current year quarter. For the nine months ended September 30, contract revenue decreased 30% from $9.1 million in 2000 to $6.4 million in 2001. As a percentage of total revenue, contract revenue was 42% for both nine month periods. The dollar decrease, in the three and nine month periods, was primarily due to a reluctance by semiconductor customers to begin new DSL chip projects given current general economic and DSL market conditions. Customers continue to cautiously evaluate new chipset projects, or postpone projects until their business improves or they raise capital. We expect that current market conditions will continue for the remainder of this year and perhaps into 2002. 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 80% from $3.8 million in the third quarter of 2000 to $751,000 in the current year quarter. As a percentage of total revenue, royalties decreased from 48% in the third quarter of 2000 to 24% in the current year quarter. For the nine months ended September 30, royalties decreased 33% from $8.9 million in 2000 to $6.0 million in 2001. As a percentage of total revenue, royalties decreased from 41% in the first nine months of 2000 to 39% in the corresponding period of 2001. For the three and nine month periods, the decrease in royalties was primarily due to a decrease in ADSL chipset sales by Analog Devices, Inc. ("ADI"), which is our largest customer. 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. This imbalance has led to overcapacity at ADSL service providers' central offices, as well as excess chipset inventory at ADSL equipment manufacturers. Because of this, chipset demand as well as pricing was lower during the first nine months of 2001. We expect that lower demand and pricing pressure will continue during the remainder of this year and into early next year as the DSL market attempts to stabilize itself. COST OF PRODUCT SALES. Since the cost of compression software license sales is minimal, cost of product sales consists primarily of the cost of DSL equipment sales. Cost of product sales decreased 25% from $231,000 in the third quarter of 2000 to $173,000 in the current year quarter. As a percentage of product sales, cost of product sales increased from 20% in the third quarter of 2000 to 21% in the current year quarter. For the nine months ended September 30, cost of product sales decreased 26% from $606,000 in 2000 to $447,000 in 2001. As a percentage of product sales, cost of product sales decreased from 17% in the first nine months of 2000 to 15% in the corresponding period of 2001. For the three and nine month periods, the decrease in cost of product sales dollars is primarily due to lower equipment sales and provisions for potentially obsolete or excess inventory. 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. Cost of contract revenue decreased 41% from $2.3 million in the third quarter of 2000 to $1.4 million in the current year quarter. As a percentage of contract revenue, cost of contract revenue increased from 78% in the third quarter of 2000 to 89% in the current year quarter. For the nine months ended September 30, cost of contract revenue decreased 15% from $6.5 million in 2000 to $5.5 million in 2001. As a percentage of contract revenue, cost of contract revenue increased from 71% in the first nine months of 2000 to 86% in the corresponding period of 2001. For the three and nine month 10 periods, the dollar and margin declines were primarily due to fewer customer contracts and a greater proportion of engineering service fees in contract revenue compared to higher margin license fees. 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 telecommunications intellectual property offerings, and our compression software technology. Research and development expense increased by 113% from $1.4 million in the third quarter of 2000 to $3.0 million in the current year quarter. As a percentage of total revenue, research and development expense increased from 18% in the third quarter of 2000 to 97% in the current year quarter. For the nine months ended September 30, research and development expense increased by 66% from $4.2 million in 2000 to $6.9 million in 2001. As a percentage of total revenue, research and development expense increased from 19% in the first nine months of 2000 to 45% in the corresponding period of 2001. For the three and nine month periods, the dollar increase was primarily due to increased spending on non-customer-specific research and development projects, including projects such as voice enabled DSL (VeDSL(TM)), Dr. DSL(R), G.SHDSL, wireless local area network communications, power line communications, as well as other internal 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 17% from $602,000 in the third quarter of 2000 to $704,000 in the current year quarter. As a percentage of total revenue, sales and marketing expense increased from 8% in the third quarter of 2000 to 23% in the current year quarter. For the nine months ended September 30, selling and marketing expense increased 13% from $1.9 million in 2000 to $2.2 million in 2001. As a percentage of total revenue, sales and marketing expense increased from 9% in the first nine months of 2000 to 14% in the corresponding period of 2001. For the three and nine month periods, the dollar increase was primarily due to the addition of sales staff, which was partially offset by lower sales commissions and public relations expenses. GENERAL AND ADMINISTRATIVE EXPENSE. General and administrative expense consists primarily of salaries for administrative personnel, facilities costs, and public company, bad debt, legal, and audit expenses. General and administrative expense decreased 6% from $766,000 in the third quarter of 2000 to $722,000 in the current year quarter. As a percentage of total revenue, general and administrative expense increased from 10% in the third quarter of 2000 to 23% in the current year quarter. For the nine months ended September 30, general and administrative expense decreased 4% from $2.3 million in 2000 to $2.2 million in 2001. As a percentage of revenue, general and administrative expense increased from 11% in the first nine months of 2000 to 14% in the corresponding period of 2001. For the three and nine month periods, the dollar decrease was primarily due to lower provisions for bad debts and public company expenses, which was partially offset by increased spending on administrative staff. INTEREST INCOME. Interest income decreased 31% from $757,000 in the third quarter of 2000 to $522,000 in the current year quarter. For the nine months ended September 30, interest income decreased 2% from $1,997,000 in 2000 to $1,953,000 in 2001. For the three and nine month periods, the dollar decrease is primarily due to lower interest rates on our cash investments, which was partially offset by higher cash balances. Higher cash balances were primarily due to positive cash flows from operations during 2000 and the first quarter of 2001. 11 INCOME TAXES. Prior to the fourth quarter of 2000, we did not make provisions for income taxes as our historical net losses had resulted in tax loss and credit carryfowards that we used to offset any income tax expense. In the fourth quarter of 2000, we determined that based on our continuing profitability, it was more likely than not that we would realize a portion of our tax assets, and recorded a deferred tax asset of $7.1 million as of December 31, 2000. We will continue to evaluate, on a quarterly basis, the positive and negative evidence affecting the realizability of our deferred tax assets, including the effect of the current industry environment. After utilizing all our tax carryforwards in the fourth quarter of 2000 that would provide an income statement benefit, we began recording income tax expense in the first quarter of 2001. We estimated an effective income tax rate of 40% in the first quarter of 2001 based on our expectations of full year 2001 revenue and profitability. As 2001 progressed, it became apparent that conditions in the ADSL market were adversely affecting our earlier revenue and profit expectations. Consequently, we revised our estimated effective tax rate for the year from 40% to 13% in the second quarter of 2001, and from 13% to zero in the third quarter of 2001. The most recent downward revision in the rate resulted in a $313,000 tax benefit in the third quarter of 2001 to adjust to the current estimated rate for 2001. 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 ("SAB 101"). The cumulative effect of the change on prior years resulted in a charge to income of $1.6 million in the first quarter of 2000. Of this amount, $0.7 million was recognized as revenue in 2000, and $0.9 million was recognized as revenue during the first quarter of 2001. We have adjusted our results for the three and nine month periods ended September 30, 2000 to conform with SAB 101. 12 LIQUIDITY AND CAPITAL RESOURCES At September 30, 2001, we had cash, cash equivalents and short-term investments of $58.2 million, which represents an increase of $666,000 from December 31, 2000. The increase is primarily due to $1.6 million of cash provided from operations and $262,000 of proceeds from the exercise of employee stock options, which was partially offset by $1.0 million of cash invested in capital equipment and $175,000 of cash invested in other assets. Cash provided from operations in the first nine months of 2001 was primarily the result of net income, excluding non-cash depreciation and amortization expenses, and the collection of accounts receivables, which was partially offset by a decrease in deferred revenue. Capital spending on property and equipment and other assets was primarily related to the purchase of computer hardware and software, laboratory equipment, furniture, and licensed technology used principally in engineering activities. 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 and short-term investments will be sufficient to fund our operations for at least the next twelve months. RISK FACTORS We believe that the occurrence of any one or some combination of the following risk factors could seriously harm our business. 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. If our quarterly revenue or operating results fall below the expectations of investors or public market analysts or if we change our financial guidance for future results, the price of our common stock could fall significantly. Many of our expenses, such as employee compensation and facilities costs, are relatively fixed. Moreover, our expense levels are based, in part, on our expectations regarding future revenue increases. As a result, any shortfalls in revenue in relation to our expectations could cause significant changes in our operating results from quarter to quarter and could result in quarterly losses. Other factors, many of which are outside our control, also could cause variations in our quarterly revenue and operating results. Some of these factors are: (i) the rate of market acceptance of DSL broadband access, generally, and of our ADSL technologies in particular; (ii) demand for our licensees' chipsets and products that incorporate our technology; (iii) the impact of channel inventory on demand for ADSL chipsets; (iv) development by us or our competitors of enhanced or alternative high-speed network access technologies; (v) the extent and timing of new license transactions; (vi) regulatory developments; and (vii) the timing and related costs of any acquisitions. 13 OUR INDUSTRY IS EXPERIENCING EXCESS CENTRAL OFFICE CAPACITY AND HAS EXCESS CHIPSET INVENTORY More ADSL chipsets were sold in 2000 than were required by new subscribers. This imbalance has led to overcapacity at ADSL service providers' central offices, as well as excess chipset inventory at ADSL equipment manufacturers. Because of this, chipset demand and pricing have been lower during 2001. We expect that lower demand and pricing will continue during the remainder of this year as the DSL market attempts to stabilize itself. If current conditions continue beyond this year, our revenue could continue to be adversely affected in those future periods. WE HAVE BEGUN TO EXPERIENCE OPERATING LOSSES We had an operating loss during the second and third quarters of 2001 after ten consecutive quarters of operating income. We expect that we will have an operating loss and a net loss for the fourth quarter of 2001. We may continue to experience losses beyond the fourth quarter of 2001 if the ADSL market does not recover. WE HAVE A UNIQUE BUSINESS MODEL The success of our business model depends upon i) our ability to license our technology to semiconductor and equipment companies, and ii) 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. Obtaining suitable licensees for our technology is difficult because of the following features of our strategy: (i) we typically undergo a lengthy and expensive process of building a relationship with a potential licensee before entering into an agreement; (ii) 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; and (iii) 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. 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 obligated to use our technology, and generally are not required to pay us royalties unless they do use our technology. Our business could be seriously harmed if: (i) we cannot obtain suitable licensees; (ii) our licensees fail to achieve significant sales of chipsets or products incorporating our technology; or (iii) we otherwise fail to implement our business strategy successfully. 14 WE DEPEND SUBSTANTIALLY ON A LIMITED NUMBER OF LICENSEES There are a relatively limited number of semiconductor and equipment companies to which we can license our DSL 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. Also, we cannot assure you that our prospective customers will not use their superior size and bargaining power to demand license terms that are unfavorable to us. WE DERIVE A SIGNIFICANT AMOUNT OF REVENUE FROM ONE CUSTOMER In 2000 and the first nine months of 2001, we derived a significant amount of our total revenue from ADI. ADI was the first customer to license ADSL technology from us in 1993 and their chipsets are the most mature implementations of our technology in the market. Our royalty revenues to date have been primarily due to sales of ADI chipsets that use our ADSL technology. While we expect to see an increase in the number of our customers with ADSL chipsets on the market, our revenue in the near term is highly dependent upon ADI's ability to maintain their 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 is unable to maintain market share or experiences further price erosion in its ADSL chipsets, our revenue could continue to decline. OUR SUCCESS REQUIRES ACCEPTANCE OF OUR DSL TECHNOLOGY BY A VARIETY OF MARKET PARTICIPANTS 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 acceptance of high-speed access over telephone lines in general, and our DSL technology in particular. Specifically, our DSL technology must be accepted by various market participants, including: |X| EQUIPMENT COMPANIES, particularly those that develop and market high-volume business and consumer products such as central office line cards, modems and personal computers, must purchase chipsets containing our DSL technology from our licensees for us to be successful. There are other solutions available for equipment companies seeking to offer high-speed network access products. Therefore, we face the risk that equipment manufacturers will choose chipset solutions that do not incorporate our technology. Generally, our ability to influence their decision whether to adopt our technology is limited. If equipment companies do not build equipment based on our DSL technology, our business will be seriously harmed. |X| SERVICE PROVIDERS must deploy DSL services based on our technology. If service providers do not deploy services based on DSL technology, our business will be seriously harmed. |X| END USERS must purchase services that incorporate our technology. If end users do not purchase services based on DSL technology, our business will be seriously harmed. 15 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 DSL technology. Although our license agreements contain non-disclosure provisions and other terms protecting our proprietary know-how and technology rights, it is possible that, despite these precautions, some of our licensees might obtain from us proprietary information that they could use to compete with us in the marketplace. Although we intend to defend our intellectual property as necessary, we cannot be sure that the steps we have taken will be adequate to prevent misappropriation. In the future, we may choose to bring legal action to enforce our intellectual property rights. Any such litigation could be costly and time-consuming for us, even if we were to prevail. Moreover, even if we are successful in protecting our proprietary information, we cannot be sure that our competitors will not independently develop technologies substantially equivalent or superior to our technology. The misappropriation of our technology or the development of competitive technology could seriously harm our business. Our technology may infringe the intellectual property rights of others. A large and increasing number of participants in the telecommunications industry have applied for or obtained patents. Some of these patent holders have demonstrated a readiness to commence litigation based on allegations of patent and other intellectual property infringement. Third parties may assert exclusive patent, copyright and other intellectual property rights to technologies that are important to our business. From time to time, we have received claims from other companies that our technology infringes their patent rights. While we believe our technology offerings do not infringe the intellectual property of others, we cannot be sure. Intellectual property rights can be uncertain and can involve complex legal and factual questions. We may be unknowingly infringing the proprietary rights of others, which could result in significant liability for us. If we were found to have infringed any third party's patents, then we could be subject to substantial damages and an injunction preventing us from conducting our business. OUR BUSINESS IS SUBJECT TO RAPID TECHNOLOGICAL CHANGE The telecommunications industry in general, and the market for high-speed network access technologies in particular, 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 DSL 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 DSL technology less desirable or obsolete. Also, the announcement of new technologies 16 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 DSL technology as well as new technologies that keep pace with other changes in the telecommunications industry 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. WE FACE INTENSE COMPETITION FROM A WIDE RANGE OF MANUFACTURERS AND VENDORS The markets for telecommunications and semiconductor products are intensely competitive. We expect competition to increase in the immediate future, because of the rapid growth projected across the DSL industry. Because of our strategy, we face three different kinds of competition and competitors, including: TECHNOLOGY LICENSING COMPETITION. Semiconductor and equipment manufacturers that develop and sell DSL products may either develop DSL technology internally or license it from third parties. We face competition from internal development teams within potential customers as well as from third parties. Some of these potential customers are some of the largest semiconductor and equipment companies in the world. Furthermore, our current customers may choose to abandon joint development projects with us and develop DSL solutions without using our technology. DSL CHIPSET COMPETITION. Our customers' chipsets compete with chipsets from other vendors of standards-based and non-standards-based DSL chipsets. Some of our current and potential competitors are some of the largest semiconductor companies in the world. NETWORK COMPETITION. DSL services offered over copper telephone networks compete with alternative broadband transmission technologies that use other network architectures, such as cable modems and wireless solutions. Many of our current and prospective licensees, as well as chipset competitors that compete with our semiconductor licensees 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. 17 WE REQUIRE ADDITIONAL HIGHLY-QUALIFIED ENGINEERING PERSONNEL Our future success will depend significantly on our ability to attract, motivate and retain additional highly qualified engineering personnel. Competition for qualified engineers is intense and there are a limited number of available persons with the necessary knowledge and experience in DSL, chip design and related technologies. Finding, training and integrating additional qualified personnel is likely to be difficult and expensive, and we may be unable to do so successfully. In the past, we have not been able to hire all of the engineers that we wanted to hire. If we are unable to hire and retain a sufficient number of engineers, our business could be seriously harmed. OUR STOCK PRICE MAY BE VOLATILE Volatility in our stock price may negatively impact 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 could fluctuate substantially based on a variety of factors, including: (i) quarterly fluctuations in our operating results; (ii) changes in future financial guidance that we may provide to investors and public market analysis; (iii) changes in our relationships with our licensees; (iv) announcements of technological innovations or new products by us, our licensees or our competitors; (v) changes in DSL market growth rates as well as investor perceptions regarding the investment opportunity that companies participating in the DSL industry afford them; (vi) changes in earnings estimates by public market analysts; (vii) key personnel losses; (viii) sales of common stock; and (ix) 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. 18 ITEM 3: 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. Historically, our investment portfolio has included: |X| Cash and cash equivalents, which consist of financial instruments with purchased maturities of three months or less; and |X| Short-term 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 September 30, 2001, all of our investments matured in twelve months or less. Due to the short duration of the financial instruments we invest in, we do not expect that an increase in interest rates would result in any material loss to our investment portfolio. 19 PART II. OTHER INFORMATION ITEM 1: 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 2: CHANGES IN SECURITIES IN USE OF PROCEEDS On October 3, 2001, we filed a current report on Form 8-K, which reported the adoption of a stockholder rights plan. 20 ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K (A) EXHIBITS None (B) REPORTS ON 8-K On October 3, 2001, we filed a current report on Form 8-K, which reported the adoption of a stockholder rights plan. - -------------------- SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. AWARE, INC. Date: November 12, 2001 By: /s/ Michael A. Tzannes ---------------------- Michael A. Tzannes, Chief Executive Officer Date: November 12, 2001 By: /s/ Richard P. Moberg --------------------- Richard P. Moberg, Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) 21 -----END PRIVACY-ENHANCED MESSAGE-----