1
================================================================================
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, 2000
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 27, 2000:
CLASS NUMBER OF SHARES OUTSTANDING
----- ----------------------------
Common Stock, par value $0.01 per share 22,581,590 shares
================================================================================
2
AWARE, INC.
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2000
TABLE OF CONTENTS
Page
----
PART I FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets as of
September 30, 2000 and December 31, 1999.......................... 3
Consolidated Statements of Operations for the
Three and Nine Months Ended September 30, 2000
and September 30, 1999............................................ 4
Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 2000
and September 30, 1999............................................ 5
Notes to Consolidated Financial Statements........................ 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations............................... 8
Item 3. Quantitative and Qualitative Disclosures about
Market Risk....................................................... 17
PART II OTHER INFORMATION
Item 1. Legal Proceedings................................................. 18
Item 6. Exhibits and Reports on Form 8-K.................................. 19
Signatures........................................................ 19
2
3
PART I. FINANCIAL INFORMATION
ITEM 1: CONSOLIDATED FINANCIAL STATEMENTS
AWARE, INC.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
SEPTEMBER 30, DECEMBER 31,
2000 1999
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents ........................................ $ 48,110,772 $ 35,248,275
Short-term investments ........................................... 3,571,837 1,017,302
Accounts receivable, net ......................................... 6,127,450 5,705,914
Inventories ...................................................... 212,995 122,058
Prepaid expenses and other assets ................................ 372,781 769,155
------------ ------------
Total current assets ....................................... 58,395,835 42,862,704
------------ ------------
Property and equipment, net ........................................... 11,237,785 11,619,761
------------ ------------
Total assets ............................................... $ 69,633,620 $ 54,482,465
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ................................................. $ 645,045 $ 787,684
Accrued expenses ................................................. 250,135 177,500
Accrued compensation ............................................. 385,084 467,806
Accrued professional ............................................. 163,021 80,678
------------ ------------
Total current liabilities .................................. 1,443,285 1,513,668
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, 22,553,258 in 2000 and 21,918,056 in 1999 . 225,533 219,181
Additional paid-in capital ....................................... 71,875,546 64,865,465
Accumulated deficit .............................................. (3,910,744) (12,115,849)
------------ ------------
Total stockholders' equity ................................. 68,190,335 52,968,797
------------ ------------
Total liabilities and stockholders' equity ................. $ 69,633,620 $ 54,482,465
============ ============
The accompanying notes are an integral part of the financial statements.
3
4
AWARE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------- -----------------------------
2000 1999 2000 1999
----------- ----------- ----------- -----------
Revenue:
Product sales ...................... $ 1,184,241 $ 1,241,098 $ 3,550,342 $ 3,896,929
Contract revenue ................... 3,221,667 2,947,000 8,943,333 8,007,211
Royalties .......................... 3,699,737 1,218,961 9,216,850 2,519,986
----------- ----------- ----------- -----------
Total revenue .................... 8,105,645 5,407,059 21,710,525 14,424,126
Costs and expenses:
Cost of product sales .............. 231,162 367,981 606,110 957,231
Cost of contract revenue ........... 2,341,860 1,827,969 6,517,949 5,212,061
Research and development ........... 1,414,496 814,061 4,166,904 2,371,846
Selling and marketing .............. 601,781 677,649 1,942,168 1,976,389
General and administrative ......... 766,302 686,769 2,268,824 1,961,291
----------- ----------- ----------- -----------
Total costs and expenses ......... 5,355,601 4,374,429 15,501,955 12,478,818
Income from operations ................. 2,750,044 1,032,630 6,208,570 1,945,308
Other income ........................... -- -- -- 18,300
Interest income ........................ 757,071 391,752 1,996,535 1,056,714
----------- ----------- ----------- -----------
Income before provision for income taxes 3,507,115 1,424,382 8,205,105 3,020,322
Provision for income taxes ............. -- -- -- --
----------- ----------- ----------- -----------
Net income ............................. $ 3,507,115 $ 1,424,382 $ 8,205,105 $ 3,020,322
=========== =========== =========== ===========
Net income per share - basic ........... $ 0.16 $ 0.07 $ 0.37 $ 0.14
Net income per share - diluted ......... $ 0.15 $ 0.06 $ 0.34 $ 0.13
Weighted average shares - basic ........ 22,528,865 21,643,728 22,411,545 21,385,157
Weighted average shares - diluted ...... 23,957,275 23,601,190 23,879,001 23,598,381
The accompanying notes are an integral part of the financial statements.
4
5
AWARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------------------
2000 1999
------------ ------------
Cash flows from operating activities:
Net income ................................................... $ 8,205,105 $ 3,020,322
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization ............................. 1,344,745 1,299,819
Increase (decrease) from changes in assets and liabilities:
Accounts receivable .................................... (421,536) (2,290,189)
Inventories ............................................ (90,937) 484
Prepaid expenses ....................................... (103,626) (68,262)
Accounts payable ....................................... (142,639) 168,519
Accrued expenses ....................................... 72,256 70,774
Deferred revenue ....................................... -- (12,500)
------------ ------------
Net cash provided by operating activities ........... 8,863,368 2,188,967
------------ ------------
Cash flows from investing activities:
Purchases of property and equipment .......................... (962,769) (1,286,991)
Other assets ................................................. 500,000 (500,000)
Net purchases of short-term investments ...................... (2,554,535) (2,892,741)
------------ ------------
Net cash used in investing activities ............... (3,017,304) (4,679,732)
------------ ------------
Cash flows from financing activities:
Proceeds from issuance of common stock ...................... 7,016,433 6,998,252
------------ ------------
Net cash provided by financing activities ........... 7,016,433 6,998,252
------------ ------------
Increase in cash and cash equivalents ........................... 12,862,497 4,507,487
Cash and cash equivalents, beginning of period .................. 35,248,275 23,512,242
------------ ------------
Cash and cash equivalents, end of period ........................ $ 48,110,772 $ 28,019,729
============ ============
The accompanying notes are an integral part of the financial statements.
5
6
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, 2000, of operations for the three and nine month periods
ended September 30, 2000 and 1999, and of cash flows for the nine month
periods ended September 30, 2000 and 1999.
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, 1999 in conjunction with its 1999 Annual Report on Form 10-K.
The results of operations for the interim period ended September 30, 2000
are not necessarily indicative of the results to be expected for the year.
In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin No. 101 (SAB 101), "Revenue Recognition in
Financial Statements." SAB 101 summarizes the SEC's views in applying
generally accepted accounting principles to selected revenue recognition
issues in financial statements. The application of the guidance in SAB 101
will be required in the Company's fourth quarter of fiscal 2000. The
Company is currently determining any impact that SAB 101 may have on its
financial position and results of operations.
B) INVENTORY
Inventory consists primarily of the following:
SEPTEMBER 30, DECEMBER 31,
2000 1999
------------- ------------
Raw materials ...................... $190,390 $ 93,847
Finished goods ..................... 22,605 28,211
-------- --------
Total ....................... $212,995 $122,058
======== ========
6
7
C) COMPUTATION OF EARNINGS PER SHARE
Basic earnings per share is computed by dividing net income by the weighted
average number of common shares outstanding. Diluted earnings per share is
computed by dividing net income 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 per share is calculated as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------- -----------------------------
2000 1999 2000 1999
----------- ----------- ----------- -----------
Net income ................................. $ 3,507,115 $ 1,424,382 $ 8,205,105 $ 3,020,322
Weighted average common shares outstanding . 22,528,865 21,643,728 22,411,545 21,385,157
Additional dilutive common stock equivalents 1,428,410 1,957,462 1,467,456 2,213,224
----------- ----------- ----------- -----------
Diluted shares outstanding ................. 23,957,275 23,601,190 23,879,001 23,598,381
=========== =========== =========== ===========
Net income per share - basic ............... $ 0.16 $ 0.07 $ 0.37 $ 0.14
Net income per share - diluted ............. $ 0.15 $ 0.06 $ 0.34 $ 0.13
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.
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:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------- -----------------------------
2000 1999 2000 1999
----------- ----------- ----------- -----------
United States .............................. $ 7,779,052 $ 3,869,902 $18,587,914 $ 9,604,211
Germany .................................... 132,375 1,058,230 1,439,660 2,417,793
Asia/Pacific ............................... 118,910 405,575 1,349,760 1,366,625
Europe, excluding Germany .................. 17,020 47,012 125,940 879,640
Rest of World .............................. 58,288 26,340 207,251 155,857
----------- ----------- ----------- -----------
$ 8,105,645 $ 5,407,059 $21,710,525 $14,424,126
=========== =========== =========== ===========
7
8
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
be materially worse than 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 modems.
Product sales decreased 5% from $1,241,000 in the third quarter of 1999 to
$1,184,000 in the current year quarter. As a percentage of total revenue,
product sales decreased from 23% in the third quarter of 1999 to 15% in the
current year quarter. For the nine months ended September 30, product sales
decreased 9% from $3,897,000 in 1999 to $3,550,000 in 2000. As a percentage of
total revenue, product sales decreased from 27% in the first nine months of 1999
to 16% in the corresponding period of 2000.
The dollar decrease in the three month period was primarily due to lower revenue
from the sale of modems, which was partially offset by an increase in revenue
from the sale of compression software. The dollar decrease in the nine month
period was primarily due to lower revenue from the sale of modems, which was
partially offset by an increase in revenue from the sale of test and development
systems. Modem revenue in both periods was lower because we have been phasing
out the development and sale of our x200 Access Router. Compression software
revenue in the three month period was higher primarily due to increased demand
by OEM customers who shipped the Company's compression software in higher
volumes. DSL test and development system revenue in the nine month period was
higher primarily because of the availability of new products and the growth of
the ADSL market, which fueled higher demand for these products.
Contract Revenue. Contract revenue consists primarily of license,
engineering development, and customer support fees that we receive under
agreements with our customers to develop and support ADSL chipsets. Contract
revenue in the first quarter of 1999 also includes a negligible amount of
revenue from U.S. government research contracts. We anticipate that revenue from
such government contracts will not continue in future periods.
8
9
Contract revenue increased 9% from $2,947,000 in the third quarter of 1999 to
$3,222,000 in the current year quarter. As a percentage of total revenue,
contract revenue decreased from 55% in the third quarter of 1999 to 40% in the
current year quarter. For the nine months ended September 30, contract revenue
increased 12% from $8,007,000 in 1999 to $8,943,000 in 2000. As a percentage of
total revenue, contract revenue decreased from 56% in the first nine months of
1999 to 41% in the corresponding period of 2000. The dollar increase, in both
the three and nine month periods, was primarily due to: (i) new chipset
development projects with existing and new semiconductor customers, and (ii)
increased support and new developments associated with the integration of
chipsets using our DSL technology into equipment used in mass-scale deployments.
Royalties. Royalties consist of royalty payments that we receive under
licensing agreements. We receive royalties when customers use our technology in
their chipsets or equipment.
Royalties increased 204% from $1,219,000 in the third quarter of 1999 to
$3,700,000 in the current year quarter. As a percentage of total revenue,
royalties increased from 23% in the third quarter of 1999 to 46% in the current
year quarter. For the nine months ended September 30, royalties increased 266%
from $2,520,000 in 1999 to $9,217,000 in 2000. As a percentage of total revenue,
royalties increased from 17% in the first nine months of 1999 to 42% in the
corresponding period of 2000. We believe that the increase in royalties was
primarily due to growing deployments of ADSL services by the telecommunications
industry in general, and of deployments using our technology in particular.
Cost of Product Sales. Cost of product sales consists primarily of the cost
of equipment sales. Compression software revenue has minimal cost of sales
associated with it. Cost of product sales decreased 37% from $368,000 in the
third quarter of 1999 to $231,000 in the current year quarter. As a percentage
of product sales, cost of product sales decreased from 30% in the third quarter
of 1999 to 20% in the current year quarter. For the nine months ended September
30, cost of product sales decreased 37% from $957,000 in 1999 to $606,000 in
2000. As a percentage of product sales, cost of product sales decreased from 25%
in the first nine months of 1999 to 17% in the corresponding period of 2000. For
the three and nine month periods, the improvement in product margins is
primarily due to a shift in the sales mix of our test and development systems
and x200 modems. In both current year periods, we sold a greater proportion of
test and development systems, which have higher margins than x200 modems.
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 increased 28% from $1,828,000 in the third
quarter of 1999 to $2,342,000 in the current year quarter. As a percentage of
contract revenue, cost of contract revenue increased from 62% in the third
quarter of 1999 to 73% in the current year quarter. The dollar increase was
primarily due to new chipset development projects with existing and new
semiconductor customers, and the nature of the customer projects we performed
during the third quarter of 2000. We have engaged in a more diverse collection
of projects in 2000 involving ASIC (application specific integrated circuit)
developments, specific DSP-based code developments, and the integration of these
technologies. These projects tend to have greater development costs associated
with them.
For the nine months ended September 30, cost of contract revenue increased 25%
from $5,212,000 in 1999 to $6,518,000 in 2000. As a percentage of contract
revenue, cost of contract
9
10
revenue increased from 65% in the first nine months of 1999 to 73% in the
corresponding period of 2000. The dollar increase is primarily due to the nature
of the customer projects we performed during the first nine months of 2000.
There were more projects involving ASIC (application specific integrated
circuit) developments, and these projects tend to have greater development costs
associated with them.
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 74% from $814,000 in the third quarter of 1999 to $1,414,000 in the
current year quarter. As a percentage of total revenue, research and development
expense increased from 15% in the third quarter of 1999 to 17% in the current
year quarter. For the nine months ended September 30, research and development
expense increased by 76% from $2,372,000 in 1999 to $4,167,000 in 2000. As a
percentage of total revenue, research and development expense increased from 16%
in the first nine months of 1999 to 19% in the corresponding period of 2000. For
both the three and nine month periods, the dollar increase was primarily due to
increased spending on non-customer-specific research and development projects,
such as our new voice enabled DSL ("VeDSL"), DMTflex and Dr. DSL(TM) line
maintenance and diagnostic technologies. Higher spending on these projects was
partially offset by lower spending on our x200 modem product.
Selling and Marketing Expense. Selling and marketing expense consists
primarily of salaries for sales and marketing personnel, travel, advertising and
promotion, recruiting, and facilities expense. Sales and marketing expense
decreased 11% from $678,000 in the third quarter of 1999 to $602,000 in the
current year quarter. As a percentage of total revenue, sales and marketing
expense decreased from 13% in the third quarter of 1999 to 7% in the current
year quarter. The dollar decrease was primarily due to lower transaction
expenses associated with completing development and licensing agreements.
For the nine months ended September 30, selling and marketing expense
decreased 2% from $1,976,000 in 1999 to $1,942,000 in 2000. As a percentage of
total revenue, sales and marketing expense decreased from 14% in the first nine
months of 1999 to 9% in the corresponding period of 2000. The dollar decrease
was primarily due to lower spending on tradeshows, public relations, and
transaction expenses associated with completing development and licensing
agreements, which was partially offset by increased spending on sales staff.
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 12% from $687,000 in the third quarter of 1999
to $766,000 in the current year quarter. As a percentage of total revenue,
general and administrative expense decreased from 13% in the third quarter of
1999 to 9% in the current year quarter. For the nine months ended September 30,
general and administrative expense increased 16% from $1,961,000 in 1999 to
$2,269,000 in 2000. As a percentage of total revenue, general and administrative
expense decreased from 14% in the first nine months of 1999 to 11% in the
corresponding period of 2000. For the three and nine month periods, the dollar
increase is primarily due to higher public company expenses. We also increased
our bad debt reserve because of generally higher revenue and accounts receivable
balances.
10
11
Other Income. Other income consists of rental income from real estate
leases for space in our headquarters building, which terminated in the first
quarter of 1999. For the nine months ended September 30, other income decreased
from $18,000 in 1999 to zero in 2000. The decrease is due to the termination of
the leases last year, and we anticipate that we will not have any more rental
income in the future.
Interest Income. Interest income increased 93% from $392,000 in the third
quarter of 1999 to $757,000 in the current year quarter. For the nine months
ended September 30, interest income increased 89% from $1,057,000 in 1999 to
$1,997,000 in 2000. The dollar increase in both periods is primarily due to
higher cash balances. Higher cash balances were due to positive cash flows from
operations and stock option exercises during 1999 and the first nine months of
2000.
Income Taxes. We have made no provision for income taxes as our historical
net losses have resulted in tax loss carryforwards that we expect to utilize.
11
12
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 2000, we had cash, cash equivalents and short-term investments
of $51,683,000, which represents an increase of $15,417,000 from December 31,
1999. The increase is primarily due to $8,863,000 of cash provided from
operations and $7,016,000 of net proceeds from the exercise of employee stock
options, which was partially offset by $963,000 of cash invested in capital
equipment.
Cash provided from operations in the first nine months of 2000 was primarily the
result of the Company's profitable operations. Capital spending was primarily
related to the purchase of computer hardware and software, laboratory equipment,
and furniture 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 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.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 1999, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin No. 101 (SAB 101), "Revenue Recognition in Financial
Statements." SAB 101 summarizes the SEC's views in applying generally accepted
accounting principles to selected revenue recognition issues in financial
statements. The application of the guidance in SAB 101 will be required in the
Company's fourth quarter of fiscal 2000. The Company is currently determining
any impact that SAB 101 may have on its financial position and results of
operations.
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, 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 DSL technologies in particular; (ii) demand for our
12
13
licensees' chipsets and products that incorporate our technology; (iii)
development by us or our competitors of enhanced or alternative high-speed
network access technologies; (iv) the extent and timing of new license
transactions; (v) regulatory developments; and (vi) the timing and related costs
of any acquisitions.
WE HAVE A UNIQUE AND UNPROVEN BUSINESS MODEL
Other than our seven-year relationship with Analog Devices, we do not have
extensive experience licensing our technology to third parties. Moreover,
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.
If we cannot obtain suitable licensees or otherwise fail to implement our
business strategy successfully, our business could be seriously harmed.
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.
Royalties from our licensees are often related to 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 utilize our technology. They
are not prohibited from competing against us. Because our business model depends
on our receipt of royalties, our licensees' failure to achieve significant sales
of chipsets and products incorporating our technology could seriously harm our
business.
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:
- Equipment companies, particularly those that develop and market
high-volume central office products, such as DSLAMS, digital loop
carriers, switches, or next generation access platforms, as well as
customer premises products, such as personal computers, gateway
devices, or modems, must purchase chipsets containing our DSL
technology
13
14
from our licensees for us to be successful. If equipment companies do
not build equipment based on our DSL technology, our business will be
seriously harmed.
- 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.
- 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.
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. 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.
14
15
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 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. While we know of no other
independent companies that license DSL technology, such as Aware, we face
intense competition from internal development teams within potential
customers. Furthermore, our current customers may choose to abandon joint
development projects with us and either internally develop or acquire other
DSL technology companies to develop their own DSL technology solutions.
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.
15
16
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 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. 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 our
relationships with our licensees; (iii) announcements of technological
innovations or new products by us, our licensees or our competitors; (iv)
changes in earnings estimates by Aware or public market analysts; (v) key
personnel losses; (vi) sales of common stock; and (vii) developments or
announcements with respect to industry standards, patents or proprietary rights.
In addition, the equity markets have experienced volatility that has
particularly affected the market prices of equity securities of many high
technology companies and that often has been unrelated or disproportionate to
the operating performance of such companies. These broad market fluctuations may
adversely affect the market price of our common stock.
WE HAVE A HISTORY OF OPERATING LOSSES
We may not be profitable in any future period. We incurred operating losses in
each fiscal year from inception to December 31, 1998. As of September 30, 2000,
we had an accumulated deficit of $3.9 million. Although we have been profitable
over the last eight quarters, we cannot assure you that we will continue to be
profitable in future quarters.
16
17
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:
- Cash and cash equivalents, which consist of financial instruments with
purchased maturities of three months or less; and
- 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 18 months 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, 2000, all of our investments matured in twelve
months or less. Due to the short duration of the financial instruments in which
we invest, we do not expect that an increase in interest rates would result in
any material loss to our investment portfolio.
17
18
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.
18
19
ITEM 6:
EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
None
(b) REPORTS ON 8-K
None.
- --------------------
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
AWARE, INC.
Date: November 10, 2000 By: /s/ Michael A. Tzannes
-----------------------------------------
Michael A. Tzannes, Chief Executive
Officer and President
Date: November 10, 2000 By: /s/ Richard P. Moberg
-----------------------------------------
Richard P. Moberg, Vice President and
Chief Financial Officer (Principal
Financial and Accounting Officer)
19