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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
COMMISSION FILE NUMBER 000-21129
AWARE, INC.
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(Exact Name of Registrant as Specified in Its Charter)
MASSACHUSETTS 04-2911026
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(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
ONE OAK PARK, BEDFORD, MASSACHUSETTS, 01730
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(Address of Principal Executive Offices)
(Zip Code)
(617) 276-4000
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(Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, PAR VALUE $.01 PER SHARE
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES X NO
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
The aggregate market value of the voting stock held by non-affiliates of the
registrant as of February 28, 1997, based on the closing price of the Common
Stock on February 28, 1997 as reported on the Nasdaq National Market, was
approximately $134,917,832.
The number of shares outstanding of the registrant's common stock as of February
28, 1997 was 19,116,561.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive Proxy Statement to be delivered to
shareholders in connection with the registrant's Annual Meeting of
Shareholders to be held on May 21, 1997 are incorporated by
reference into Part III of this Annual Report on Form 10-K.
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AWARE, INC.
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1996
TABLE OF CONTENTS
PART I
Item 1. Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Item 2. Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Item 3. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Item 4. Submission of Matters to a Vote of Security Holders . . . . . . . . . . . . . . . . 15
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters . . . . . . 16
Item 6. Selected Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Item 8. Financial Statements and Supplementary Data . . . . . . . . . . . . . . . . . . . . . 23
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37
PART III
Item 10. Directors and Executive Officers of the Registrant . . . . . . . . . . . . . . . . . 38
Item 11. Executive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39
Item 12. Security Ownership of Certain Beneficial Owners and Management . . . . . . . . . . . 39
Item 13. Certain Relationships and Related Transactions . . . . . . . . . . . . . . . . . . . 39
PART IV
Item 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K . . . . . . . . . . . 40
Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43
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PART I
ITEM 1. BUSINESS
GENERAL
Aware, Inc. (the "Company" or "Aware") was incorporated in Massachusetts in
1986. During its first seven years, the Company was engaged primarily in
research, specializing in wavelet mathematics applications, digital compression,
and telecommunications and channel modulation and coding. The Company holds
thirteen patents in areas related to wavelet mathematics, digital compression
and similar technologies. The Company's revenue during this period consisted
largely of research grants from agencies of the U.S. government and certain
commercial companies. In 1993, the Company began to shift its business from
contract research toward development of: (i) Asymmetric Digital Subscriber Line
("ADSL") and other broadband technologies, and (ii) image compression products.
Two principal lines of business emerged as a result of the decision to
commercialize the Company's core technology: telecommunications and image
compression.
The Company's telecommunications products include software and hardware
interfaces that integrate ADSL and Hybrid Fiber Coaxial ("HFC") chipsets into
modems and other communications devices, and high speed ADSL Internet Access
Modems that incorporate the Company's proprietary technology and software. The
Company has co-developed chipsets incorporating the Company's technology with
Analog Devices, Inc. ("ADI"), a leading supplier of integrated circuits. ADI has
an exclusive license to manufacture and sell such chipsets for which the Company
receives royalty payments. The Company's broadband products are designed to
increase the speed of data communications over conventional copper telephone and
cable television networks. The Company believes that its products will enable
telephone companies ("telcos") and cable companies to utilize their installed
bases of dedicated copper lines and coaxial cable to provide both residential
and business customers with interactive data transmission at speeds much higher
than currently available.
The Company's image compression products include WSQ by Aware, AccuPress
for Radiology, AccuPress for Remote Sensing, AccuPress for Multimedia, and
SeisPact. In addition, the Company's image compression organization continues to
perform some contract research for the U.S. government.
The Company's executive offices are located at One Oak Park, Bedford,
Massachusetts, 01730, and its telephone number is (617) 276-4000.
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PRODUCTS AND MARKETS
TELECOMMUNICATIONS
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TELECOMMUNICATIONS MARKET
With the rise of the Internet and World Wide Web, network service providers
are experiencing a fundamental shift in the type of communications traffic
transmitted over their networks. The existing network infrastructure of
twisted-pair copper wiring, which was originally designed to provide analog
voice service ("Plain Old Telephone Service" or "POTS" ), and coaxial cable,
which was designed to provide cable television service, are increasingly
required to carry large amounts of data produced by computers. Service providers
are faced with the challenge of providing high-speed data communications at
reasonable costs, while preserving their investment in copper wire and coaxial
cable networks.
Copper wire telephone networks are estimated to include over 150 million
lines in the United States and over 600 million lines worldwide, according to
industry sources. These networks represent an undepreciated capital investment
of approximately $100 billion. Cable television service is currently available
to ninety percent of the homes in the U.S. and sixty-five percent of the homes
in the U.S. subscribe to the service.
To date, telcos' copper wire and cable companies' HFC infrastructures have
not proven adequate for the increasing volume of traffic generated by computers
remotely connected to each other and the Internet. Digital information requires
more bandwidth than traditional analog voice communications if it is to be
transmitted at a speed that is satisfactory to the computer user. Currently, the
fastest transmission rate readily available to typical home or remote office
computer users over existing copper wire is achieved through the use of a 33.6
kilobits per second ("Kbps") modem, although many users still employ modems that
are slower than this. For the over 30 million and growing Internet users, these
transmission rates are one of the chief frustrations of using the World Wide
Web, which is the fastest growing and most data intensive segment of the
Internet.
Service providers, recognizing the need for higher speed data
communications, are increasingly seeking to upgrade their networks. The telcos
are replacing copper wire with fiber optic cable, which permits high speed data
transmissions, particularly through the backbone of the network that links their
central offices to one another. However, installing fiber optic cable all the
way into customers' homes or businesses is prohibitively expensive and would
take decades. Similarly, cable companies are testing cable modems, which permit
two-way data transmissions over their existing HFC networks.
Telcos are seeking cost-effective technologies to accommodate high speed
data transmission over copper wires. Some of these technologies are described
below:
ISDN. In the early 1980's, telcos introduced Integrated Service
Digital Network ("ISDN") technology, which provides digital
transmission over copper wire typically at basic rates up to 144 Kbps.
Although this technology is several times faster than a voiceband
modem, the market penetration of existing ISDN technology is limited
because its equipment and installation costs are relatively high, and
it does not allow simultaneous POTS and data transmission on those
wires.
T-1. T-1 (E-1 in countries outside the U.S.) is a multiplexing format
that allows digital conversion of an analog line. Once converted, a
T-1 digital line can deliver data at speeds up to 1.544 megabits per
second ("Mbps"). However, T-1 service cannot use the existing copper
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wire networks without expensive and time-consuming modifications,
including installation of repeaters every 3,000 to 5,000 feet to
regenerate the signal as it passes along the line. T-1 also requires
two sets of twisted-pair copper wires and does not allow simultaneous
POTS and data transmission on those wires.
HDSL. In 1992, telcos introduced High bit-rate Digital Subscriber Line
("HDSL") technology, which reduces the cost of installing T-1 service.
HDSL increases the distance of T-1 transmission over copper wires to
approximately 12,000 feet, which reduces the need for repeaters. As a
result, some telcos are deploying HDSL technology in their local
access networks. However, HDSL still requires two sets of twisted-pair
copper wires and does not allow simultaneous POTS and data
transmission on those wires.
ADSL. Telcos are currently considering deployment of ADSL technology,
which uses digital signal processing technology to expand the useable
bandwidth of copper telephone wire. ADSL was initially created in the
late 1980s by Bellcore, the research entity jointly created and funded
by the Regional Bell Operating Companies ("RBOCs"). ADSL technology
allows non-repeated transmissions of data at a distance of up to
18,000 feet over telcos' existing copper networks at a rate of up to 8
Mbps downstream to the customer and at a rate of up to 640 Kbps
upstream from the customer, with the speed of transmission decreasing
as distance increases. ADSL allows simultaneous POTS and high speed
digital data transmission on a single set of twisted-pair copper
wires.
In addition to these telco technologies, cable company suppliers are
working to improve HFC technology, which would permit two-way broadband digital
communications over typical cable networks. HFC technology uses digital signal
processing to allow efficient sharing of upstream bandwidth so that a cable line
can be used for two-way transmissions. New HFC networks are also being installed
by telcos so that they can offer television service as well as telephone and
data dial-tone services.
Telcos typically put new products through a rigorous approval process
before deploying them on a broad basis. The approval process usually involves a
number of different phases, including (i) laboratory evaluations, in which the
product is tested against relevant industry standards; (ii) technical trials, in
which the product is tested in the field with a small number of users; (iii)
marketing trials, in which the product is tested in the field with a larger
number of users and telcos begin to train their personnel to install and
maintain the product; (iv) initial commercial deployment, in which telcos make
the product available to selected customers for selected applications; and (v)
commercial deployment, in which telcos make the product available to a
substantial number of customers.
During 1996, a number of telcos performed laboratory and technical trials,
in which they evaluated and tested the Company's, as well as competitors', ADSL
products. The Company believes the telcos' trial experience provided them with
evidence that ADSL technology is capable of delivering high-speed data
transmissions rates. This knowledge coupled with rapidly dropping equipment
prices may have obviated the need for many of the marketing trials the Company
and others had anticipated. The Company now believes the telcos will commence
commercial ADSL deployment in late 1997 and that such deployment will continue
into 1998.
TELECOMMUNICATIONS PRODUCTS
The Company designs and develops products utilizing its proprietary
software to implement ADSL that it believes have advantages over its
competitors' ADSL products. The ASDL products developed by Aware incorporate
proprietary software and algorithms based on digital signal processing
technology as
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well as application specific integrated circuits (ASICs). In contrast to the
approach taken by some competing developers of ADSL technology, Aware's approach
is to maintain a high level of functionality in the software component of the
product as opposed to the ASIC. The Company believes that this approach allows
it to engineer improvements in its technology quickly and efficiently, rather
than having to design and produce a new ASIC each time an improvement is made.
The Company's ADSL technology enables data communications protocols, such as
Frame Relay, TCP/IP, and ATM, to operate at higher transmission rates over
copper wire. The Company has chosen to use the multi-carrier Discrete Multi-Tone
("DMT") modulation for ADSL, rather than the single-carrier Carrierless
Amplitude Phase ("CAP") modulation technique. The Company believes that ADSL/DMT
technology has greater potential for deployment than CAP, because (i) DMT is
more flexible, (ii) the standardization process for DMT is more advanced, and
(iii) there are multiple vendors who supply DMT as opposed to CAP which is
offered by one vendor. (See Item 1. Business - TECHNOLOGY)
Existing Telecommunications Products
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Chipsets. The Company and ADI developed a first generation ADSL chipset,
which began shipping in November 1995. The chipset uses a combination of ASICs,
digital signal processors, and proprietary software developed by the Company to
provide all the functions necessary in a modem. The ADSL chipset meets the
performance objectives of the DMT multi-carrier modulation chosen by the
American National Standards Institute ("ANSI") as the standard for ADSL.
In 1993 ADI and the Company entered into an agreement, under which ADI
produces and markets broadband chipsets incorporating the Company's DMT-based
ADSL technology, and for which the Company receives royalties and development
funding. The relationship between ADI and the Company is an exclusive
arrangement, under which neither party may enter into competing agreements with
third parties. The Company's ability to achieve its business objectives will
depend on ADI's ability and desire to deliver chipsets to the market place. (See
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations - FACTORS THAT MAY AFFECT FUTURE RESULTS.)
In 1994 and 1995, the Company and ADI entered into additional agreements to
expand their relationship to include the development and marketing of chipsets
incorporating the Company's Discrete Wavelet Multi-Tone ("DWMT") technology for
HFC and VDSL data communications. The Company also agreed that, if it develops
and sells ADSL technology that implements DWMT technology, it would license such
technology to ADI on substantially the same terms as those for the Company's
ADSL technology.
Software and Hardware Interfaces. The Company develops software and
hardware interfaces for its ADSL chipset which can be used to connect the
chipset with PCs, network and central office equipment, and other telephony and
data communications devices. The interfaces are custom developed by the Company
for OEMs, who seek to incorporate the Company's ADSL technology into their
systems.
Modems. The Company developed and markets an ADSL Internet Access Modem,
which contains the Company's ADSL chipset and software and hardware interfaces
developed by the Company. In a typical configuration, the Company's ADSL modem
is designed to receive data at speeds up to 4.4 Mbps and send it at speeds of up
to 440 Kbps at a distance of up to 12,000 feet over standard copper wire. This
modem was designed to demonstrate technical feasibility and will not be suitable
for mass production without additional redesign to reduce the power
requirements, size and costs of the modem.
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Products Under Development
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The Company is currently engaged in the following product development and
enhancement activities:
Chipsets. The Company and ADI have announced a second generation ADSL
chipset, which the Company anticipates will begin shipping in production
quantities in the third quarter of 1997. While maintaining the same data
transmission speed, the second generation chipset contains the following
enhancements as compared to the first generation chipset: (i) the number of
chips in the core transceiver has been reduced from twelve to five; (ii) the
power requirement has been reduced from twelve to five watts, and (iii) the
dimensions of the core transceiver, DSP circuitry, and line driver circuitry
have been reduced from 7" by 9" to 3" by 5".
The Company and ADI have announced that ADI expects to begin shipping an
HFC chipset, which is based upon the Company's DWMT technology, in June 1997.
This chipset is the first implementation of the Company's DWMT technology.
Board-Level Products. The Company plans to design, manufacture and market
board-level products for installation into ADSL systems offered by OEMs. The
first such board-level product that the Company has announced is an ADSL module.
This module is a 3" by 5" transceiver card which will contain a second
generation ADSL chipset. The Company anticipates that its module will be
available in limited production quantities in the third quarter of 1997.
Modems. The Company has announced and intends to begin shipping a rate
adaptive ADSL modem in the first quarter of 1997. In addition to rate
adaptability, this modem will contain a single board first generation chipset
design, an improved user interface, and improved diagnostic capabilities.
Advanced ADSL, SDSL, VDSL, and HFC. The Company also intends to offer new
generations of advanced ADSL products, as well as chipsets, interfaces, modems,
boards and systems incorporating SDSL, VDSL, and HFC technology. (See Item 1.
Business - TECHNOLOGY.) The Company has not announced any such products other
than those described herein.
IMAGE COMPRESSION
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In 1993, the Company began an effort to produce commercially marketable
wavelet image compression software products. The Company currently offers five
software-based compression products and has an agreement with ADI to produce a
wavelet video compression ASIC. The Company's compression products include the
following: WSQ by Aware (which compresses digital fingerprint data for use by
law enforcement agencies, such as the FBI); AccuPress for Radiology (which is
used to compress digital radiographs and other types of medical imagery);
AccuPress for Multimedia (which is a general purpose compression product);
AccuPress for Remote Sensing (which is designed for compression of
satellite-based remote sensing imagery); and SeisPact (which companies in the
oil and gas industry can use to store and transmit large amounts of seismic
data).
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TECHNOLOGY
The Company's core technology is based on its research into wavelet
mathematics and digital compression. From that core technology, three principal
technologies have emerged, including: (i) DMT-based ADSL technology, (ii) DWMT
technology, and (iii) image compression technology.
ADSL Technology
ADSL is a method for expanding the useable bandwidth of copper wire.
Typically, ADSL systems divide a one megahertz (MHz) bandwidth on copper wire
into three segments: (i) the 0 to 4 kilohertz (KHz) range is used for POTS, (ii)
the 25 KHz to 100 KHz range is used to transmit data upstream and (iii) the 100
KHz to 1 MHz range is used to transmit information downstream. The ANSI
specification for ADSL calls for operation rates of 1.5 to 8 Mbps downstream and
64 to 640 Kbps upstream when operating over existing copper wires at a distance
of up to 18,000 feet.
There are two primary ADSL modulation techniques for transmitting data
signals: (i) DMT, which the Company uses, and (ii) CAP. DMT is a multi-carrier
modulation technique that was chosen by ANSI as the telecommunications industry
standard for ADSL. CAP is a single-carrier modulation technique originally
developed by AT&T Paradyne Corporation (now Globespan Technologies, Inc.). The
fundamental difference between CAP and DMT is that CAP treats each of the
upstream and downstream frequency ranges as a single element over which as many
information bits as possible are transmitted. In contrast, DMT divides the
upstream and downstream bands into groups of different smaller subchannel
frequency ranges (approximately 4 KHz each) into which a much smaller number of
bits are coded and transmitted simultaneously.
The Company believes that DMT technology is better able than CAP technology
to address the inherent problems of the telcos' copper wire networks. Because of
its multiple small frequency bands, DMT is able to adjust and adapt the movement
of information to both extract more throughput from a wire and to avoid sending
information into frequency ranges that are not useable. Since CAP treats the
entire frequency range as a single element, it does not have the ability to
balance as easily the use of the frequency spectrum to match efficiently the
performance of a given wire. DMT-based systems have greater flexibility than
CAP-based systems, because DMT-based modems are better able to adapt and operate
to within 32 Kbps of the highest speed achievable on the link.
DWMT Technology
The Company has invented a proprietary technology based on wavelet
mathematics called DWMT. The Company believes that, as a result of its research
and development of DWMT technology, it is a leader in commercialization of
wavelets for telecommunications.
Multi-carrier systems divide a frequency range into the desired number of
subchannels by using a digital filter bank, which is a mathematical process.
Because of basic limits of the form of mathematics and the limits of time and
computerization speeds, the process of creating isolated subchannels is
imperfect. These imperfections inhibit modems from achieving theoretical
performance limits. The subchannelization method used in creating DMT modems
utilized a technique called a Fourier transform. This technique has been used in
the telecommunications industry since the 1960s, but has become more practical
for high speed, high volume use as digital signal processors have improved. The
wavelet transform yields significantly better subchannelization than the Fourier
transform. Because this technique more closely approximates ideal
subchannelization, the performance of a wavelet-based
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DWMT system can produce performance superior to a non-wavelet DMT system
operating in a noisy environment.
The Company intends to apply DWMT technology to new products using SDSL,
VDSL and HFC applications. The Company is seeking to incorporate DWMT techniques
into industry standards body recommendations. The following is a brief
description of possible applications using SDSL, VDSL and HFC:
SDSL. Symmetric Digital Subscriber Line technology is similar to ADSL, but
allows two-way data transmission at the same rates. The Company is developing an
SDSL application using its DWMT technology. SDSL provides up to 2 Mbps of data
in both directions on single twisted-pair copper wire at distances up to 18,000
feet while allowing simultaneous POTS. The Company expects that this SDSL
application can be used for LAN interconnecting and enhanced telephony
applications.
VDSL. The Company believes that Very high-speed Digital Subscriber Line
technology will be the next generation of high-speed user access, critical to
the implementation of fiber-to-the-neighborhood and fiber-to-the-curb
architectures. These architectures involve the deployment of an access node that
utilizes fiber optic cable from a telco's central office to the access node,
thus bringing fiber closer to the user. The final connection to the user is new
or existing copper wire or new coaxial cable. VDSL is being designed with the
objective of providing performance up to six times faster than ADSL, but over a
shorter distance. The goal of VDSL is to enable telcos to provide a combination
of digital TV, data dial-tone and regular telephony service on a single
twisted-pair of copper wire. The Company is using DWMT to develop the upstream
portion of a VDSL system.
HFC. By using the frequency band from 5 to 40 MHz for upstream transmission
and the frequency band from 450 to 750 MHz for downstream transmission, it is
possible to provide two-way services, such as telephony and data communications,
on existing HFC networks. Each of these frequency bands is typically divided
into smaller bands, 1 to 2 MHz wide. The Company's HFC technology, called
WaveTel HFC, is based upon DWMT and will provide up to 8 Mbps transmission over
a 2 MHz band. HFC telephony and cable modem technology enables cable companies
to re-use their existing network to provide two-way services.
Image Compression Technology
Since 1988, the Company has developed expertise, trade secrets, and
intellectual property in the field of wavelet transform-based data compression
and has obtained several patents in this area. The Company's wavelet compression
technology enables digital image, video and certain types of data to be
compressed to between 1% and 10% of their original size. Using wavelet
compression, the decompressed data are not bit for bit identical to the original
data. A risk with this technique is that, as the original data get smaller, a
larger amount of error is introduced into the decompressed data. However,
compressed data can be transmitted across networks faster and storage costs are
reduced.
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RESEARCH AND DEVELOPMENT
The Company believes that its future success depends on its ability to
adapt to the rapidly changing telecommunications environment and to meet its
customers' needs. The timely development and introduction of new products is
essential to maintain the Company's competitive position. The Company's product
development activities are focused on delivering products to its service
provider customers that will enable them to make maximum use of the capabilities
of their existing copper wire and coaxial cable networks. Key development
objectives include enhancements to the Company's ADSL technology as well as on
products incorporating DWMT technology for VDSL, SDSL, and HFC applications.
Most of the Company's products are developed internally. As of December 31,
1996, the Company had a research and development staff of 35 employees,
including ten employees holding doctorate degrees related to digital signal
processing and digital communications theory. The Company anticipates that its
research and development organization will grow significantly in the future as
the Company attempts to strengthen its technology and product position in the
telecommunications marketplace.
During the years ended December 31, 1996, 1995 and 1994, research and
development costs charged to operations were $3,234,799, $2,333,200, and
$3,492,249, respectively. Such costs are net of software development costs
capitalized in accordance with Statement of Financial Accounting Standards
("SFAS") No. 86. There were no SFAS 86 costs capitalized in 1996, 1995 or 1994.
New product development schedules are difficult to predict, because
telecommunications product development, quality assurance testing and debugging
are complex processes that often take longer than expected. Accordingly,
although the Company estimates the shipment dates of proposed new products for
internal purposes, such estimates are subject to frequent adjustment based on
the Company's own periodic assessment of its progress in the development
process. No assurance can be given that any of the development projects referred
to in the "Products and Markets" section will be successful or that any
announced shipping dates for new products will be met.
SALES AND MARKETING
To date, the Company's principal telecommunications sales and marketing
strategy has been to partner with OEM equipment suppliers. These OEM customers
manufacture and sell telephone network equipment, cable plant equipment, data
communications equipment, and end user customer premises equipment. The
Company's objective is to incorporate its technology and components into
products offered by its OEM customers. Examples of companies with whom the
Company has announced partnership agreements as of December 31, 1996, include
DSC Communications Corporation, Teltrend, Inc., Hayes Microcomputer Products,
Inc., PairGain Technologies, Inc., and RELTEC Corporation.
Due to the complexity of the Company's telecommunications technology, the
Company's sales people must have a high degree of technical sophistication in
order to market its products effectively. The Company believes that technology
selections involving the Company's products are frequently made at senior levels
within a prospective customer's organization. Consequently, the Company relies
primarily on presentations by senior management to key employees of OEMs.
This type of OEM selling does not require a large sales force, therefore as
of December 31, 1996, the Company had four people in its telecommunications
sales and marketing organization. As ADSL technologies are more broadly adopted,
the Company expects to hire additional sales and marketing
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employees to support the efforts of senior management. Additional sales and
marketing employees will also be required to develop new channels of
distribution so that the Company may sell its products to non-OEM customers,
such as telcos, cable operators, Internet service providers, and competitive
access providers.
The Company sells its software-based compression products through
distributors and directly to end user customers. As of December 31, 1996, there
were two people in the Company's compression software sales organization.
The Company has in the past and expects in the future to derive a
substantial portion of its revenues from a limited number of customers. There
are relatively few OEM equipment suppliers, telcos and cable operators to whom
the Company can sell its products. Consequently, the Company's future success
will depend to a large extent upon: (i) the timing and size of future purchase
orders for the Company's products from these customers, (ii) the financial and
operating success of these customers, and (iii) the success of services offered
by these customers that use the Company's products. Any attempt by such
customers to seek out additional or alternative suppliers or to undertake the
internal development and sale of products comparable to those of the Company
could have a material adverse effect on the Company's business, financial
condition and results of operations. (See Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations - FACTORS THAT MAY
AFFECT FUTURE RESULTS.)
The Company derived approximately 22%, 17%, 12%, and 10% of its total
revenue in 1996 from DSC Communications Corporation, ADI, the United States
government, and Teltrend, Inc., respectively. The Company derived approximately
23%, 18%, 12%, and 10% of its total revenue in 1995 from ADI, General Instrument
Corporation, the United States government, and GSS/Array Technology,
respectively. The Company derived approximately 38% and 10% of its total revenue
in 1994 from the United States government and ADI, respectively. Substantially
all revenue in 1996, 1995, and 1994 was sold to unaffiliated customers in North
America.
MANUFACTURING
The Company does its own final assembly and testing of its ADSL products at
its Bedford, Massachusetts facility. The Company believes that its manufacturing
capacity is relatively limited. A modest number of ADSL modems have been
manufactured to date. As demand for ADSL and other products increases, the
Company intends to rely on third party manufacturers as well as its internal
manufacturing capacity to assemble and test its products. The Company obtains
ADSL chipsets directly from ADI and other components needed for its ADSL
products from a variety of suppliers. The Company expects that third party
manufacturers will obtain product parts directly from the Company, and from
suppliers chosen by the Company or the third party manufacturer. Other than the
ADSL chipset, which is available through ADI, the Company believes that other
components for its ADSL products are available from a large number of suppliers
and that there exist many qualified manufacturers to assemble and test the
Company's products. (See Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations - FACTORS THAT MAY AFFECT FUTURE
RESULTS.)
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COMPETITION
The markets for the Company's products are intensely competitive and the
Company expects competition to increase in the immediate future, especially in
the emerging ADSL market. The Company intends to compete on the basis of
technology, price, the timing of product delivery, product features, quality,
reliability, and customer satisfaction. The Company currently competes, or
expects to compete in the future, with the following categories of companies:
(i) other vendors of DMT-based ADSL technology, such as Amati Communications
Corporation ("Amati"), Orckit Communications Limited ("Orckit") and Alcatel
Network Systems, Inc. ("Alcatel"); (ii) vendors of alternative ADSL
technologies, such as Globespan Technologies, Inc. ("Globespan"), which is
currently marketing its CAP-based ADSL technology, (iii) Regional Bell Operating
Companies ("RBOCs") and other telcos, who are no longer prohibited from
manufacturing telecommunications equipment as a result of deregulation, and (iv)
OEMs and other systems integrators, such as Pairgain Technologies, Inc., U.S.
Robotics Corporation, Ericsson, Inc., and Motorola, Inc.
The Company's success will depend on telcos' willingness to invest in
broadband digital services based on ADSL technology. The Company expects that
its ADSL products will compete not only with other products that increase the
efficiency of digital transmission technologies over copper wire, such as ISDN
for Internet access, but also with other broadband transmission technologies,
such as HFC, coaxial cable, fiber optic cable, digital broadcast satellite and
other wireless technologies. The Company believes its current and future
broadband products will permit telcos to upgrade their networks in a flexible
and cost effective way, but telcos may choose to deploy products using better
established technologies to upgrade their networks including fiber optic cable,
which many telcos favor. To the extent that telcos choose to install fiber optic
cable or other transmission media between central offices and end users, the
Company's business, financial condition and results of operations will be
materially adversely affected.
The Company believes that, in the ADSL market, its DMT-based products are
more flexible and will enjoy greater potential for deployment than products
using the CAP technique. However, CAP-based ADSL products were introduced prior
to the Company's products and are more readily available than the Company's
products.
To date, there has been only limited commercial deployment of the Company's
competitors' DMT-based ADSL products. Therefore, the Company is uncertain how
its products will compare with products sold by Amati and Orckit, each of whom
manufacture DMT-based ADSL products. Amati and Orckit have each made claims in
their sales literature and elsewhere suggesting that their products provide data
transmission rates that are equal to or faster than that of the Company's
products. However, there is no independent means by which the Company can
corroborate these claims.
In the HFC market, the Company is attempting to sell its products to system
integrators such as Tellabs, Inc., Northern Telecom Ltd., Scientific-Atlanta,
Inc. and General Instrument Corporation. The Company believes that these
companies have developed or are developing proprietary modulation schemes using
in-house technology that may be competitive with the Company's technology.
Although the Company believes that its DWMT technology will offer more robust
communications than these proprietary modulation schemes, the Company has not
manufactured any marketable products based on its DWMT technology, and there can
be no assurance that the Company will be able to do so or that a market or such
products will develop.
The markets for the Company's wavelet image compression technology are
competitive, and are expected to become increasingly so in the near future. In
addition, the Company's WSQ product is an implementation of an open standard and
is therefore subject to competition.
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Many of the Company's competitors and potential competitors, including the
RBOCs and Alcatel, have significantly greater financial, technological,
manufacturing, marketing and personnel resources than the Company. There can be
no assurance that the Company will be able to compete successfully or that
competition will not have a material adverse effect on the Company's business,
financial condition and results of operations. (See Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations -
FACTORS THAT MAY AFFECT FUTURE RESULTS.)
INTELLECTUAL PROPERTY
In the field of telecommunications technology, the Company holds three
patents for applying wavelet mathematics to communications systems. The Company
has five pending patent applications that pertain to the application of
multi-carrier technology to broadband communications. The Company also holds six
patents for image compression and processing, three patents for video
compression, two patents for audio compression and one patent for certain
optical applications.
Although the Company has patented certain aspects of its technology, the
Company relies primarily on know-how and trade secrets to protect its
intellectual property. The Company attempts to protect its trade secrets and
other proprietary information through agreements with its customers, suppliers,
employees and consultants, and through security measures. Each of the Company's
employees is required to sign a nondisclosure and noncompetition agreement.
Although the Company intends to protect its rights vigorously, there can be no
assurance that these measures will be successful. In addition, the laws of
certain countries in which products incorporating the Company's technology may
be developed, manufactured or sold may not protect the Company's products and
intellectual property rights to the same extent as the laws of the United
States.
While the Company's ability to compete may be affected by its ability to
protect its intellectual property, the Company believes that, because of the
rapid pace of technological change in the telecommunications industry, its
technical expertise and ability to introduce new products on a timely basis will
be more important in maintaining its competitive position than protection of its
existing intellectual property and that patent, trade secret and copyright
protections are important but must be supported by other factors such as the
expanding knowledge, ability and experience of the Company's personnel, new
technology and products, and product enhancements. Although the Company
continues to implement protective measures and intends to defend vigorously its
intellectual property rights, there can be no assurance that these measures will
be successful.
Many participants in the telecommunications industry have an increasing
number of patents and have frequently demonstrated a readiness to commence
litigation based on allegations of patent and other intellectual property
infringement. Third parties may assert exclusive patent, copyright and other
intellectual property rights to technologies that are important to the Company.
The Company has received letters from two companies, Amati and Telebit
Corporation ("Telebit"), each asserting that it owns certain U.S. and foreign
patents that are necessary for products that comply with the ANSI standard for
ADSL, claiming that the Company's ADSL technology would infringe such patents,
and offering the Company the opportunity to enter into a license agreement with
respect to such patents. The Company has been informed that ADI has received
similar letters. The Company has reviewed the Amati and Telebit patents and has
received an opinion of its patent counsel, based upon the Company's oral
description of its technology, to the effect that the Company's ADSL modem does
not infringe any valid
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claim of any of the Amati and Telebit patents. Based upon this opinion, the
Company believes that it does not require a license under the Amati or Telebit
patents in order to conduct its business.
Despite this opinion, there can be no assurance that a court to which the
issue is submitted would not find that the Company's products infringe the Amati
or Telebit patents, nor that Amati or Telebit will not continue to assert
infringement. If the Company is found to have infringed any of such patents, the
Company could be subject to substantial damages and/or an injunction preventing
it from conducting its proposed business, and the Company's business could be
materially and adversely affected. The Company has also received notice from
Amati of the pendency of various patent applications which Amati considers to be
pertinent to the design and operation of ADSL modems. Unless and until a patent
actually issues, there can be no infringement, and the Company has not examined
any such patent applications or received opinion of patent counsel with respect
thereto. Although Amati and Telebit have offered to license their patents and
their patent applications to the Company, there can be no assurance that any
license would be available on acceptable terms should the Company choose to
pursue such license or be found to infringe such patents. In addition, there can
be no assurance that other third parties will not assert infringement claims
against the Company in the future, that these assertions or those of Amati and
Telebit, will not result in protracted and costly litigation, or that the
Company would prevail in any such litigation or be able to license any valid
patents from third parties on commercially reasonable terms. Further, such
litigation, regardless of its outcome, could result in substantial costs to and
diversion of effort by the Company. Litigation may also be necessary to enforce
the Company's intellectual property rights. Any infringement claim or other
litigation against or by the Company could have a material adverse effect on the
Company's business, financial condition and results of operations. (See Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations - FACTORS THAT MAY AFFECT FUTURE RESULTS.)
EMPLOYEES
At December 31, 1996, the Company employed 53 people, including 35 in
research and development, 6 in sales and marketing, 3 in manufacturing, and 9 in
finance, information systems and administration. All of these employees were
based in Massachusetts. As necessary, the Company supplements its regular
employees with temporary and contract personnel. The Company believes that its
future success will depend in large part on the continued service of its
technical and senior management personnel and upon the Company's continuing
ability to attract and retain highly qualified technical, sales and marketing,
and managerial personnel. Competition for highly qualified personnel is intense,
and there can be no assurance that the Company will be able to retain its key
managerial and technical employees or that it will be able to attract and retain
additional highly qualified personnel in the future. None of the Company's
employees is represented by a labor union. The Company considers its employee
relations to be good.
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ITEM 2. PROPERTIES
The Company has two office facilities located in Bedford and Billerica,
Massachusetts. The Bedford location consists of 11,000 square feet and serves as
the Company's headquarters. The Company's sales and marketing, finance and
administration, manufacturing and image compression organizations are housed at
this location. The Company has occupied this space since June 1995 under a lease
that expires in 1998 with an option to renew for two additional one-year
periods.
The Company subleases approximately 16,000 square feet of space in
Billerica, which is located approximately 1.5 miles from the Bedford location.
This building is occupied by the Company's telecommunications research and
development organization. The Company has occupied this space since December
1996 under a lease that expires in 1997 with an option to renew for an
additional three months.
The Company believes that its facilities are substantially utilized, well
maintained and suitable for the products and services offered by the Company,
and that suitable space will be available as needed.
ITEM 3. LEGAL PROCEEDINGS
There are no pending legal proceedings to which the Company is a party or
to which any of its properties are subject which, either individually or in the
aggregate, are expected by the Company to have a material adverse effect on its
business, financial position or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of 1996.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company has one class of stock outstanding, its common stock, which has
a par value of $.01 per share. The Company's common stock is traded on the
Nasdaq National Market under the symbol AWRE. The following table sets forth the
high and the low sales prices as reported on the Nasdaq National Market from
August 9, 1996, the date of the Company's initial public offering, to December
31, 1996.
1996 HIGH LOW
- -------------------------------------------------------------
Third Quarter 19 10 1/2
Fourth Quarter 17 1/2 8 1/2
As of February 21, 1997, the Company had approximately 134 shareholders of
record. This number does not include shareholders from whom shares were held in
a "nominee" or "street" name. The Company has never paid cash dividends on its
common stock and anticipates it will continue to reinvest earnings to finance
future operations.
The Company did not sell any equity securities that were not registered
under the Securities Act during the three months ended December 31, 1996.
ITEM 6. SELECTED FINANCIAL DATA
The following selected historical financial data has been derived from the
Company's audited consolidated financial statements. The historical financial
data should be read in conjunction with the Company's consolidated financial
statements and notes thereto included in Item 8.
(in 000's, except per share data)
Year Ended December 31, 1996 1995 1994 1993 1992
- --------------------------------------------------------------------------------------------------
Statements of Operations Data
- -----------------------------
Revenue $ 5,301 $3,260 $ 3,827 $ 3,172 $ 1,908
Income (loss) from operations (538) (454) $(1,095) (1,028) (3,267)
Net income (loss) 259 (343) $(1,012) (992) (3,249)
Net income (loss) per share $ 0.01 $(0.17)
Balance Sheet Data
- ------------------
Cash and short-term investments $36,719 $2,154 $ 2,566 $ 186 $ 813
Working capital 38,280 2,516 2,877 281 1,114
Total assets 40,123 3,228 3,930 978 1,902
Total liabilities 676 309 684 493 405
Total stockholders' equity 39,446 2,920 3,246 485 1,497
- --------------------------------------------------------------------------------------------------
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain line
items from the Company's consolidated statements of operations as a percentage
of total revenue:
Year ended December 31, 1996 1995 1994
- --------------------------------------------------------------------------------
Revenue:
Product 12.3 % 12.5 % 4.7 %
License and royalty 56.0 31.8 26.4
Research and development 31.7 55.7 68.9
- --------------------------------------------------------------------------------
Total revenue 100.0 100.0 100.0
Costs and expenses:
Cost of product revenue 15.7 7.5 3.0
Research and development 61.0 71.6 91.3
Sales and marketing 14.5 12.6 8.6
General and administrative 18.9 22.3 25.8
- --------------------------------------------------------------------------------
Total costs and expenses 110.2 113.9 128.6
Income (loss) from operations (10.2) (13.9) (28.6)
Interest income 15.0 3.4 2.2
- --------------------------------------------------------------------------------
Net income (loss) 4.9 % (10.5)% (26.5)%
================================================================================
PRODUCT REVENUE
Product revenue consists primarily of revenue from the sale of tangible
products, such as ADSL modems and video editing chipset products, which are
manufactured by the Company or third party suppliers. Product revenue increased
by 60% from $406,000 in 1995 to $649,000 in 1996. Product revenue as a
percentage of total revenue was 12.3% and 12.5% in 1996 and 1995, respectively.
A year to year comparison of product revenue is not meaningful due to
differences in the composition of product revenue. Product revenue in 1996
consists primarily of revenue from the sale of the Company's ADSL Internet
access modems, which were introduced in early 1996. Product revenue in 1995
consists primarily of revenue from the sale of video editing chipset products,
which the Company discontinued in 1995.
Product revenue increased by 124% from $181,000 in 1994 to $406,000 in
1995. Product revenue in 1995 and 1994 was comprised of sales of video editing
chipset products. The increase in video editing chipset product revenue was
primarily due to significant orders from a customer purchasing large quantities
in 1995 before the Company discontinued that product line.
LICENSE AND ROYALTY REVENUE
License and royalty revenue consists primarily of revenue from the sale of
intellectual property, such as hardware and software technology licenses,
compression software licenses, and royalties from the sale of chipsets by
customers who have licensed the Company's technology. As such revenue has only a
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nominal cost of sale associated with it, the Company does not report a separate
cost of license and royalty revenue line in its Statements of Operations.
License and royalty revenue increased by 187% from $1,037,000 in 1995 to
$2,971,000 in 1996. License and royalty revenue as a percentage of total revenue
was 56.0% and 31.8% in 1996 and 1995, respectively. The increase in 1996 is
primarily attributable to an increase in the sale of ADSL and other broadband
technology licenses to telephone company equipment suppliers. Revenue from the
sale of compression software licenses also contributed to the increase in
license and royalty revenue in 1996. Approximately 51% of license and royalty
revenue in 1996 was received from three customers.
License and royalty revenue increased by 3% from $1,008,000 in 1994 to
$1,037,000 in 1995. The increase is primarily due to increased sales of
compression software licenses and royalty revenue in 1995, which was partially
offset by a decline in revenue from sales of technology licenses.
RESEARCH AND DEVELOPMENT REVENUE
Research and development revenue consists primarily of revenue from
commercial contract engineering and development, and government research
contracts. In 1993, the Company made a decision to reduce its government
research activities and focus on the commercialization of its technology. This
decision has resulted in lower research and development revenue and higher
product and license and royalty revenue, which explains why research and
development revenue as a percentage of total revenue has declined from 68.9% in
1994 to 55.7% in 1995 to 31.7% in 1996.
Research and development revenue decreased by 8% from $1,817,000 in 1995 to
$1,680,000 in 1996. The decrease is primarily due to lower revenue from
commercial research and development contracts and slightly lower revenue from
U.S. government research contracts. Research and development revenue decreased
by 31% from $2,637,000 in 1994 to $1,817,000 in 1995. The decrease is primarily
due to a significant decrease in U.S. government research revenue, which was
partially offset by an increase in commercial contract engineering revenue.
COST OF PRODUCT REVENUE
Cost of product revenue consists primarily of direct material, direct labor
and overhead costs to produce the Company's products, and cost of goods for
purchases of finished goods inventory from third party suppliers. Cost of
product revenue as a percentage of product revenue was 128% in 1996 as compared
to 60% in 1995. Such percentages primarily reflect the cost of modem revenue in
1996 and the cost of video editing chipset revenue in 1995. The cost of product
revenue in 1996 also includes a $365,000 provision for excess and obsolete
inventory related to modems. Excluding this charge, cost of product revenue as a
percentage of product revenue was 72%. Accordingly, a comparison of cost of
product revenue on a year to year basis is not meaningful due to differences in
the composition of product revenue.
Cost of product revenue increased by 115% from $113,000 in 1994 to $243,000
in 1995. As a percentage of product revenue, cost of product revenue decreased
from 62% in 1994 to 60% in 1995. The slight improvement in cost as a percentage
of product revenue is primarily due to marginally lower pricing from the third
party supplier of video editing chipset products as a result of higher volumes
in 1995.
RESEARCH AND DEVELOPMENT
Research and development expense consists primarily of employee and
consultant costs, supplies and allocated facilities costs related to the
development of the Company's products and technology. Research and development
expense increased by 39% from $2,333,000 in 1995 to $3,235,000 in 1996. The
increase in research and development expense is primarily attributable to higher
spending on projects to
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develop, enhance, and commercialize the Company's ADSL, VDSL, SDSL and HFC
broadband technologies. Higher spending on these projects was partially offset
by lower spending as a result of the discontinuance of research involving audio
compression technology and lower facilities costs as a result of the relocation
of the Company's facilities in June 1995. The Company anticipates that research
and development spending will grow significantly in 1997.
Research and development expense decreased by 33% from $3,492,000 in 1994
to $2,333,000 in 1995. The decrease is primarily due to the discontinuance, in
January 1995, of research and development efforts associated with audio
compression technology, lower facilities costs as a result of the relocation of
the Company's facilities in June 1995, and a reduction of U.S. government
research activity.
SELLING AND MARKETING
Selling and marketing expense consists primarily of salaries for sales and
marketing personnel, travel, product advertising, and allocated facilities
expense. Selling and marketing expense increased 87% from $412,000 in 1995 to
$769,000 in 1996. The increase is primarily due to the addition of sales
personnel and increased product advertising related to the Company's ADSL
Internet access modem. Selling and marketing expense increased 25% from $329,000
in 1994 to $412,000 in 1995. The increase is primarily due to increases in the
Company's sales force and product advertising. The Company anticipates that
selling and marketing expenses will increase significantly in 1997.
GENERAL AND ADMINISTRATIVE
General and administrative expense consists primarily of salaries for
administrative officers and support personnel, allocated facilities costs, and
professional services, such as legal and audit expenses. General and
administrative expense increased by 38% from $726,000 in 1995 to $1,004,000 in
1996. The increase is primarily attributable to additions to the Company's
management team and administrative infrastructure, and expenses associated with
becoming a public company. General and administrative expense decreased by 27%
from $988,000 in 1994 to $726,000 in 1995. The decrease is primarily due to
management and support staff reductions in January 1995.
INTEREST INCOME
Interest income increased 621% from $111,000 in 1995 to $798,000 in 1996
primarily as a result of higher average cash balances due to the investment of
net proceeds from the Company's initial public offering. Interest income
increased 34% from $83,000 in 1994 to $111,000 in 1995 primarily due to higher
average cash balances in 1995 as compared to 1994.
INCOME TAXES
The Company has made no provision for income taxes as it has a history of
net losses, which has resulted in tax loss carryforwards. As of December 31,
1996, the Company had net operating loss carryforwards of approximately
$9,773,000 and approximately $493,000 of research and development tax credit
carryforwards to offset future federal taxable income. To the extent not
utilized, the net operating loss and tax credit carryforwards expire between
2003 and 2011.
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LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1996, the Company had cash, cash equivalents and short-term
investments of $36.7 million, an increase of $34.5 million from the prior year.
The Company has funded its operations primarily from sales of common stock,
including an initial public offering in August 1996, which generated net
proceeds of $35.2 million. The Company also received proceeds of $1.1 million
from the issuance of common stock in connection with its stock option plans in
1996.
Cash used by operations was $586,000 in 1996. Accounts receivable and
unbilled accounts receivable increased $1.1 million from December 31, 1995. The
increase in total accounts receivable reflects increased revenue in 1996, as
well as the achievement of significant contract milestones and the closure of
several license agreements late in the year. Inventory balances increased
$408,000 from December 31, 1995, which reflects the purchase of raw materials to
manufacture ADSL modems in larger quantities.
Investment activities in 1996 included capital expenditures of $1.1
million. Capital investments included the purchase of engineering development
equipment, manufacturing equipment, and engineering and administrative software.
The Company purchased $5.6 million of short-term investments, which were placed
in highly rated corporate debt and U.S. agency securities.
While there can be no assurance that the Company will not require
additional financing, or that such financing will be available to the Company,
the Company believes that its financial resources are adequate to meet its
liquidity requirements over the next twelve months.
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FACTORS THAT MAY AFFECT FUTURE RESULTS
The statements contained in this Annual Report on Form 10-K which are not
historical are "forward looking statements" within the meaning of Section 27A of
the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. These forward-looking statements represent the
Company's present expectations or beliefs concerning future events, however the
Company cautions that such statements are qualified by important factors. Such
factors, which are identified under the heading "Risk Factors" below, could
cause actual results to differ materially from those indicated in Management's
Discussion and Analysis of Financial Condition and Results of Operations.
The Company believes that the occurrence of any one or some combination of
the following risk factors could have a material adverse effect on the Company's
business, financial condition and results of operations.
History of Operating Losses
The Company has incurred operating losses in every fiscal year since
inception. Substantial additional research and development expenses to enhance
the performance and reduce the manufacturing costs of the Company's products
will be required before market acceptance can be determined. Also, the Company
anticipates that substantial selling and marketing expenses will be required to
establish sales channels for the Company's products and technology. There can be
no assurance that the Company will achieve profitable operations in any future
period.
Dependence on Acceptance of ADSL Technology
The Company's future success is substantially dependent upon whether ADSL
technology gains widespread commercial acceptance by the telcos ("telcos") and
end users of telco services. The Company has invested substantial resources in
the development of ADSL technology implemented through the Discrete Multi-Tone
("DMT") modulation technique. Telcos have only begun evaluating DMT-based ADSL
technology, and there can be no assurance that the telcos will pursue the
deployment of such ADSL technology.
Reliance on Telcos; Dependence on a Limited Number of Customers
Even if telcos adopt policies favoring full-scale implementation of ADSL
technology, there can be no assurance that sales of the Company's ADSL products
will become significant. The Company's customers, including Regional Bell
Operating Companies ("RBOCs"), OEMs and other telcos, are relatively few in
number and have significantly greater resources than that of the Company. The
Company has limited ability to influence or control decisions made by these
customers. There can be no assurance that these customers will not use their
size and bargaining power to demand unfavorable terms and conditions (including
price), seek alternative suppliers, or undertake internal development of
products comparable to those of the Company's.
Substantial Dependence on Analog Devices, Inc.
The Company and Analog Devices, Inc. ("ADI") have entered into a series of
agreements to develop integrated chipsets based on the Company's technology. The
inability or refusal of ADI to manufacture, market and sell such chipsets in
substantial quantities would prevent telcos from adopting the Company's
technology and would have a material adverse effect on the Company's business.
There can be no assurance that ADI will succeed or, in the event that ADI is not
successful, that the Company would be able to find a substitute chipset
manufacturer without significant delays.
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Proprietary Technology; Risk of Third Party Claims of Infringement
The Company's ability to compete effectively will depend to a significant
extent on its ability to protect it proprietary information and to operate
without infringing the intellectual property rights of others. Despite the
precautions the Company has taken to protect its intellectual property, there
can be no assurance that such steps will be adequate to prevent the
misappropriation of its technology. In addition, third parties may assert
exclusive patent, copyright and other intellectual property rights to
technologies that are important to the Company. There can be no assurance that
other third parties will not assert such claims against the Company in the
future.
Rapid Technological Change; Dependence on New Products
The markets for the Company's products are characterized by rapid
technological advances, evolving industry standards, changes in end-user
requirements, frequent new product introductions, and evolving telco offerings.
The Company's business will be materially adversely affected if technologies or
standards on which Company's products are based become obsolete, or if the
Company is unable to develop and introduce new products in a timely manner in
response to changing market conditions.
Competition
The markets for the Company's products are intensely competitive and the
Company expects competition to increase in the immediate future. Many of the
Company's competitors and potential competitors have significantly greater
financial, technological, manufacturing, marketing and personnel resources than
the Company. There can be no assurance that the Company will be able to compete
successfully or that competition will not adversely affect the Company's
business.
Manufacturing
The Company has limited experience in manufacturing or in supervising the
manufacture of its products, including its ADSL modem. There can be no assurance
that the Company will not encounter significant difficulties in manufacturing or
controlling the quality of its products, or that its products will be reliable
in the field.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT ACCOUNTANTS
We have audited the accompanying consolidated balance sheets of Aware, Inc.
as of December 31, 1996 and 1995, and the related consolidated statements of
operations, stockholders' equity, and cash flows for each of the three years in
the period ended December 31, 1996. Our audits also included the financial
statement schedule listed in the Index at Item 14. These financial statements
and financial statement schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on the financial
statements and financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements present fairly, in
all material respects, the financial position of Aware, Inc. at December 31,
1996 and 1995, and the results of its operations and its cash flows for each of
the three years in the period ended December 31, 1996, in conformity with
generally accepted accounting principles. Also, in our opinion, such financial
statement schedule, when considered in relation to the basic consolidated
financial statements taken as a whole, present fairly, in all material respects,
the information set forth therein.
/s/ Deloitte & Touche LLP
Boston, Massachusetts
January 30, 1997
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AWARE, INC.
CONSOLIDATED BALANCE SHEETS
December 31, 1996 1995
- -----------------------------------------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 31,092,273 $ 2,153,681
Short-term investments 5,626,725 --
Accounts receivable (less allowance for doubtful
accounts of $35,000 in 1996 and $5,300 in 1995) 1,654,980 500,828
Unbilled accounts receivable 110,722 116,261
Inventories 447,534 39,713
Prepaid expenses 23,426 14,471
- -----------------------------------------------------------------------------------------------------------------
Total current assets 38,955,660 2,824,954
- -----------------------------------------------------------------------------------------------------------------
Property and equipment, net of accumulated depreciation and
amortization of $557,901 in 1996 and $1,480,614 in 1995 1,166,928 403,405
- -----------------------------------------------------------------------------------------------------------------
Total assets $ 40,122,588 $ 3,228,359
=================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 337,339 $ 111,519
Accrued expenses 60,091 65,404
Accrued compensation 173,692 67,887
Accrued professional 65,000 14,000
Deferred revenue 40,000 50,000
- -----------------------------------------------------------------------------------------------------------------
Total current liabilities 676,122 308,810
- -----------------------------------------------------------------------------------------------------------------
Stockholders' equity:
Preferred stock, $1.00 par value; 1,000,000 shares authorized,
none outstanding -- --
Preferred stock, $1.00 par value:
Series B convertible preferred stock, 15,875 shares authorized; issued
and outstanding, none in 1996 and 15,875 in 1995 -- 15,875
Series C convertible preferred stock, 13,525 shares authorized; issued
and outstanding, none in 1996 and 13,525 in 1995 -- 13,525
Series D convertible preferred stock, 74,800 shares authorized; issued
and outstanding, none in 1996 and 69,166 in 1995 -- 69,166
Series E convertible preferred stock, 45,000 shares authorized; issued
and outstanding, none in 1996 and 29,432 in 1995 -- 29,432
Common stock, $.01 par value; 30,000,000 shares authorized; issued
and outstanding, 18,959,897 in 1996 and 1,166,960 in 1995 189,600 11,670
Additional paid-in capital 50,025,548 13,807,945
Accumulated deficit (10,315,720) (10,575,102)
Treasury stock (452,962) (452,962)
- -----------------------------------------------------------------------------------------------------------------
Total stockholders' equity 39,446,466 2,919,549
- -----------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 40,122,588 $ 3,228,359
=================================================================================================================
The accompanying notes are an integral part of the financial statements.
24
25
AWARE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31, 1996 1995 1994
- --------------------------------------------------------------------------------------
Revenue:
Product $ 649,422 $ 406,459 $ 181,217
License and royalty 2,971,238 1,036,615 1,008,434
Research and development 1,680,449 1,816,820 2,637,199
- -------------------------------------------------------------------------------------
Total revenue 5,301,109 3,259,894 3,826,850
- -------------------------------------------------------------------------------------
Costs and expenses:
Cost of product revenue 831,241 242,983 112,925
Research and development 3,234,799 2,333,200 3,492,249
Selling and marketing 769,395 411,777 329,068
General and administrative 1,003,948 725,511 987,640
- -------------------------------------------------------------------------------------
Total costs and expenses 5,839,383 3,713,471 4,921,882
- -------------------------------------------------------------------------------------
Income (loss) from operations (538,274) (453,577) (1,095,032)
Interest income 797,656 110,615 82,683
- -------------------------------------------------------------------------------------
Net income (loss) before provision for 259,382 (342,962) (1,012,349)
income taxes
Provision for income taxes -- -- --
=====================================================================================
Net income (loss) $ 259,382 $ (342,962) $(1,012,349)
=====================================================================================
Net income (loss) per share $ 0.01 $ (0.17)
======================================================================
Weighted average number of
shares used in per share calculation 18,394,395 2,045,006
======================================================================
The accompanying notes are an integral part of the financial statements.
25
26
AWARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31, 1996 1995 1994
- ---------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income (loss) $ 259,382 $ (342,962) $ (1,012,349)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 352,715 200,701 206,140
Increase (decrease) from changes in assets and
liabilities:
Accounts receivable (1,154,152) 94,168 (326,756)
Unbilled accounts receivable 5,539 187,840 (55,603)
Inventories (407,821) (18,044) 25,071
Prepaid expenses (8,955) 59,071 (49,385)
Accounts payable 225,820 14,757 (115,045)
Accrued expenses 151,492 (350,150) 314,595
Deferred revenue (10,000) (39,720) (8,408)
- ----------------------------------------------------------------------------------------------------------
Net cash used in operating activities (585,980) (194,339) (1,021,740)
- ----------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Purchases of property and equipment (1,116,238) (234,131) (371,658)
Net purchases of short-term investments (5,626,725) - -
- ---------------------------------------------------------------------------------------------------------
Net cash used in investing activities (6,742,963) (234,131) (371,658)
- ---------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Proceeds from issuance of common stock, net of
issuance costs 36,267,535 16,023 9,500
Proceeds from issuance of preferred stock, net of
issuance costs - - 3,764,058
Proceeds from stockholders' loans - - 150,000
Repayment of stockholders' loans - - (150,000)
- ---------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 36,267,535 16,023 3,773,558
- ---------------------------------------------------------------------------------------------------------
Increase (decrease) in cash and cash equivalents 28,938,592 (412,447) 2,380,160
Cash and cash equivalents, beginning of period 2,153,681 2,566,128 185,968
- ---------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of period $31,092,273 $2,153,681 $ 2,566,128
=========================================================================================================
- ---------------------------------------------------------------------------------------------------------
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest $ 820 $ 877 $ 4,359
- ---------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------
SUPPLEMENTAL NONCASH DISCLOSURES:
Conversion of preferred stock to common stock $ 127,998 - -
Increase in notes receivable for accrued interest - - $ 25,413
Repurchase of Series D preferred shares for
cancellation of notes - $ 457,062 -
- ---------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of the financial statements.
26
27
AWARE, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Convertible Preferred Stock Additional
--------------------------------------------- Common Paid-In Accumulated
Series B Series C Series D Series E Stock Capital Deficit
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1993 $ 15,875 $ 13,525 $ 73,266 $ $ 11,401 $10,022,652 $ (9,219,791)
- ------------------------------------------------------------------------------------------------------------------------------------
Sale of 29,432 shares of Series E
convertible preferred stock,
net of issuance costs of $36,689 - - - 29,432 - 3,760,039 -
Exercise of common stock options, 10,000
shares - - - - 100 9,400 -
Accrued interest on notes receivable for
stock issuances - - - - - - -
Net loss - - - - - - (1,012,349)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1994 15,875 13,525 73,266 29,432 11,501 13,792,091 (10,232,140)
- ------------------------------------------------------------------------------------------------------------------------------------
Exercise of common stock options, 16,867
shares - - - - 169 15,854 -
Repurchase of Series D preferred stock,
4,100 shares - - (4,100) - - - -
Net loss - - - - - - (342,962)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1995 15,875 13,525 69,166 29,432 11,670 13,807,945 (10,575,102)
- ------------------------------------------------------------------------------------------------------------------------------------
Issuance of common stock in initial
public offering, net of
issuance costs, 3,910,000 shares - - - - 39,100 35,123,900 -
Exercise of common stock options,
1,083,162 shares - - - - 10,832 1,093,703 -
Conversion of preferred stock to common
stock, 12,799,800 shares (15,875) (13,525) (69,166) (29,432) 127,998 - -
Net income - - - - - - 259,382
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1996 $ - $ - $ - $ - $189,600 $50,025,548 $(10,315,720)
- ------------------------------------------------------------------------------------------------------------------------------------
Notes
Receivable Total
For Treasury Stockholders'
Issued Stock Stock Equity
- ---------------------------------------------------------------------------------------------------------
Balance, December 31, 1993 $(431,649) $ - $ 485,279
- ---------------------------------------------------------------------------------------------------------
Sale of 29,432 shares of Series E convertible
preferred stock, net of issuance costs of $36,689 - - 3,789,471
Exercise of common stock options, 10,000 shares - - 9,500
Accrued interest on notes receivable for
stock issuances (25,413) - (25,413)
Net loss - - (1,012,349)
- ---------------------------------------------------------------------------------------------------------
Balance, December 31, 1994 (457,062) - 3,246,488
- ---------------------------------------------------------------------------------------------------------
Exercise of common stock options, 16,867 shares - - 16,023
Repurchase of Series D preferred stock,
4,100 shares 457,062 (452,962) -
Net loss - - (342,962)
- ---------------------------------------------------------------------------------------------------------
Balance, December 31, 1995 - (452,962) 2,919,549
- ---------------------------------------------------------------------------------------------------------
Issuance of common stock in initial public
offering, net of issuance costs,
3,910,000 shares - - 35,163,000
Exercise of common stock options,
1,083,162 shares - - 1,104,535
Conversion of preferred stock to common
stock, 12,799,800 shares - - -
Net income - - 259,382
- ---------------------------------------------------------------------------------------------------------
Balance, December 31, 1996 $ - $(452,962) $39,446,466
=========================================================================================================
The accompanying notes are an integral part of the financial statements.
27
28
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF BUSINESS
Aware, Inc. (the "Company") designs, develops and markets
telecommunications software, chipsets and modems that incorporate
Asymmetric Digital Subscriber Line (ADSL), Very High Speed Digital
Subscriber Line (VDSL), Symmetric Digital Subscriber Line (SDSL), and
Hybrid Fiber Coaxial (HFC) technologies. Such broadband technologies are
designed to increase the speed of data communications over conventional
copper telephone lines and coaxial cable. The Company's products are
designed to allow telephone and cable companies to utilize their installed
bases of dedicated copper lines and coaxial cable to provide both
residential and business customers with interactive data transmission at
speeds much higher than currently available. The Company also offers image
compression software products.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION - The consolidated financial statements include the
accounts of Aware, Inc. and its subsidiary. All significant intercompany
transactions have been eliminated.
CASH AND CASH EQUIVALENTS - Cash and cash equivalents consist primarily of
demand deposits, money market funds, commercial paper, and discount notes
in highly liquid short-term instruments with original maturities of three
months or less from the date of purchase and are stated at cost, which
approximates market.
SHORT-TERM INVESTMENTS - The Company follows Statement of Financial
Accounting Standard ("SFAS") No. 115, "Accounting for Certain Investments
in Debt and Equity Securities ("SFAS 115"). The Company has the intent and
the ability to hold to maturity all securities that mature in less than one
year. Accordingly, these "held-to-maturity" securities have been recorded
at amortized cost. The Company has categorized all other securities as
"available-for-sale," since the Company may liquidate these investments
currently. SFAS 115 requires that unrealized gains and losses on
available-for-sale securities be excluded from earnings and reported in a
separate component of stockholders' equity. As of December 31, 1996, the
unrealized gain was immaterial.
The amortized cost of securities, which approximates fair value, consists
of the following at December 31, 1996:
----------------------------------------------------------------------------
MATURITY
LESS THAN ONE TO
TYPE OF SECURITY ONE YEAR FIVE YEARS TOTAL
----------------------------------------------------------------------------
Corporate debt securities $3,040,072 $1,602,023 $4,642,095
U.S. agency securities 984,630 - 984,630
----------------------------------------------------------------------------
Total $4,024,702 $1,602,023 $5,626,725
----------------------------------------------------------------------------
ALLOWANCE FOR DOUBTFUL ACCOUNTS - Accounts are charged to the allowance for
doubtful accounts as they are deemed uncollectible based on a periodic
review of the accounts. Bad debt expense was approximately $20,000, $5,000,
and $0 for 1996, 1995, and 1994, respectively.
28
29
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
INVENTORIES - Inventories are stated at the lower of cost or market with
cost being determined by the first-in, first-out ("FIFO") method.
PROPERTY AND EQUIPMENT - Property and equipment are stated at cost.
Depreciation and amortization of property and equipment is provided using
the straight-line method over the estimated useful lives of the assets (3
to 5 years).
REVENUE RECOGNITION - Product revenue consists primarily of revenue from
the sale of tangible products, such as modems and compression chipsets.
Revenue is recognized upon shipment.
License and royalty revenue consists primarily of revenue from the sale of
intellectual property, such as hardware and software technology licenses,
compression software licenses, and royalties from the sale of chipsets by
customers who have licensed the Company's technology. Revenue from the sale
of technology licenses for the initial transfer of hardware and software
designs is recognized when a definitive agreement is reached, the transfer
has been effected, and no contingent factors are present. Revenue from the
sale of compression software licenses is recognized upon shipment. Royalty
revenue is recognized based upon billing schedules when no right to return
exists or upon sales reports from customers.
Research and development revenue is comprised of revenue from government
and commercial research and development contracts. Revenue on government
contracts is generally recognized when services are performed. Certain
long-term contracts are accounted for using the percentage-of-completion
method, whereby revenue and profit are recognized throughout the
performance period of the contract based on the ratio that incurred costs
bear to established total costs to complete. Losses, if any, on contracts
are provided for in the period in which the losses are first identified.
Revenue on commercial contracts is generally recognized as research is
performed under the terms of the respective agreements.
Unbilled accounts receivable are stated at estimated realizable value.
These amounts will be billable to customers based on the terms of contracts
which include achievement of milestones or completion of the contract.
INCOME TAXES - The Company accounts for income taxes under SFAS No. 109,
"Accounting for Income Taxes." This Statement requires the Company to
compute deferred income taxes based on the differences between the
financial statement and tax basis of assets and liabilities using enacted
rates in effect in the years in which the differences are expected to
reverse.
CAPITALIZATION OF SOFTWARE COSTS - The Company capitalizes certain
internally generated software development costs after technological
feasibility of the product has been established. Capitalized software costs
also include amounts paid for purchased software which has reached
technological feasibility. Such costs are amortized, on a
product-by-product basis, on a straight-line basis over their useful
economic lives (generally two to four years), or the ratio of current gross
revenues to total gross current and future revenues, whichever is greater.
There were no capitalized software costs at December 31, 1995 and 1996,
because such costs incurred subsequent to the establishment of
technological feasibility, but prior to commercial availability, were
immaterial.
CONCENTRATION OF RISK - At December 31, 1996 and 1995, the Company had bank
cash balances and money market investments, in excess of federally insured
deposit limits of approximately $36,619,000 and $2,079,000, respectively.
29
30
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Concentration of credit risk with respect to accounts receivable is limited
to $549,000, $275,000, and $155,000 with three customers at December 31,
1996 and to $250,000 with one customer at December 31, 1995.
STOCK-BASED COMPENSATION - The Company grants stock options for a fixed
number of shares to employees with an exercise price equal to the fair
value of the shares at the date of grant. The Company adopted SFAS No. 123,
"Accounting for Stock-Based Compensation" on January 1, 1996. As permitted
by SFAS No. 123, the Company accounts for stock option grants in accordance
with Accounting Principles Board ("APB") Opinion No. 25, "Accounting for
Stock Issued to Employees." Accordingly, the Company recognized no
compensation expense for stock option grants.
NET INCOME (LOSS) PER SHARE - Net income (loss) per share (pro forma for
1995) is based on the weighted average number of common and dilutive common
equivalent shares (common stock options and convertible preferred stock)
outstanding. Common equivalent shares are not included in the per share
calculations for the year ended December 31, 1995, because the effect of
their inclusion would be antidilutive, except in accordance with Securities
and Exchange Commission Staff Accounting Bulletin No. 83. The Bulletin
requires all common shares issued and options to purchase shares of common
stock granted by the Company during the twelve-month period prior to the
filing of a proposed initial public offering to be included in the
calculation as if they were outstanding for all periods. Fully diluted net
income (loss) per share is not presented as the dilutive effect is
immaterial.
USE OF ESTIMATES - The preparation of the Company's financial statements in
conformity with generally accepted accounting principles necessarily
requires management to make estimates and assumptions that effect the
reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the balance sheet date. Significant estimates
include reserves for doubtful accounts, reserves for excess and obsolete
inventory, useful lives of fixed assets, valuation allowance for deferred
income tax assets and accrued liabilities. Actual results may differ from
these estimates.
FAIR VALUE OF FINANCIAL INSTRUMENTS - SFAS No. 107, "Disclosures About Fair
Value of Financial Instruments," requires disclosure of the fair value of
certain financial instruments. The carrying amounts of cash and cash
equivalents, short-term investments, accounts receivable, accounts payable
and accrued expenses approximate fair value because of their short-term
nature.
ACCOUNTING FOR LONG-LIVED ASSETS - The Company adopted SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of", in 1996. This Statement establishes accounting
standards for the impairment of long-lived assets, certain identifiable
intangibles, and goodwill related to those assets to be held and used and
for long-lived assets and certain identifiable intangibles to be disposed
of. Adoption did not have a material effect on the Company's financial
position or results of operations.
RECLASSIFICATIONS - Certain prior year amounts have been reclassified to be
consistent with the current year presentation.
30
31
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. INVENTORY
Inventory consists primarily of the following at December 31:
1996 1995
-----------------------------------------------------------
Raw materials $408,643 $39,713
Work-in-process 38,891 -
Finished goods - -
-----------------------------------------------------------
Total $447,534 $39,713
===========================================================
4. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following at December 31:
1996 1995
-----------------------------------------------------------------------------------
Computer equipment $ 983,819 $ 1,556,790
Office equipment 83,917 88,390
Furniture and fixtures 124,677 106,499
Purchased software 375,467 117,638
Manufacturing equipment 118,998 --
Leasehold improvements 37,951 14,702
-----------------------------------------------------------------------------------
Total 1,724,829 1,884,019
Less accumulated depreciation and amortization (557,901) (1,480,614)
-----------------------------------------------------------------------------------
Net $1,166,928 $ 403,405
===================================================================================
In 1996, the Company removed from the accounts approximately $1,275,000 of
fully depreciated assets, which were no longer in service.
5. INCOME TAXES
Deferred income tax assets at December 31 are attributable to the
following:
1996 1995
------------------------------------------------------------------------------------------------
Depreciation $ 69,000 $ 75,000
Accrued expenses 187,000 28,000
Deferred revenue 22,000 21,000
Alternative minimum tax credit 6,000 -
Federal net operating loss carryforwards 3,367,000 3,383,000
State net operating loss carryforwards 518,000 587,000
Research and development and other tax credit carryforwards 761,000 576,000
------------------------------------------------------------------------------------------------
Total 4,930,000 4,670,000
Valuation allowance (4,930,000) (4,670,000)
------------------------------------------------------------------------------------------------
Net $ - $ -
===============================================================================================
31
32
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A valuation allowance is provided against temporary deductible differences,
net operating loss carryforwards and tax credits which are not likely to be
realized. During 1996 and 1995, the net valuation allowance was changed to
fully reserve gross deferred tax assets.
A reconciliation of the U.S. federal statutory rate to the effective tax
rate is as follows:
1996 1995 1994
-----------------------------------------------------------------------------------
Federal statutory rate 34 % (34)% (34)%
State rate, net of federal benefit 6 (6) (6)
Operating losses with no current tax benefit - 40 40
Tax benefit from the utilization of net
operating loss carryforwards (40) - -
-----------------------------------------------------------------------------------
Effective tax rate - % - % - %
===================================================================================
At December 31, 1996, the Company had available federal net operating loss
carryforwards of approximately $9,773,000 which expire in 2004 through
2010, and federal research and development credit carryforwards of
approximately $493,000 which expire in 2003 through 2011. The Company also
had available state net operating loss carryforwards of approximately
$5,448,000 which expire in 1997 through 2000 and state research and
development and investment tax credit carryforwards of approximately
$268,000 which expire in 2006 through 2011.
6. STOCKHOLDERS' EQUITY
COMMON STOCK - In 1996, the Company increased the number of shares of
authorized common stock from 18,650,000 to 30,000,000.
In August 1996, the Company completed an initial public offering of its
common stock consisting of 3,910,000 shares at $10.00 per share. Proceeds
to the Company, net of issuance costs, were approximately $35,163,000
(issuance costs were approximately $3,937,000).
In accordance with the terms of the underlying agreements, all outstanding
shares of Series B, C, D, and E convertible preferred stock were
automatically converted into common stock upon completion of the initial
public offering.
PREFERRED STOCK - In 1996, the Company authorized 1,000,000 shares of $1.00
par value preferred stock.
NOTES RECEIVABLE FOR STOCK ISSUANCES - In December 1992, the Company issued
4,100 shares of Series D preferred stock to two officers of the Company in
exchange for notes receivable totaling $410,000. Interest was payable
quarterly at the applicable federal rate (approximately 5.3% at December
31, 1994). At December 31, 1994, unpaid interest on the notes amounted to
$47,062. The notes were secured by the related Series D preferred stock.
Upon the resignation of the two officers from the Company in March 1995,
the Company accepted the Series D preferred stock in payment of the notes
and unpaid interest thereon.
32
33
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. STOCK COMPENSATION PLANS
At December 31, 1996, the Company has three stock-based compensation plans,
which are described below. The Company applies APB Opinion 25 and related
Interpretations in accounting for its plans. Accordingly, no compensation
cost has been recognized for its fixed stock option plans and its employee
stock purchase plan. The Company has no performance-based stock option
plans. Had compensation cost for the Company's three stock-based
compensation plans been determined based on the fair value at the grant
dates for awards under those plans consistent with the method of SFAS 123,
the Company's net income (loss) and per share amounts would have been
adjusted to the pro forma amounts indicated below:
Year ended December 31, 1996 1995
---------------------------------------------------------------------------------------------
Net income (loss)
As reported $ 259,382 $(342,962)
Pro forma $(4,405,824) $(580,611)
Primary earnings (loss) per share
As reported $ 0.01 $ (0.17)
Pro forma $ ($0.24) $ (0.28)
Fully diluted earnings (loss) per share
As reported $ 0.01 $ (0.17)
Pro forma $ (0.24) $ (0.28)
The fair value of each option grant in the pro forma presentation is
estimated on the date of grant using the Black-Scholes option-pricing
model. The following assumptions were used to determine the pro forma
compensation cost of option grants in 1996 and 1995 for both stock option
plans: dividend yield of 0%; expected volatility of 97%; risk-free interest
rates of 6.25%; and expected lives of four years.
FIXED STOCK OPTION PLANS - The Company has two fixed option plans. Under
the 1990 Incentive and Nonstatutory Stock Option Plan, the Company may
grant incentive stock options or nonqualified stock options to its
employees and directors for up to 2,873,002 shares of common stock. Under
the 1996 Stock Option Plan, the Company may grant incentive stock options
or nonqualified stock options to its employees and directors for up to
3,000,000 shares of common stock. Under both plans, options: are granted at
an exercise price as determined by the Board of Directors; have a maximum
term of ten years; and generally vest on a monthly basis over three years.
33
34
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A summary of the status of the Company's two fixed stock option plans as of
December 31, 1996, 1995, and 1994, and changes during the years ending on
those dates is presented below:
1996 1995 1994
----------------------------- ---------------------------- -----------------------------
Wgtd. Avg. Wgtd. Avg. Wgtd. Avg.
Shares Exer. Price Shares Exer. Price Shares Exer. Price
----------------------------- ---------------------------- -----------------------------
Outstanding at
beginning of year 2,757,500 $ 1.21 2,481,948 1.45 1,533,448 $ .98
Granted 1,818,250 9.10 1,139,750 1.30 1,138,000 1.45
Exercised 1,083,162 1.02 16,867 .95 10,000 .95
Forfeited 96,180 14.54 847,331 1.90 179,500 1.90
---------- ---------- ---------
Outstanding at
end of year 3,396,408 7.71 2,757,500 1.21 2,481,948 1.45
========== ========== =========
Options exercisable at year
end 1,343,617 1,447,474 1,378,633
Weighted-average fair value
of options granted during
the year $ 6.07 $ 0.92
The following table summarizes information about stock options outstanding at
December 31, 1996:
Options Outstanding Options Exercisable
---------------------------------------------------------- -----------------------------------------
Number Weighted-Avg. Number
Range of Outstanding Remaining Weighted-Avg. Exercisable Weighted-Avg.
Exercise Prices at 2/31/96 Contractual Life Exercise Price at 12/31/96 Exercise Price
- --------------- ---------------------------------------------------------- -----------------------------------------
$ 0 to 1 40,400 4.85 years $ .95 40,400 $ .95
1 to 2 1,620,258 8.07 1.30 910,173 1.30
8 to 9 1,456,000 9.39 8.25 388,671 8.25
10 to 11 279,750 9.93 $10.25 4,373 $10.25
- ------------------------------------------------------------------------------- ----------------------------------------
3,396,408 8.83 $ 7.71 1,343,617 $ 6.37
=============================================================================== =========================================
EMPLOYEE STOCK PURCHASE PLAN - In June 1996, the Company adopted an
Employee Stock Purchase Plan (the "ESPP Plan") under which eligible
employees may purchase common stock at a price equal to 85% of the lower of
the fair market value of the common stock at the beginning or end of each
six month offering period. Participation in the ESPP Plan is limited to 6%
of an employee's compensation, may be terminated at any time by the
employee and automatically ends on termination of employment with the
Company. A total of 100,000 shares of common stock have been reserved for
issuance. During 1996, no shares of common stock were issued under this
plan, as the Company had not commenced implementation of the plan.
34
35
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. COMMITMENTS
LEASE COMMITMENTS - During December 1994, management of the Company decided
to relocate its office and research facilities and initiated negotiations
to terminate its lease. In March 1995, the Company completed negotiations
to terminate the lease effective May 31, 1995. The Company's cost to
terminate the lease of approximately $180,000 was included in rent expense
in 1994.
The Company entered into a three year noncancelable operating lease for its
office and research facilities commencing June 1, 1995. The lease provides
that the Company pay a base monthly rental of $10,500, plus, as additional
rent, a proportionate annual share of the building common expenses and real
estate taxes in excess of a specified amount.
In November 1996, the Company entered into a twelve month operating lease
for additional space for its research facilities commencing December 1,
1996. The lease provides that the Company pay a total monthly rental of
$18,600, which includes the rental of furniture from the lessor.
Rental expense approximated $143,000, $283,000, and $494,000 in 1996, 1995
and 1994, respectively.
Future annual minimum lease payments under the leases are as follows:
Year
------------------------------------
1997 $330,000
1998 52,000
------------------------------------
Total $382,000
====================================
LITIGATION - There are no material pending legal proceedings to which the
Company is a party or to which any of its properties are subject which,
either individually or in the aggregate, are expected by the Company to
have a material adverse effect on its business, financial position or
results of operations.
9. TRANSACTIONS WITH RELATED PARTIES
CONSULTING AGREEMENTS - The Company pays consulting fees for scientific
research and development services provided by certain stockholders. The
total charges from related parties approximated $8,000, $66,000, and
$27,000 in 1996, 1995 and 1994, respectively. There were no amounts due to
related parties at December 31, 1996 and 1995.
35
36
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. MAJOR CUSTOMERS
The portion of total revenue that was derived from major customers was as
follows:
1996 1995 1994
--------------------------------------------------------------
Customer A 17% 23% 10%
Customer B 12% 12% 38%
Customer C 22% - -
Customer D 10% - -
Customer E - 18% -
Customer F - 10% -
11. EMPLOYEE BENEFIT PLAN
In 1994, the Company established a qualified 401(k) Retirement Plan (the
"Plan") under which employees are allowed to contribute certain percentages
of their pay, up to the maximum allowed under Section 401(k) of the
Internal Revenue Code. Company contributions to the Plan are at the
discretion of the Board of Directors. There were no Company contributions
in 1996, 1995 and 1994.
12. QUARTERLY RESULTS OF OPERATIONS - UNAUDITED
The following table presents unaudited quarterly operating results for each
of the Company's eight quarters in the two-year period ended December 31,
1996:
1996
- ----------------------------------------------------------------------------------
Quarters ended March 31, June 30 Sept. 30 Dec. 31
-------------------------------------------------
Revenue $962,003 $1,128,475 $1,505,820 $1,704,811
Income (loss) from operations 17,651 18,300 4,250 (578,475)
Net income (loss) 41,151 48,668 261,683 (92,120)
- ----------------------------------------------------------------------------------
Net income (loss) per share $ 0.00 $ 0.00 $ 0.01 $ 0.00
==================================================================================
1995
- ----------------------------------------------------------------------------------
Quarters ended March 31, June 30 Sept. 30 Dec. 31
-------------------------------------------------
Revenue $ 950,376 $ 361,575 $963,498 $984,445
Income (loss) from operations (115,837) (562,514) 155,034 69,740
Net income (loss) (87,213) (530,282) 179,965 94,568
- ----------------------------------------------------------------------------------
Net income (loss) per share $ ( 0.04) $ (0.26) $ 0.01 $ 0.01
==================================================================================
36
37
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
37
38
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information with respect to Directors and Executive Officers and compliance
with Section 16(a) of the Exchange Act may be found in the sections captioned
"Directors and Executive Officers" and "Section 16(a) Beneficial Ownership
Reporting Compliance" appearing in the Company's definitive Proxy Statement to
be delivered to shareholders in connection with the Annual Meeting of
Shareholders to be held on Wednesday, May 21, 1997. Such information is
incorporated herein by reference.
EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of the Company as of February 28, 1997 are:
NAME AGE POSITION
---- --- --------
James C. Bender .............. 44 President, Chief Executive Officer, and Director
David C. Hunter .............. 41 Senior Vice President, Product Development
Richard P. Moberg ............ 41 Chief Financial Officer and Treasurer
Edmund C. Reiter ............. 33 Vice President, Advanced Products
Michael A. Tzannes ........... 35 Senior Vice President, Telecommunications
James C. Bender has been President, Chief Executive Officer and a director of
the Company since October 1994. From April 1992 to February 1994, Mr. Bender
served as President and Chief Executive Officer of Logicraft, Inc., a network
service provider. From 1986 to April 1992, Mr. Bender serviced as Logicraft's
President and Chief Operating Officer. Mr. Bender received an M.B.A. from the
Harvard Graduate School of Business Administration and a B.S. from Lowell
Technological Institute.
David C. Hunter joined the Company in May 1996 as Senior Vice President, Product
Development. From 1982 to April 1996, Mr. Hunter served as Vice President,
Research and Development of I.D.E. Corporation ("IDEA"), a manufacturer of data
communications equipment. Mr. Hunter was a founder and director of IDEA. Mr.
Hunter received an M.B.A. with high distinction from the Harvard Graduate School
of Business Administration and a B.S. with distinction from Cornell University.
Richard P. Moberg joined the Company in June 1996 as Chief Financial Officer and
Treasurer. From December 1990 to June 1996, Mr. Moberg held a number of
positions at Lotus Development Corporation, a computer software developer,
including Corporate Controller from June 1995 to June 1996, Assistant Corporate
Controller from May 1993 to June 1995, and Director of Financial Services from
December 1990 to May 1993. Mr. Moberg received an M.B.A. from Bentley College
and a B.B.A. in accounting from the University of Massachusetts at Amherst.
Edmund C. Reiter has been the Company's Vice President, Advanced Products since
August 1995. Prior to that, he served as the Company's Manager of Product
Development for still image compression products from June 1994 to August 1995,
as a Senior Member of the Company's Technical Staff from November 1993 to June
1994, and as a Member of the Technical Staff from December 1992 to November
1993. Dr. Reiter served as Senior Scientist at New England Research, Inc. from
January 1991 to October 1992. Dr. Reiter received a B.S. from Boston College and
a Ph.D. from the Massachusetts Institute of Technology.
38
39
Michael A. Tzannes has been the Company's Senior Vice President,
Telecommunications since April 1996. Dr. Tzannes served as the Company's Vice
President, Telecommunications from December 1992 to April 1996, as a Senior
Member of the Company's Technical Staff from January 1991 to November 1992, and
as a consultant to the Company from October 1990 to December 1990. From 1986 to
1990, he was a Staff Engineer at Signatron, Inc., a telecommunications
technology and systems developer. Dr. Tzannes received a Ph.D. in electrical
engineering from Tufts University, an M.S. from the University of Michigan at
Ann Arbor, and a B.S. from the University of Patras, Greece.
ITEM 11. EXECUTIVE COMPENSATION
Information with respect to this item may be found in the section captioned
"Compensation of Directors and Executive Officers" appearing in the Company's
definitive Proxy Statement to be delivered to shareholders in connection with
the Annual Meeting of Shareholders to be held on Wednesday, May 21, 1997. Such
information is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information with respect to this item may be found in the section captioned
"Security Ownership of Certain Beneficial Owners and Management" appearing in
the Company's definitive Proxy Statement to be delivered to shareholders in
connection with the Annual Meeting of Shareholders to be held on Wednesday, May
21, 1997. Such information is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information with respect to this item may be found in the section captioned
"Certain Transactions" appearing in the Company's definitive Proxy Statement to
be delivered to shareholders in connection with the Annual Meeting of
Shareholders to be held on Wednesday, May 21, 1997. Such information is
incorporated herein by reference.
39
40
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K
(A) (1) INDEX TO FINANCIAL STATEMENTS
The following consolidated financial statements are included in Part II, Item 8:
Page
----
Report of the Independent Accountants ................................ 23
Consolidated Balance Sheets as of December 31, 1996 .................. 24
Consolidated Statements of Operations for each of the three 25
years ended December 31, 1996 ....................................
Consolidated Statements of Cash Flows for each of the 26
three years ended December 31, 1996 ..............................
Consolidated Statements of Stockholders Equity for each of 27
the three years ended December 31, 1996 ..........................
Notes to Consolidated Financial Statements ........................... 28
(2) INDEX TO FINANCIAL STATEMENT SCHEDULE
Page
----
Schedule II - Valuation and Qualifying Accounts ...................... 42
Schedules other than those listed above have been omitted since they
are either not required or not applicable or the information is
otherwise included.
(3) INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION OF EXHIBIT
---------- ----------------------
3.1 Amended and Restated Articles of Organization (filed as Exhibit
3.2 to the Company's Registration Statement on Form S-1, File No.
333-6807 and incorporated herein by reference).
3.2 Amended and Restated By-Laws (filed as Exhibit 3.3 to the
Company's Form 10Q for the quarter ended June 30, 1996
and incorporated herein by reference).
10.1 1990 Incentive and Non-Statutory Stock Option Plan (filed as
Exhibit 10.2 to the Company's Registration Statement on Form S-1,
File No. 333-6807 and incorporated herein by reference).
10.2 1996 Stock Option Plan (filed as Exhibit 10.3 to the Company's
Registration Statement on Form S-1, File No. 333-6807 and
incorporated herein by reference).
10.3 1996 Employee Stock Purchase Plan (filed as Exhibit 10.4 to the
Company's Registration Statement on Form S-1, File No. 333-6807
and incorporated herein by reference).
10.4 License Agreement with Analog Devices, Inc., dated
September 25, 1993,
40
41
together with appendices thereto (filed as Exhibit 10.5 to the
Company's Registration Statement on Form S-1, File No. 333-6807
and incorporated herein by reference).
10.5 Development Contract with Analog Devices, Inc., dated
September 25, 1993, together with amendments thereto (filed as
Exhibit 10.6 to the Company's Registration Statement on Form S-1,
File No. 333-6807 and incorporated herein by reference).
10.6 Agreement with DSC Telecom L.P., dated March 6, 1996, (filed as
Exhibit 10.7 to the Company's Registration Statement of Form S-1,
File No. 333-6807 and incorporated herein by reference).
10.7 Lease Agreement dated April 3, 1995, with respect to real
property located at One Oak Park, Bedford, Massachusetts, between
R.W. Connelly as lessor and the Company as lessee (filed as
Exhibit 10.11 to the Company's Registration Statement on Form
S-1. File No. 333-6807 and incorporated herein by reference).
10.8* Employment Agreement of James C. Bender, dated October 27, 1994,
together with amendment thereto dated December 20, 1996.
10.9 Form of Director Indemnification Agreement (filed as Exhibit
10.13 to the Company's Registration Statement on Form S-1, File
No. 333-6807 and incorporated herein by reference).
10.10* Sublease Agreement dated November 15, 1996, with respect to real
property located at 39 Manning Road, Billerica, Massachusetts,
between Bay Networks, Inc. as sublandlord and the Company as
sublessee.
11.1* Computation of primary and fully diluted net income (loss) per
share.
21.1* Subsidiaries of Registrant
23.1* Consent of Independent Accountants
* Filed herewith.
(B) Reports on Form 8-K
No reports on Form 8-K were filed during the fourth quarter of 1996.
41
42
SCHEDULE II
AWARE, INC.
VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 31, 1996, 1995, 1994
- ---------------------------------------------------------------------------------------
COL. A COL. B COL. C (1) COL. C (2) COL. D COL. E
- ---------------------------------------------------------------------------------------
ADDITIONS
---------------------
BALANCE AT CHARGED TO CHARGED DEDUCTIONS BALANCE
BEGINNING COSTS AND TO OTHER CHARGED TO AT END
OF PERIOD EXPENSES ACCOUNTS RESERVES OF PERIOD
- ---------------------------------------------------------------------------------------
Accounts receivable
allowances:
1996 .................... $5,300 $ 19,698 $20,000 $ 9,998 $ 35,000
1995 .................... - $ 5,300 - - $ 5,300
1994 .................... - - - - -
Inventory reserves:
1996 ................... - $365,000 - $65,000 $300,000
1995 ................... - - - - -
1994 ................... - - - - -
42
43
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
AWARE, INC.
By: /s/ James C. Bender
--------------------
James C. Bender, Chief Executive Officer &
President
Date: March 26, 1997
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities indicated on the 26th day of March 1997.
SIGNATURE TITLE
--------- -----
/s/ James C. Bender Chief Executive Officer, President, and Director
- --------------------------- (Principal Executive Officer)
James C. Bender
/s/ Richard P. Moberg Chief Financial Officer, Treasurer
- --------------------------- (Principal Financial and Accounting Officer)
Richard P. Moberg
/s/ Charles K. Stewart Chairman of the Board of Directors
- ---------------------------
Charles K. Stewart
/s/ Jerald G. Fishman Director
- ---------------------------
Jerald G. Fishman
/s/ John K. Kerr Director
- ---------------------------
John K. Kerr
/s/ John S. Stafford, Jr. Director
- ---------------------------
John S. Stafford, Jr.
43