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                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-Q

             QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
                         SECURITIES EXCHANGE ACT OF 1934

                       FOR THE QUARTER ENDED JUNE 30, 2003

                        COMMISSION FILE NUMBER 000-21129


                                   AWARE, INC.
                                   -----------
             (Exact Name of Registrant as Specified in Its Charter)


          MASSACHUSETTS                                  04-2911026
          -------------                                  ----------
(State or Other Jurisdiction of             (I.R.S. Employer Identification No.)
Incorporation or Organization)


              40 MIDDLESEX TURNPIKE, BEDFORD, MASSACHUSETTS, 01730
              ----------------------------------------------------
                    (Address of Principal Executive Offices)
                                   (Zip Code)


                                 (781) 276-4000
                                 --------------
              (Registrant's Telephone Number, Including Area Code)


Indicate by check whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES  X  NO
                                       ---    ---

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2). YES  X  NO
                            ---    ---

Indicate the number of shares outstanding of the issuer's common stock as of
July 31, 2003:

                  CLASS                       NUMBER OF SHARES OUTSTANDING
                  -----                       ----------------------------
Common Stock, par value $0.01 per share            22,717,784 shares


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                                   AWARE, INC.
                                    FORM 10-Q
                       FOR THE QUARTER ENDED JUNE 30, 2003

                                TABLE OF CONTENTS
                                                                          Page
                                                                          ----
PART I   FINANCIAL INFORMATION

Item 1.  Consolidated Financial Statements

         Consolidated Balance Sheets as of
         June 30, 2003 and December 31, 2002.......................         3

         Consolidated Statements of Operations for the
         Three and Six Months Ended June 30, 2003
         and June 30, 2002.........................................         4

         Consolidated Statements of Cash Flows for the
         Six Months Ended June 30, 2003
         and June 30, 2002.........................................         5

         Notes to Consolidated Financial Statements................         6

Item 2.  Management's Discussion and Analysis of Financial
         Condition and Results of Operations.......................        11

Item 3.  Quantitative and Qualitative Disclosures about
         Market Risk...............................................        24

Item 4.  Controls and Procedures...................................        25

PART II  OTHER INFORMATION

Item 1.  Legal Proceedings.........................................        26

Item 4.  Submission of Matters to a Vote of Security Holders.......        26

Item 6.  Exhibits and Reports on Form 8-K..........................        27

         Signatures................................................        27


                                       2




                                               PART I. FINANCIAL INFORMATION
                                         ITEM 1: CONSOLIDATED FINANCIAL STATEMENTS
                                                        AWARE, INC.
                                                CONSOLIDATED BALANCE SHEETS
                                      (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
                                                        (UNAUDITED)


                                                                                         JUNE 30,           DECEMBER 31,
                                                                                           2003                 2002
                                                                                     ----------------     ----------------
                                                           ASSETS
                                                                                                    
Current assets:
     Cash and cash equivalents................................................             $21,715              $25,268
     Short-term investments...................................................              14,950                8,034
     Accounts receivable, net.................................................                 871                1,258
     Inventories..............................................................                 357                   50
     Prepaid expenses and other assets........................................                 383                  530
                                                                                     ----------------     ----------------
           Total current assets                                                             38,276               35,140
                                                                                     ----------------     ----------------

Property and equipment, net...................................................               9,437               10,038
Investments...................................................................               6,428               13,816
Other assets, net.............................................................                 155                  243
                                                                                     ----------------     ----------------

           Total assets.......................................................             $54,296              $59,237
                                                                                     ================     ================

                                            LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
     Accounts payable........................................................                 $379                 $274
     Accrued expenses ........................................................                 119                  213
     Accrued compensation ....................................................                 798                  965
     Accrued professional.....................................................                  92                   65
     Deferred revenue.........................................................                 100                  142
                                                                                     ----------------     ----------------
             Total current liabilities........................................               1,488                1,659
                                                                                     ----------------     ----------------

Stockholders' equity:
      Preferred stock, $1.00 par value; 1,000,000 shares authorized,
             none outstanding.................................................                   -                    -
      Common stock, $.01 par value; 70,000,000 shares authorized; issued
             and outstanding, 22,717,784 in 2003 and 22,698,171 in 2002......                  227                  227
      Additional paid-in capital..............................................              77,338               77,301
      Accumulated deficit....................................................              (24,757)             (19,950)
                                                                                     ----------------     ----------------
             Total stockholders' equity......................................               52,808               57,578
                                                                                     ----------------     ----------------

             Total liabilities and stockholders' equity.......................             $54,296              $59,237
                                                                                     ================     ================


                          The accompanying notes are an integral part of the financial statements.


                                                             3




                                                        AWARE, INC.
                                           CONSOLIDATED STATEMENTS OF OPERATIONS
                                           (IN THOUSANDS, EXCEPT PER SHARE DATA)
                                                        (UNAUDITED)


                                                               THREE MONTHS ENDED                 SIX MONTHS ENDED
                                                                    JUNE 30,                          JUNE 30,
                                                         -------------------------------    ------------------------------
                                                              2003            2002               2003            2002
                                                         --------------  ---------------    --------------  --------------
                                                                                                   
Revenue:
    Product sales.......................................           $586          $1,095             $1,296         $2,102
    Contract revenue....................................          1,192           2,158              1,522          4,251
    Royalties...........................................          1,039             759              1,946          1,235
                                                         --------------  ---------------    --------------  --------------
     Total revenue.....................................           2,817           4,012              4,764          7,588

Costs and expenses:
    Cost of product sales...............................            191             176                336            342
    Cost of contract revenue............................            287           1,527                550          2,992
    Research and development............................          3,104           3,172              6,552          6,537
    Selling and marketing...............................            625             818              1,200          1,501
    General and administrative..........................            611             681              1,259          1,393
                                                         --------------  ---------------    --------------  --------------
     Total costs and expenses...........................          4,818           6,374              9,897         12,765

Loss from operations....................................         (2,001)         (2,362)            (5,133)        (5,177)
Interest income.........................................            157             232                326            471
                                                         --------------  ---------------    --------------  --------------

Loss before provision for income taxes..................         (1,844)         (2,130)            (4,807)        (4,706)
Provision for income taxes..............................              -               -                  -              -
                                                         --------------  ---------------    --------------  --------------

Net loss................................................        ($1,844)        ($2,130)           ($4,807)       ($4,706)
                                                         ==============  ===============    ==============  ==============


Net loss per share - basic and diluted................           ($0.08)         ($0.09)           ($0.21)        ($0.21)


Weighted average shares - basic and diluted.............         22,705          22,673             22,701         22,669


                          The accompanying notes are an integral part of the financial statements.


                                                             4




                                               AWARE, INC.
                                  CONSOLIDATED STATEMENTS OF CASH FLOWS
                                             (IN THOUSANDS)
                                               (UNAUDITED)


                                                                             SIX MONTHS ENDED
                                                                                 JUNE 30,
                                                                   ------------------------------------
                                                                         2003                2002
                                                                   ----------------    ----------------
                                                                                      
Cash flows from operating activities:
   Net loss...................................................            ($4,807)            ($4,706)
   Adjustments to reconcile net loss to net cash
      used in operating activities:
      Depreciation and amortization...........................                786                 941
      Increase (decrease) from changes in assets and
      liabilities:
         Accounts receivable..................................                387              (1,221)
         Inventories..........................................               (307)                179
         Prepaid expenses.....................................                147                 356
         Accounts payable.....................................                105                (152)
         Accrued expenses.....................................               (234)               (364)
         Deferred revenue.....................................                (42)                 49
                                                                   ----------------    ----------------
            Net cash used in operating activities............              (3,965)             (4,918)
                                                                   ----------------    ----------------

Cash flows from investing activities:
    Purchases of property and equipment.......................                (97)               (466)
    Net sales (purchases) of short-term investments...........             (6,916)             13,336
    Net purchases of investments.............................               7,388                   -
                                                                   ----------------    ----------------
            Net cash provided by investing activities........                 375              12,870
                                                                   ----------------    ----------------

Cash flows from financing activities:
     Proceeds from issuance of common stock...................                 37                 121
                                                                   ----------------    ----------------
            Net cash provided by financing activities.........                 37                 121
                                                                   ----------------    ----------------

Increase (decrease) in cash and cash equivalents..............             (3,553)              8,073
Cash and cash equivalents, beginning of period................             25,268              36,056
                                                                   ----------------    ----------------

Cash and cash equivalents, end of period......................            $21,715             $44,129
                                                                   ================    ================


                The accompanying notes are an integral part of the financial statements.


                                                   5


                                   AWARE, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (UNAUDITED)


A)   BASIS OF PRESENTATION

     The accompanying unaudited consolidated balance sheet, statements of
     operations, and statements of cash flows reflect all adjustments
     (consisting only of normal recurring items) which are, in the opinion of
     management, necessary for a fair presentation of financial position at June
     30, 2003, and of operations and cash flows for the interim periods ended
     June 30, 2003 and 2002.

     The accompanying unaudited consolidated financial statements have been
     prepared in accordance with the instructions for Form 10-Q and therefore do
     not include all information and footnotes necessary for a complete
     presentation of our financial position, results of operations and cash
     flows, in conformity with generally accepted accounting principles. We
     filed audited financial statements which included all information and
     footnotes necessary for such presentation for the three years ended
     December 31, 2002 in conjunction with our 2002 Annual Report on Form 10-K.

     The results of operations for the interim period ended June 30, 2003 are
     not necessarily indicative of the results to be expected for the year.


B)   INVENTORY

     Inventory consists primarily of the following (in thousands):

                                         JUNE 30,              DECEMBER 31,
                                           2003                   2002
                                    -------------------    -------------------
          Raw materials.........             $352                    $46
          Finished goods........                5                      4
                                    -------------------    -------------------
                 Total..........             $357                    $50
                                    ===================    ===================


                                       6


C)   COMPUTATION OF EARNINGS PER SHARE

     Basic earnings per share is computed by dividing net income or loss by the
     weighted average number of common shares outstanding. Diluted earnings per
     share is computed by dividing net income or loss by the weighted average
     number of common shares outstanding plus additional common shares that
     would have been outstanding if dilutive potential common shares had been
     issued. For the purposes of this calculation, stock options are considered
     common stock equivalents in periods in which they have a dilutive effect.
     Stock options that are anti-dilutive are excluded from the calculation.

     Net income or loss per share is calculated as follows (in thousands, except
     per share data):



                                                       THREE MONTHS ENDED             SIX MONTHS ENDED
                                                            JUNE 30,                      JUNE 30,
                                                  ---------------------------   ---------------------------
                                                      2003          2002            2003          2002
                                                  ------------- -------------   ------------- -------------
                                                                                       
Net loss..........................................    ($1,844)      ($2,130)         ($4,807)      ($4,706)

Weighted average common shares outstanding........     22,705        22,673           22,701        22,669
Additional dilutive common stock equivalents......          -             -                -             -
                                                  ------------- -------------   ------------- -------------
Diluted shares outstanding .......................     22,705        22,673           22,701        22,669
                                                  ============= =============   ============= =============

Net loss per share - basic........................     ($0.08)       ($0.09)         ($0.21)       ($0.21)
Net loss per share - diluted......................     ($0.08)       ($0.09)         ($0.21)       ($0.21)


     For the three month periods ended June 30, 2003 and 2002, potential common
     stock equivalents of 479 and 148,885, respectively, were not included in
     the per share calculation for diluted EPS, because we had net losses and
     the effect of their inclusion would be anti-dilutive. For the six month
     periods ended June 30, 2003 and 2002, potential common stock equivalents of
     476 and 305,905, respectively, were not included in the per share
     calculation for diluted EPS, because we had net losses and the effect of
     their inclusion would be anti-dilutive. For the three month periods ended
     June 30, 2003 and 2002, options to purchase 688,967 and 5,427,845 shares of
     common stock, respectively, were outstanding, but were not included in the
     computation of diluted EPS because the options' exercise prices were
     greater than the average market price of the common stock and thus would be
     anti-dilutive. For the six month periods ended June 30, 2003 and 2002,
     options to purchase 688,967 and 5,175,682 shares of common stock,
     respectively, were outstanding, but were not included in the computation of
     diluted EPS because the options' exercise prices were greater than the
     average market price of the common stock and thus would be anti-dilutive.

D)   STOCK-BASED COMPENSATION

     We grant stock options to our employees and directors. Such grants are for
     a fixed number of shares with an exercise price equal to the fair value of
     the shares at the date of grant. As permitted by SFAS No. 123, "Accounting
     for Stock-Based Compensation", we account for stock option grants in
     accordance with Accounting Principles Board ("APB")

                                       7


     Opinion No. 25, "Accounting for Stock Issued to Employees" and FASB
     Interpretation No. 44 ("FIN 44"), "Accounting for Certain Transactions
     Involving Stock Compensation." Accordingly, we have adopted the provisions
     of SFAS No. 123 through disclosure only.

     No stock-based employee compensation cost is reflected in net loss, as all
     options granted under those plans had an exercise price equal to the fair
     market value of the underlying common stock on the date of grant. The
     following table illustrates the pro forma effect on net loss and earnings
     per share if we had applied the fair value recognition provisions of SFAS
     No. 123 and SFAS No. 148 to stock-based employee compensation (in
     thousands, except per share data):



                                                      THREE MONTHS ENDED             SIX MONTHS ENDED
                                                           JUNE 30,                      JUNE 30,
                                                  ---------------------------   ---------------------------
                                                      2003          2002            2003          2002
                                                  ------------- -------------   ------------- -------------
                                                                                      
Net loss - as reported............................    ($1,844)      ($2,130)         ($4,807)      ($4,706)
Deduct: Total stock-based employee compensation
  expense determined under fair value based
  method for all awards...........................      5,007         5,283           10,012        10,566
                                                  ------------- -------------   ------------- -------------
Net loss - pro forma .............................    ($6,851)      ($7,413)        ($14,819)     ($15,272)
                                                  ============= =============   ============= =============

Basic loss per share - as reported................     ($0.08)       ($0.09)         ($0.21)       ($0.21)
Basic loss per share - pro forma..................     ($0.30)       ($0.33)         ($0.65)       ($0.67)

Diluted loss per share - as reported..............     ($0.08)       ($0.09)         ($0.21)       ($0.21)
Diluted loss per share - pro forma................     ($0.30)       ($0.33)         ($0.65)       ($0.67)


     The fair value of options on their grant date was measured using the
     Black-Scholes option pricing model. Key assumptions used to apply this
     pricing model are as follows:


                                                         THREE MONTHS ENDED             SIX MONTHS ENDED
                                                              JUNE 30,                      JUNE 30,
                                                     ---------------------------   ---------------------------
                                                         2003          2002            2003          2002
                                                     ------------- -------------   ------------- -------------

   Average risk-free interest rate...................       2.57%         3.82%           2.74%         3.82%
   Expected life of option grants....................    5 years       5 years         5 years       5 years
   Expected volatility of underlying stock...........         97%           99%             97%           99%
   Expected dividend yield...........................          -            -               -              -


E)   EMPLOYEE STOCK OPTION EXCHANGE PROGRAM

     On March 3, 2003, we commenced an offer to exchange outstanding stock
     options with eligible employees. Under the terms of the program, eligible
     employees had the right to tender for cancellation all stock options that
     they held with an exercise price above $3.00 per share by April 1, 2003. We
     accepted for exchange options to purchase an aggregate of 6,162,952 shares
     of our common stock. Subject to the terms and conditions of the offer, we
     will issue new options to purchase an aggregate of up to 3,081,563 shares
     of our common stock between October 2, 2003 and November 13, 2003. Such
     replacement

                                       8


     options will be priced at the current market value of our stock on the
     replacement grant date.

F)   BUSINESS SEGMENTS

     The Company organizes itself as one segment and conducts its operations in
     the United States.

     The Company sells its products and technology to domestic and international
     customers. Revenues were generated from the following geographic regions
     (in thousands):



                                                        THREE MONTHS ENDED             SIX MONTHS ENDED
                                                             JUNE 30,                      JUNE 30,
                                                   ----------------------------  ----------------------------
                                                       2003           2002           2003          2002
                                                   -------------  -------------  ------------- --------------
                                                                                      
  United States....................................     $2,527         $3,123         $4,041        $6,141
  Germany..........................................        176            674            550         1,115
  Rest of World....................................        114            215            173           332
                                                   -------------  -------------  ------------- --------------
                                                        $2,817         $4,012         $4,764        $7,588
                                                   =============  =============  ============= ==============


G)   RECENT ACCOUNTING PRONOUNCEMENTS

     In May 2003, FASB issued Statement of Financial Accounting Standards 150
     ("SFAS 150"), "Accounting for Certain Financial Instruments with
     Characteristics of Both Liabilities and Equity." SFAS 150 establishes
     standards for how an issuer classifies and measures certain financial
     instruments with characteristics of both liabilities and equity. It
     requires that an issuer classify a financial instrument that is within its
     scope as a liability. For all financial instruments entered into or
     modified after May 31, 2003, SFAS 150 is effective immediately. For all
     other instruments, SFAS 150 goes into effect at the beginning of the first
     interim period beginning after June 15, 2003. We do not expect that the
     adoption of SFAS 150 will have a material impact on our financial position
     and results of operations.

     In April 2003, FASB issued Statement of Financial Accounting Standards 149
     ("SFAS 149"), "Amendment of Statement 133 on Derivative Instruments and
     Hedging Activities." SFAS 149 amends and clarifies accounting and reporting
     of derivative instruments, including certain derivative instruments
     embedded in other contracts, and hedging activities under SFAS 133,
     "Accounting for Derivative Instruments and Hedging Activities." This
     statement is effective for contracts entered into or modified after June
     30, 2003 and for hedging relationships designated after June 30, 2003. We
     do not expect that the adoption of SFAS 149 will have a material impact on
     our financial position and results of operations.

     In December 2002, the FASB issued SFAS 148, "Accounting for Stock-Based
     Compensation-Transition and Disclosure - An Amendment of SFAS No. 123."
     SFAS 148 amends SFAS 123, "Accounting for Stock-Based Compensation" to
     provide alternative methods of transition for those companies who
     voluntarily change to the fair value based method of accounting for
     stock-based employee compensation. In addition,


                                       9


     this Statement amends the disclosure requirements of SFAS 123 to require
     prominent disclosures in both the annual and interim financial statements
     about the method of accounting for stock-based employee compensation and
     the effect of the method used on reported results. The transition and
     annual disclosure provisions of SFAS 148 are effective for fiscal years
     ending after December 15, 2002. We have not adopted the fair value method
     of accounting for stock-based compensation, and will continue to apply APB
     25 for our stock-based compensation plans. We have adopted the disclosure
     requirements of SFAS 148 in this Form 10-Q, which is included in the
     "Stock-Based Compensation" footnote of our consolidated financial
     statements.

     In January 2003, FASB issued FASB Interpretation No. 46 ("FIN 46"),
     "Consolidation of Variable Interest Entities," which addresses
     consolidation by a business of variable interest entities in which it is
     the primary beneficiary. The Interpretation is effective immediately for
     certain disclosure requirements and variable interest entities created
     after January 31, 2003, and periods beginning after June 15, 2003 for
     variable interest entities created before February 1, 2003. We do not
     expect that the adoption of FIN 46 will have a material impact on our
     financial position and results of operations.

     In November 2002, the EITF issued No. 00-21, "Accounting for Revenue
     Arrangements with Multiple Deliverables." EITF Issue No. 00-21 addresses
     certain aspects of the accounting by a vendor for arrangements under which
     it will perform multiple revenue-generating activities. EITF Issue No.
     00-21 establishes three principles: revenue should be recognized separately
     for separate units of accounting, revenue for a separate unit of accounting
     should be recognized only when the arrangement consideration is reliably
     measurable and the earnings process is substantially complete, and
     consideration should be allocated among the separate units of accounting in
     an arrangement based on their relative fair values. EITF Issue No. 00-21 is
     effective for all revenue arrangements entered into in fiscal periods
     beginning after June 15, 2003, with early adoption permitted. We are
     currently determining the impact EITF Issue No. 00-21 will have on our
     financial position and results of operations.


                                       10


                                     ITEM 2:
                     MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                  FINANCIAL CONDITION AND RESULTS OF OPERATIONS


CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995

SOME OF THE INFORMATION IN THIS FORM 10-Q CONTAINS FORWARD-LOOKING STATEMENTS
THAT INVOLVE SUBSTANTIAL RISKS AND UNCERTAINTIES. YOU CAN IDENTIFY THESE
STATEMENTS BY FORWARD-LOOKING WORDS SUCH AS "MAY," "WILL," "EXPECT,"
"ANTICIPATE," "BELIEVE," "ESTIMATE," "CONTINUE" AND SIMILAR WORDS. YOU SHOULD
READ STATEMENTS THAT CONTAIN THESE WORDS CAREFULLY BECAUSE THEY: (1) DISCUSS OUR
FUTURE EXPECTATIONS; (2) CONTAIN PROJECTIONS OF OUR FUTURE OPERATING RESULTS OR
FINANCIAL CONDITION; OR (3) STATE OTHER "FORWARD-LOOKING" INFORMATION. HOWEVER,
WE MAY NOT BE ABLE TO PREDICT FUTURE EVENTS ACCURATELY. THE RISK FACTORS LISTED
IN THIS SECTION, AS WELL AS ANY CAUTIONARY LANGUAGE IN THIS FORM 10-Q, PROVIDE
EXAMPLES OF RISKS, UNCERTAINTIES AND EVENTS THAT MAY CAUSE OUR ACTUAL RESULTS TO
DIFFER MATERIALLY FROM THE EXPECTATIONS WE DESCRIBE IN OUR FORWARD-LOOKING
STATEMENTS. YOU SHOULD BE AWARE THAT THE OCCURRENCE OF ANY OF THE EVENTS
DESCRIBED IN THESE RISK FACTORS AND ELSEWHERE IN THIS FORM 10-Q COULD MATERIALLY
AND ADVERSELY AFFECT OUR BUSINESS.


RESULTS OF OPERATIONS

     PRODUCT SALES. Product sales consist primarily of revenue from the sale of
hardware products and compression software. Hardware products primarily include
ADSL test and development systems, modules, and modems. Compression software
consists of standard off-the-shelf software products that are sold to OEM
customers that integrate our software into their equipment-based products.

Product sales decreased 46% from $1.1 million in the second quarter of 2002 to
$0.6 million in the current year quarter. As a percentage of total revenue,
product sales decreased from 27% in the second quarter of 2002 to 21% in the
current year quarter. For the six months ended June 30, product sales decreased
38% from $2.1 million in 2002 to $1.3 million in 2003. As a percentage of total
revenue, product sales decreased from 28% in the first six months of 2002 to 27%
in the corresponding period of 2003.

For the three and six month periods, the dollar decrease was primarily due to a
decrease in revenue from the sale of compression software and to a lesser extent
lower revenue from the sale of test and development systems. Compression
software revenue decreased primarily due to lower sales of our electronic
identification products. Lower sales of electronic identification products in
the 2003 periods were due to the timing of orders from our OEM customers. Test
and development system revenue decreased primarily due to lower demand from our
semiconductor and equipment customers.

     CONTRACT REVENUE. Contract revenue consists primarily of license and
engineering service fees that we receive under agreements with our customers to
develop ADSL chipsets.

Contract revenue decreased 45% from $2.2 million in the second quarter of 2002
to $1.2 million in the current year quarter. As a percentage of total revenue,
contract revenue decreased from 54% in the second quarter of 2003 to 42% in the
current year quarter. For the six months ended June 30, contract revenue
decreased 64% from $4.3 million in 2002 to $1.5 million in 2003. As a percentage
of total revenue, contract revenue decreased from 56% in the first six months of


                                       11


2002 to 32% in the corresponding period of 2003. Contract revenue in the second
quarter of 2003 includes a significant one-time contractual termination fee from
a large customer.

For the three and six month periods, the dollar decrease was primarily due to a
difficult environment for licensing intellectual property for communications
integrated circuits. Both existing and prospective ADSL chipset licensees have
been reluctant to begin new development projects given: (i) generally weak
worldwide economic conditions, (ii) a difficult and uncertain environment in the
semiconductor and telecommunications industries, and (iii) intense ADSL chipset
competition and falling chipset prices. During the last several years, customers
and potential customers cautiously evaluated new chipset projects or delayed or
cancelled projects in the face of such conditions. We are uncertain when the
economic and market conditions we faced over the last several years will
materially improve.

     ROYALTIES. Royalties consist of royalty payments that we receive under
licensing agreements. We receive royalties from customers for the right to use
our technology in their chipsets or solutions.

Royalties increased 37% from $0.8 million in the second quarter of 2002 to $1.0
million in the current year quarter. As a percentage of total revenue, royalties
increased from 19% in the second quarter of 2002 to 37% in the current year
quarter. For the six months ended June 30, royalties increased 58% from $1.2
million in 2002 to $1.9 million in 2003. As a percentage of total revenue,
royalties increased from 16% in the first six months of 2002 to 41% in the
corresponding period of 2003.

For the three and six month periods, the increase in royalties was primarily due
to an increase in ADSL chipset sales by our largest customer, Analog Devices,
Inc. ("ADI"). Despite the increase in ADSL chipset sales by ADI over the last
two quarters, ADI's chipset sales have declined in previous quarters primarily
due to falling ADSL chipset pricing and lower ADI sales volumes. Despite steady
growth of worldwide ADSL subscribers over the last several years, the
availability of ADSL chipsets from a number of suppliers and intense competition
among those suppliers has caused chipset prices to drop sharply. Additionally,
deployments of ADSL service in geographic areas where chipsets based upon our
technology have been sold, leveled off or declined. We are uncertain when ADSL
chipset pricing will improve, whether ADI will be able to continue to grow its
presence or whether our other licensees will contribute meaningful royalty
revenue.

Infineon Technologies AG ("Infineon"), our second largest customer, has begun
selling higher volumes of ADSL chipsets. Infineon has announced design wins with
several telecommunications equipment suppliers, including Siemens AG and Alcatel
Alsthom S.A., for chipsets that are based on our ADSL technology. We are
uncertain how quickly sales of these chipsets will increase and whether they
will contribute meaningful royalties to us. To date, we have not received
significant royalties from Infineon.

     COST OF PRODUCT SALES. Since the cost of compression software license sales
is minimal, cost of product sales consists primarily of ADSL equipment sales.
Cost of product sales increased 9% from $176,000 in the second quarter of 2002
to $191,000 in the current year quarter. As a percentage of product sales, cost
of product sales increased from 16% in the second quarter of 2002 to 33% in the
current year quarter. In terms of dollars, the increase in cost of product sales
was primarily due to higher sales of modules during the current quarter. The
decline in product margins was primarily due to a smaller proportion of
compression software sales in the product sales revenue mix.


                                       12


For the six months ended June 30, cost of product sales decreased 2% from
$342,000 in 2002 to $336,000 in 2003. As a percentage of product sales, cost of
product sales increased from 16% in the first six months of 2002 to 26% in the
corresponding period of 2003. In terms of dollars, the decrease in cost of
product sales was primarily due to lower sales of test and development systems.
The decline in product margins was primarily due to a smaller proportion of
compression software sales in the product sales revenue mix.

     COST OF CONTRACT REVENUE. Cost of contract revenue consists primarily of
salaries for engineers and expenses for consultants, technology licensing fees,
recruiting, supplies, equipment, depreciation and facilities associated with
customer development projects. Our total engineering costs are allocated between
cost of contract revenue and research and development expense. In a given
period, the allocation of engineering costs between cost of contract revenue and
research and development is a function of the level of effort expended on each.

Cost of contract revenue decreased 81% from $1.5 million in the second quarter
of 2002 to $0.3 million in the current year quarter. As a percentage of contract
revenue, cost of contract revenue decreased from 71% in the second quarter of
2002 to 24% in the current year quarter. For the six months ended June 30, cost
of contract revenue decreased 82% from $3.0 million in 2002 to $0.6 million in
2003. As a percentage of contract revenue, cost of contract revenue decreased
from 70% in the first six months of 2002 to 36% in the corresponding period of
2003.

For the three and six month periods, the dollar and percentage decrease in cost
of contract revenue was primarily due to the following factors: i) there were
fewer customer contracts in contract revenue in the 2003 periods as compared
with the 2002 periods, so our cost of contract revenue declined as well; ii) in
2003, we began licensing a more technically mature intellectual property package
that requires us to provide less engineering services to our customers; and iii)
contract revenue in the second quarter of 2003 includes a one-time contractual
termination fee that had no cost of contract revenue associated with it.

     RESEARCH AND DEVELOPMENT EXPENSE. Research and development expense consists
primarily of salaries for engineers and expenses for consultants, recruiting,
supplies, equipment, depreciation and facilities related to engineering projects
to enhance and extend our broadband intellectual property offerings, and our
compression software technology. Research and development expense decreased 2%
from $3.2 million in the second quarter of 2002 to $3.1 million in 2003. As a
percentage of total revenue, research and development expense increased from 79%
in the second quarter of 2002 to 110% in the current year quarter. For the six
months ended June 30, research and development expense was essentially the same
at approximately $6.5 million in 2002 and 2003. As a percentage of total
revenue, research and development expense increased from 86% in the first six
months of 2002 to 138% in the corresponding period of 2003.

Although research and development expenses were essentially unchanged for both
the three and six-month periods in 2003 and 2002, there were two approximately
equal and offsetting factors that caused research and development expenses to be
unchanged. Research and development spending increased in the 2003 periods
because of a shift of engineers from customer projects, where spending is
classified as cost of contract revenue, to internal research and development
projects, where spending is classified as research and development expense. This
shift occurred because we had fewer customer projects in 2003 than in 2002, and
we changed our technology offering such that it requires less engineering
support by us. This increase in research and

                                       13


development spending was offset by a decrease of approximately $1.0 million per
quarter in salaries and related expenses due to the reduction in force we
implemented in October 2002 and salary reductions we imposed on January 1, 2003.

Our research and development spending is principally focused on projects related
to core ADSL technology, including our StratiPHY chip, as well as for Dr. DSL,
G.SHDSL, wireless local area network communications, VDSL, and other development
projects.

     SELLING AND MARKETING EXPENSE. Selling and marketing expense consists
primarily of salaries for sales and marketing personnel, travel, advertising and
promotion, recruiting, and facilities expense. Sales and marketing expense
decreased 24% from $818,000 in the second quarter of 2002 to $625,000 in the
current year quarter. As a percentage of total revenue, sales and marketing
expense increased from 20% in the second quarter of 2002 to 22% in the current
year quarter. For the six months ended June 30, selling and marketing expense
decreased 20% from $1.5 million in 2002 to $1.2 million in 2003. As a percentage
of total revenue, selling and marketing expense increased from 20% in the first
six months of 2002 to 25% in the corresponding period of 2003.

For the three and six month periods, the dollar decrease was primarily due to
lower tradeshow expenses and sales commissions; as well as the reduction in
force and salary reductions we implemented in October 2002 and January 2003,
respectively.

     GENERAL AND ADMINISTRATIVE EXPENSE. General and administrative expense
consists primarily of salaries for administrative personnel, facilities costs,
and public company, bad debt, legal, and audit expenses. General and
administrative expense decreased 10% from $681,000 in the second quarter of 2002
to $611,000 in the current year quarter. As a percentage of total revenue,
general and administrative expense increased from 17% in the second quarter of
2002 to 22% in the current year quarter. For the six months ended June 30,
general and administrative expense decreased 10% from $1.4 million in 2002 to
$1.3 million in 2003. As a percentage of total revenue, general and
administrative expense increased from 18% in the first six months of 2002 to 26%
in the corresponding period of 2003.

For the three and six month periods, the dollar decrease was primarily due to
lower annual meeting expenses; as well as the reduction in force and salary
reductions we implemented in October 2002 and January 2003, respectively.

     INTEREST INCOME. Interest income decreased 32% from $232,000 in the second
quarter of 2003 to $157,000 in the current year quarter. For the six months
ended June 30, interest income decreased 31% from $471,000 in 2002 to $326,000
in 2003. For the three and six month periods, the dollar decrease was primarily
due to lower interest rates earned on our cash balances and lower cash balances.

     INCOME TAXES. We made no provision for income taxes in the first six months
of 2003 and 2002 due to net losses incurred. In 2002, we determined that due to
our continuing operating losses as well as the uncertainty of the timing of
profitability in future periods, we should fully reserve our deferred tax
assets. As of June 30, 2003, our deferred tax assets continue to be fully
reserved. We will continue to evaluate, on a quarterly basis, the positive and
negative evidence affecting the realizability of our deferred tax assets.


                                       14


LIQUIDITY AND CAPITAL RESOURCES

At June 30, 2003, we had cash, cash equivalents, short-term investments and
investments of $43.1 million, which represents a decrease of $4.0 million from
December 31, 2002. The decrease is primarily due to $4.0 million of cash used in
operations.

Cash used in operations in the first six months of 2003 was primarily the result
of operating losses and working capital requirements. Capital spending was
primarily related to the purchase of computer hardware and software, and
laboratory equipment used principally in engineering activities.

While we can not assure you that we will not require additional financing, or
that such financing will be available to us, we believe that our cash, cash
equivalents and short-term investments will be sufficient to fund our operations
for at least the next twelve months.


RECENT ACCOUNTING PRONOUNCEMENTS

In May 2003, FASB issued Statement of Financial Accounting Standards 150 ("SFAS
150"), "Accounting for Certain Financial Instruments with Characteristics of
Both Liabilities and Equity." SFAS 150 establishes standards for how an issuer
classifies and measures certain financial instruments with characteristics of
both liabilities and equity. It requires that an issuer classify a financial
instrument that is within its scope as a liability. For all financial
instruments entered into or modified after May 31, 2003, SFAS 150 is effective
immediately. For all other instruments, SFAS 150 goes into effect at the
beginning of the first interim period beginning after June 15, 2003. We do not
expect that the adoption of SFAS 150 will have a material impact on our
financial position and results of operations.

In April 2003, FASB issued Statement of Financial Accounting Standards 149
("SFAS 149"), "Amendment of Statement 133 on Derivative Instruments and Hedging
Activities." SFAS 149 amends and clarifies accounting and reporting of
derivative instruments, including certain derivative instruments embedded in
other contracts, and hedging activities under SFAS 133, "Accounting for
Derivative Instruments and Hedging Activities." This statement is effective for
contracts entered into or modified after June 30, 2003 and for hedging
relationships designated after June 30, 2003. We do not expect that the adoption
of SFAS 149 will have a material impact on our financial position and results of
operations.

In December 2002, the FASB issued SFAS 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure - An Amendment of SFAS No. 123." SFAS 148
amends SFAS 123, "Accounting for Stock-Based Compensation" to provide
alternative methods of transition for those companies who voluntarily change to
the fair value based method of accounting for stock-based employee compensation.
In addition, this Statement amends the disclosure requirements of SFAS 123 to
require prominent disclosures in both the annual and interim financial
statements about the method of accounting for stock-based employee compensation
and the effect of the method used on reported results. The transition and annual
disclosure provisions of SFAS 148 are effective for fiscal years ending after
December 15, 2002. We have not adopted the fair value method of accounting for
stock-based compensation, and will continue to apply APB 25 for our stock-based
compensation plans. We have adopted the disclosure requirements of SFAS


                                       15


148 in this Form 10-Q, which is included in the "Stock-Based Compensation"
footnote of our consolidated financial statements.

In January 2003, FASB issued FASB Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities," which addresses consolidation by
a business of variable interest entities in which it is the primary beneficiary.
The Interpretation is effective immediately for certain disclosure requirements
and variable interest entities created after January 31, 2003, and periods
beginning after June 15, 2003 for variable interest entities created before
February 1, 2003. We do not expect that the adoption of FIN 46 will have a
material impact on our financial position and results of operations.

In November 2002, the EITF issued No. 00-21, "Accounting for Revenue
Arrangements with Multiple Deliverables." EITF Issue No. 00-21 addresses certain
aspects of the accounting by a vendor for arrangements under which it will
perform multiple revenue-generating activities. EITF Issue No. 00-21 establishes
three principles: revenue should be recognized separately for separate units of
accounting, revenue for a separate unit of accounting should be recognized only
when the arrangement consideration is reliably measurable and the earnings
process is substantially complete, and consideration should be allocated among
the separate units of accounting in an arrangement based on their relative fair
values. EITF Issue No. 00-21 is effective for all revenue arrangements entered
into in fiscal periods beginning after June 15, 2003, with early adoption
permitted. We are currently determining the impact EITF Issue No. 00-21 will
have on our financial position and results of operations.


RISK FACTORS

We believe that the occurrence of any one or some combination of the following
risk factors could seriously harm our business.


OUR QUARTERLY RESULTS ARE UNPREDICTABLE AND MAY FLUCTUATE SIGNIFICANTLY

Our quarterly revenue and operating results are difficult to predict and may
fluctuate significantly from quarter to quarter. Because our revenue components
fluctuate and are difficult to predict, and our expenses are largely independent
of revenues in any particular period, it is difficult for us to accurately
forecast revenues and profitability. We generally recognize contract revenues
ratably over the period during which we expect to provide engineering services.
While this means that contract revenues from current licenses are generally
predictable, changes can be introduced by a reevaluation of the length of the
development period, or by the termination of a contract. The initial estimate of
this period is subject to revision as the product being developed under a
contract nears completion, and a revision may result in an increase or decrease
to the quarterly revenue for that contract. In addition, accurate prediction of
revenues from new licensees is difficult because the development of a business
relationship with a potential licensee is a lengthy process, frequently spanning
a year or more, and the fiscal period in which a new license agreement will be
entered into, if at all, and the financial terms of such an agreement are
difficult to predict. Contract revenues also include fees for engineering
services, which are dependent upon the varying level of assistance desired by
licensees and, therefore, the revenue from these services is also difficult to
predict.


                                       16


It is also difficult for us to make accurate forecasts of royalty revenues.
Royalties are recognized in the quarter in which we receive a report from a
licensee regarding the shipment of licensed integrated circuits in the prior
quarter, and are dependent upon fluctuating sales volumes and/or prices of chips
containing our technology, all of which are beyond our ability to control or
assess in advance.

Our business is subject to a variety of additional risks, which could materially
adversely affect quarterly and annual operating results, including:

     |X|  market acceptance of our broadband technologies by semiconductor
          companies;
     |X|  the extent and timing of new license transactions with semiconductor
          companies;
     |X|  changes in our and our licensees' development schedules and levels of
          expenditure on research and development;
     |X|  the loss of a strategic relationship or termination of a project by a
          licensee;
     |X|  equipment companies' acceptance of integrated circuits produced by our
          licensees;
     |X|  the loss by a licensee of a strategic relationship with an equipment
          company customer;
     |X|  announcements or introductions of new technologies or products by us
          or our competitors;
     |X|  delays or problems in the introduction or performance of enhancements
          or of future generations of our technology;
     |X|  delays in the adoption of new industry standards or changes in market
          perception of the value of new or existing standards;
     |X|  competitive pressures resulting in lower contract revenues or royalty
          rates;
     |X|  personnel changes, particularly those involving engineering and
          technical personnel;
     |X|  costs associated with protecting our intellectual property;
     |X|  the potential that licensees could fail to make payments under their
          current contracts;
     |X|  ADSL market-related issues, including lower ADSL chipset unit demand
          brought on by excess channel inventory and lower average selling
          prices for ADSL chipsets as a result of market surpluses;
     |X|  regulatory developments; and
     |X|  general economic trends and other factors.


WE EXPERIENCED NET LOSSES

We had a net loss during 2001, 2002 and the first six months of 2003. We expect
that we will have a net loss during the third quarter of 2003. We may continue
to experience losses in the future if;

     |X|  the semiconductor and telecommunications markets do not recover from
          the downturn that began in 2001;
     |X|  our existing customers do not increase their revenues from sales of
          chipsets with our technology;
     |X|  new and existing customers do not choose to license our intellectual
          property for new chipset products; or
     |X|  a profitable business does not emerge from our Dr. DSL efforts.


                                       17


WE HAVE A UNIQUE BUSINESS MODEL

The success of our business model depends upon our ability to license our
technology to semiconductor and equipment companies, and our customers'
willingness and ability to sell products that incorporate our technology so that
we may receive significant royalties that are consistent with our plans and
expectations.

We face numerous risks in successfully obtaining suitable licensees on terms
consistent with our business model, including, among others:

     |X|  we must typically undergo a lengthy and expensive process of building
          a relationship with a potential licensee before there is any assurance
          of a license agreement with such party;
     |X|  we must persuade semiconductor and equipment manufacturers with
          significant resources to rely on us for critical technology on an
          ongoing basis rather than trying to develop similar technology
          internally;
     |X|  we must persuade potential licensees to bear development costs
          associated with our technology applications and to make the necessary
          investment to successfully produce chipsets and products using our
          technology; and
     |X|  we must successfully transfer technical know-how to licensees.

Moreover, the success of our business model also depends on the receipt of
royalties from licensees. Royalties from our licensees are often based on the
selling prices of our licensees' chipsets and products, over which we have
little or no control. We also have little or no control over our licensees'
promotional and marketing efforts. Our licensees are not required to pay us
royalties unless they use our technology. They are not prohibited from competing
against us.

Our business could be seriously harmed if:

     |X|  we cannot obtain suitable licensees;
     |X|  our licensees fail to achieve significant sales of chipsets or
          products incorporating our technology; or
     |X|  we otherwise fail to implement our business strategy successfully.


THERE HAS BEEN AND MAY CONTINUE TO BE AN OVERSUPPLY OF ADSL CHIPSETS, WHICH HAS
CAUSED OUR ROYALTY REVENUE TO DECLINE

The royalties we receive are influenced by many of the risks faced by the ADSL
market in general, including reduced average selling prices ("ASPs") for ADSL
chipsets during periods of surplus. Since late 2000, the ADSL industry has
experienced an oversupply of ADSL chipsets and central office equipment.
Excessive inventory levels led to soft chipset demand, which in turn led to
declining ASPs. As a result of the soft demand and declining ASPs for ADSL
chipsets, our royalty revenue has decreased substantially from the levels we
achieved in 2000. Price decreases for ADSL chipsets, and the corresponding
decreases in per unit royalties received by us, can be sudden and dramatic.
Pricing pressures may continue during the third quarter of 2003 and beyond. Our
royalty revenue may continue to decline over the long term.


                                       18


WE DEPEND SUBSTANTIALLY UPON A LIMITED NUMBER OF LICENSEES

There is a relatively limited number of semiconductor and equipment companies to
which we can license our broadband technology in a manner consistent with our
business model. If we fail to maintain relationships with our current licensees
or fail to establish a sufficient number of new licensee relationships, our
business could be seriously harmed. We are less certain than we have been in the
past that one of our large customers, Intel, will offer ADSL products based upon
licensed technology from Aware. Over the last year, our confidence that Intel
will be a large, long term source of revenue for us has diminished. In addition,
our prospective customers may use their superior size and bargaining power to
demand license terms that are unfavorable to us and prospective customers may
not elect to license from us.


WE DERIVE A SIGNIFICANT AMOUNT OF REVENUE FROM ONE CUSTOMER

In 2001, 2002 and the first six months of 2003, we derived 52%, 32% and 33%,
respectively of our total revenue from ADI. ADI was the first customer to
license ADSL technology from us in 1993, and their chipsets are the most mature
implementations of our technology in the market. Our royalty revenues to date
have been primarily due to sales of ADI chipsets that use our ADSL technology.
Our royalty revenue in the near term is highly dependent upon ADI's ability to
maintain its market share and pricing. The ADSL market has experienced
significant price erosion, which has adversely affected ADI's ADSL revenue,
which in turn has adversely affected our royalty revenue. To the extent that ADI
has lost market share, or loses market share in the future, or experiences
further price erosion in its ADSL chipsets, our royalty revenue could continue
to decline.


OUR SUCCESS REQUIRES ACCEPTANCE OF OUR TECHNOLOGY BY EQUIPMENT COMPANIES

Due to our business strategy, our success is dependent on our ability to
generate significant royalties from our licensing arrangements with
semiconductor manufacturers. Our ability to generate significant royalties is
materially affected by the willingness of equipment companies to purchase
integrated circuits that incorporate our technology from our licensees. There
are other competitive solutions available for equipment companies seeking to
offer broadband communications products. We face the risk that equipment
manufacturers will choose those alternative solutions. Generally, our ability to
influence equipment companies' decision whether to purchase integrated circuits
that incorporates our technology is limited.

We also face the risk that equipment companies that elect to use integrated
circuits that incorporate our technology into their products will not compete
successfully against other equipment companies. Many factors beyond our control
could influence the success or failure of a particular equipment company that
uses integrated circuits based on our technology, including:

     |X|  competition from other businesses in the same industry;
     |X|  market acceptance of its products;
     |X|  its engineering, sales and marketing, and management capabilities;
     |X|  technical challenges of developing its products unrelated to our
          technology; and
     |X|  its financial and other resources.


                                       19


Even if equipment companies incorporate our chipsets based on our intellectual
property into their products, their products may not achieve commercial
acceptance or result in significant royalties to us.


OUR SUCCESS REQUIRES TELEPHONE COMPANIES TO INSTALL ADSL SERVICE IN VOLUME

The success of our ADSL licensing business depends upon telephone companies
installing ADSL service in significant volumes. Factors that affect the volume
deployment of ADSL service include:

     |X|  the desire of telephone companies to install ADSL service, which is
          dependent on the development of a viable business model for ADSL
          service, including the capability to market, sell, install and
          maintain the service;
     |X|  the pricing of ADSL services by telephone companies;
     |X|  the quality of telephone companies' networks;
     |X|  government regulations; and
     |X|  the willingness of residential telephone customers to demand ADSL
          service in the face of competitive service offerings, such as cable
          modems.

If telephone companies do not install ADSL service in significant volumes, or if
telephone companies install ADSL service based on other technology, our business
will be seriously harmed.


OUR INTELLECTUAL PROPERTY IS SUBJECT TO LIMITED PROTECTION

Because we are a technology provider, our ability to protect our intellectual
property and to operate without infringing the intellectual property rights of
others is critical to our success. We regard our technology as proprietary, and
we have a number of patents and pending patent applications. We also rely on a
combination of trade secrets, copyright and trademark law and non-disclosure
agreements to protect our unpatented intellectual property. Despite these
precautions, it may be possible for a third party to copy or otherwise obtain
and use our technology without authorization.

As part of our licensing arrangements, we typically work closely with our
semiconductor and equipment manufacturer licensees, many of whom are also our
potential competitors, and provide them with proprietary know-how necessary for
their development of customized chipsets based on our ADSL technology. Although
our license agreements contain non-disclosure provisions and other terms
protecting our proprietary know-how and technology rights, it is possible that,
despite these precautions, some of our licensees might obtain from us
proprietary information that they could use to compete with us in the
marketplace. Although we intend to defend our intellectual property as
necessary, the steps we have taken may be inadequate to prevent
misappropriation.

In the future, we may choose to bring legal action to enforce our intellectual
property rights. Any such litigation could be costly and time-consuming for us,
even if we were to prevail. Moreover, even if we are successful in protecting
our proprietary information, our competitors may independently develop
technologies substantially equivalent or superior to our technology. The


                                       20


misappropriation of our technology or the development of competitive technology
could seriously harm our business.

Our technology, software or products may infringe the intellectual property
rights of others. A large and increasing number of participants in the
telecommunications and compression industries have applied for or obtained
patents. Some of these patent holders have demonstrated a readiness to commence
litigation based on allegations of patent and other intellectual property
infringement. Third parties may assert patent, copyright and other intellectual
property rights to technologies that are important to our business. In the past,
we have received claims from other companies that our technology infringes their
patent rights. Intellectual property rights can be uncertain and can involve
complex legal and factual questions. We may infringe the proprietary rights of
others, which could result in significant liability for us. If we were found to
have infringed any third party's patents, we could be subject to substantial
damages and an injunction preventing us from conducting our business.


OUR BUSINESS IS SUBJECT TO RAPID TECHNOLOGICAL CHANGE

The semiconductor and telecommunications industries, as well as the market for
high-speed network access technologies, are characterized by rapid technological
change, with new generations of products being introduced regularly and with
ongoing evolutionary improvements. We expect to depend on our ADSL technology
for a substantial portion of our revenue for the foreseeable future. Therefore,
we face risks that others could introduce competing technology that renders our
ADSL technology less desirable or obsolete. Also, the announcement of new
technologies could cause our licensees or their customers to delay or defer
entering into arrangements for the use of our existing technology. Either of
these events could seriously harm our business.

We expect that our business will depend to a significant extent on our ability
to introduce enhancements and new generations of our ADSL technology as well as
new technologies that keep pace with changes in the telecommunications and
broadband industries and that achieve rapid market acceptance. We must
continually devote significant engineering resources to achieving technical
innovations. These innovations are complex and require long development cycles.
Moreover, we may have to make substantial investments in technological
innovations before we can determine their commercial viability. We may lack
sufficient financial resources to fund future development. Also, our licensees
may decide not to share certain research and development costs with us. Revenue
from technological innovations, even if successfully developed, may not be
sufficient to recoup the costs of development.

One element of our business strategy is to assume the risks of technology
development failure while reducing such risks for our licensees. In the past, we
have spent significant amounts on development projects that did not produce any
marketable technologies or products, and we cannot assure you that it will not
occur again.


WE FACE INTENSE COMPETITION FROM A WIDE RANGE OF COMPETITORS

Our success as an intellectual property supplier depends on the willingness and
ability of semiconductor manufacturers to design, build and sell integrated
circuits based on our intellectual property. The semiconductor industry is
intensely competitive and has been


                                       21


characterized by price erosion, rapid technological change, short product life
cycles, cyclical market patterns and increasing foreign and domestic
competition.

As an intellectual property supplier to the semiconductor industry, we face
intense competition from internal development teams within potential
semiconductor customers. We must convince potential licensees to license from us
rather than develop technology internally. Furthermore, semiconductor customers,
who have licensed our intellectual property, may choose to abandon joint
development projects with us and develop chipsets themselves without using our
technology. In addition to competition from internal development teams, we
compete against other independent suppliers of intellectual property. We
anticipate intense competition from suppliers of intellectual property for ADSL,
and wireless local area networking.

The market for ADSL chipsets is also intensely competitive. Our success within
the ADSL industry requires that ADSL equipment manufacturers buy chipsets from
our semiconductor licensees, and that telephone companies buy ADSL equipment
from those equipment manufacturers. Our customers' chipsets compete with
products from other vendors of standards-based and ADSL chipsets, including
Broadcom, Centillium, Conexant, GlobespanVirata, ST Microelectronics and Texas
Instruments.

ADSL services offered over copper telephone networks also compete with
alternative broadband transmission technologies that use the telephone network
as well as other network architectures. Alternative technologies for the
telephone network include symmetric high speed DSL (also known as HDSL, SDSL and
G.SHDSL), and very high speed DSL, also known as VDSL. These DSL technologies
are based on techniques other than those used by ADSL to transport high-speed
data over telephone lines. Alternative technologies that use other network
architectures to provide high-speed data service include cable modems using
cable networks, and wireless solutions using wireless networks. These
alternative broadband technologies may be more successful than ADSL and we may
not be able to participate in the markets involving these alternative
technologies.

Many of our current and prospective ADSL licensees, as well as chipset
competitors that compete with our semiconductor licensees, including Broadcom,
Conexant, GlobespanVirata, ST Microelectronics and Texas Instruments have
significantly greater financial, technological, manufacturing, marketing and
personnel resources than we do. We may be unable to compete successfully, and
competitive pressures could seriously harm our business.


OUR RECENT REDUCTION IN WORKFORCE MAY ADVERSELY AFFECT THE MORALE AND
PERFORMANCE OF OUR PERSONNEL, OUR ABILITY TO HIRE NEW PERSONNEL AND OUR
OPERATIONS

In October 2002, as part of an effort to reduce operating expenses, we
terminated 35 employees, which constituted approximately 22 percent of our
workforce. Our restructuring plan may yield unanticipated consequences, such as
attrition beyond our planned reduction in workforce. As a result of these
reductions, our ability to respond to unexpected challenges may be impaired, and
we may be unable to take advantage of new opportunities. Further, the reduction
in force may reduce employee morale and may create concern among existing
employees about job security, which may lead to increased attrition or turnover.
As a result of these factors, our remaining personnel may decide to seek
employment with more established companies, and we may have difficulty
attracting new personnel that we might wish to hire in the future.


                                       22


WE MUST MAKE JUDGMENTS IN THE PROCESS OF PREPARING OUR FINANCIAL STATEMENTS

We prepare our financial statements in accordance with generally accepted
accounting principles and certain critical accounting polices that are relevant
to our business. The application of these principles and policies requires us to
make significant judgments and estimates. In the event that judgments and
estimates we make are incorrect, we may have to change them, which could
materially affect our financial position and results of operations.

Moreover, accounting standards have been subject to rapid change and evolving
interpretations by accounting standards setting organizations over the past few
years. The implementation of new standards requires us to interpret and apply
them appropriately. If our current interpretations or applications are later
found to be incorrect, our financial position and results of operations could be
materially affected.

OUR STOCK PRICE MAY BE EXTREMELY VOLATILE

Volatility in our stock price may negatively affect the price you may receive
for your shares of common stock and increases the risk that we could be the
subject of costly securities litigation. The market price of our common stock
has fluctuated substantially and could continue to fluctuate based on a variety
of factors, including:

     |X|  quarterly fluctuations in our operating results;
     |X|  changes in future financial guidance that we may provide to investors
          and public market analysts;
     |X|  changes in our relationships with our licensees;
     |X|  announcements of technological innovations or new products by us, our
          licensees or our competitors;
     |X|  changes in ADSL market growth rates as well as investor perceptions
          regarding the investment opportunity that companies participating in
          the ADSL industry afford them;
     |X|  changes in earnings estimates by public market analysts;
     |X|  key personnel losses;
     |X|  sales of common stock; and
     |X|  developments or announcements with respect to industry standards,
          patents or proprietary rights.

In addition, the equity markets have experienced volatility that has
particularly affected the market prices of equity securities of many high
technology companies and that often has been unrelated or disproportionate to
the operating performance of such companies. These broad market fluctuations may
adversely affect the market price of our common stock.

OUR BUSINESS MAY BE AFFECTED BY GOVERNMENT REGULATIONS

The extensive regulation of the telecommunications industry by federal, state
and foreign regulatory agencies, including the Federal Communications
Commission, and various state public utility and service commissions, could
affect us through the effects of such regulation on our licensees and their
customers. In addition, our business may also be affected by the imposition of
certain tariffs, duties and other import restrictions on components that our
customers obtain from non-domestic suppliers or by the imposition of export
restrictions on products sold internationally and incorporating our technology.
Changes in current or future laws or regulations, in the United States or
elsewhere, could seriously harm our business.


                                       23


                                     ITEM 3:
           QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK


Our exposure to market risk relates primarily to our investment portfolio, and
the effect that changes in interest rates would have on that portfolio. Our
investment portfolio has included:

     |X|  Cash and cash equivalents, which consist of financial instruments with
          original maturities of three months or less; and
     |X|  Investments, which consist of financial instruments that meet the high
          quality standards specified in our investment policy. This policy
          dictates that all instruments mature in three years or less, and
          limits the amount of credit exposure to any one issue, issuer, and
          type of instrument.

We do not use derivative financial instruments for speculative or trading
purposes. As of June 30, 2003, we had $36.7 million in cash, cash equivalents
and short-term investments that matured in twelve months or less. Due to the
short duration of these financial instruments, we do not expect that an increase
in interest rates would result in any material loss to our investment portfolio.

As of June 30, 2003, we had invested $6.5 million in long-term investments that
matured in one to three years. These long-term securities are invested in high
quality corporate securities and U.S. government securities. Despite the high
quality of these securities, they may be subject to interest rate risk. This
means that if interest rates increase, the principal amount of our investment
would probably decline. A large increase in interest rates may cause a material
loss to our long-term investments. The following table (dollars in thousands)
presents hypothetical changes in the fair value of our long-term investments at
June 30, 2003. The modeling technique measures the change in fair value arising
from selected potential changes in interest rates. Movements in interest rates
of plus or minus 50 basis points (BP) and 100 BP reflect immediate hypothetical
shifts in the fair value of these investments.



                                        VALUATION OF SECURITIES                        VALUATION OF SECURITIES
                                         GIVEN AN INTEREST RATE                         GIVEN AN INTEREST RATE
                                              DECREASE OF             NO CHARGE             INCREASE OF
                                       -------------------------     IN INTEREST      -------------------------
Type of security                         (100BP)      (50 BP)           RATES           100 BP        50 BP
---------------------------------------------------------------------------------------------------------------
                                                                                         
Long-term investments with
  maturities of one to three years           $6,548      $6,487            $6,428          $6,310       $6,368



                                       24


                                     ITEM 4:
                             CONTROLS AND PROCEDURES


Our management, including our chief executive officer and chief financial
officer, has evaluated our disclosure controls and procedures as of the end of
the quarterly period covered by this Form 10-Q and has concluded that our
disclosure controls and procedures are effective. They also concluded that there
were no changes in our internal control over financial reporting that occurred
during the quarterly period covered by this Form 10-Q that have materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting.




                                       25


                           PART II. OTHER INFORMATION

                                     ITEM 1:
                                LEGAL PROCEEDINGS


From time to time we are involved in litigation incidental to the conduct of our
business. We are not party to any lawsuit or proceeding that, in our opinion, is
likely to seriously harm our business.


                                     ITEM 4:
               SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

On May 29, 2003, we held our Annual Meeting of Stockholders (the "Annual
Meeting"). Matters voted on and the results of those votes are set forth below:

(1)  Each of Michael A. Tzannes and G. David Forney was elected to serve as a
     Class I director of the Company for a term expiring at the annual meeting
     of stockholders of the Company in 2006 or a special meeting in lieu
     thereof. Each of Edmund C. Reiter, John K. Kerr, David Ehreth and Frederick
     D. D'Alessio continued to serve as a director following the Annual Meeting.

     The votes cast to elect the Class I directors were:

     Name                         For                       Abstain
     ----                         ---                       -------

     Michael A. Tzannes           21,699,034                158,253
     G. David Forney              21,717,355                139,932

(2)  The Company's 1996 Employee Stock Purchase Plan was amended to increase the
     number of shares available for issuance under the plan from 100,000 to
     350,000.

     The votes cast to amend the Company's 1996 Employee Stock Purchase Plan
     were:

     For                          Against                   Abstain
     ---                          -------                   -------

     21,411,111                   393,891                   52,285



                                       26


                                     ITEM 6:
                        EXHIBITS AND REPORTS ON FORM 8-K


(A)  EXHIBITS


          Exhibit 31.1     Certification of Chief Executive Officer pursuant to
                           Section 302 of the Sarbanes-Oxley Act of 2002.

          Exhibit 31.2     Certification of Chief Financial Officer pursuant to
                           Section 302 of the Sarbanes-Oxley Act of 2002.

          Exhibit 32.1     Certification of Chief Executive Officer and Chief
                           Financial Officer pursuant to Section 906 of the
                           Sarbanes-Oxley Act of 2002.


(B)  REPORTS ON 8-K


          We filed a Form 8-K dated May 1, 2003, which included as an exhibit a
          press release dated May 1, 2003 announcing our financial results for
          the quarter ended March 31, 2003.


--------------------



                                   SIGNATURES


          Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.


                                         AWARE, INC.


          Date: August 8, 2003           By:  /s/ Michael A. Tzannes
                                              ----------------------
                                              Michael A. Tzannes,
                                              Chief Executive Officer


          Date: August 8, 2003           By:  /s/ Richard P. Moberg
                                              ---------------------
                                              Richard P. Moberg, Vice President
                                              and Chief Financial Officer
                                              (Principal Financial and
                                              Accounting Officer)


                                       27