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, 2006
COMMISSION FILE NUMBER 000-21129
AWARE, INC.
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(Exact Name of Registrant as Specified in Its Charter)
Massachusetts 04-2911026
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(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
40 MIDDLESEX TURNPIKE, BEDFORD, MASSACHUSETTS 01730
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(Address of Principal Executive Offices)
(Zip Code)
(781) 276-4000
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(Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
------------------- -----------------------------------------
COMMON STOCK, PAR VALUE $.01 THE NASDAQ STOCK MARKET LLC
PER SHARE
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes [ ] No [X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes [ ] No [X]
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large Accelerated Filer [ ] Accelerated Filer [X ] Non-Accelerated Filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
As of June 30, 2006 the aggregate market value of the registrant's common stock
held by non-affiliates of the registrant, based on the closing sale price as
reported on the Nasdaq Global Market, was approximately $128,958,890.
The number of shares outstanding of the registrant's common stock as of March 5,
2007 was 23,673,603.
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 23, 2007 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, 2006
TABLE OF CONTENTS
PART I
Item 1. Business......................................................... 3
Item 1A. Risk Factors..................................................... 12
Item 1B. Unresolved Staff Comments........................................ 18
Item 2. Properties....................................................... 18
Item 3. Legal Proceedings................................................ 19
Item 4. Submission of Matters to a Vote of Security Holders.............. 19
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities................ 20
Item 6. Selected Financial Data.......................................... 22
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations........................................ 23
Item 7A. Quantitative and Qualitative Disclosures About Market Risk....... 29
Item 8. Consolidated Financial Statements and Supplementary Data......... 31
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure......................................... 50
Item 9A. Controls and Procedures.......................................... 50
Item 9B. Other Information................................................ 50
PART III
Item 10. Directors, Executive Officers and Corporate Governance........... 50
Item 11. Executive Compensation........................................... 50
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters....................... 51
Item 13. Certain Relationships and Related Transactions, and
Director Independence............................................ 51
Item 14. Principal Accountant Fees and Services........................... 51
PART IV
Item 15. Exhibits and Financial Statement Schedules....................... 52
Signatures................................................................. 54
2
PART I
ITEM 1. BUSINESS
COMPANY OVERVIEW
We have been a leading innovator in Digital Subscriber Line ("DSL") technology
for over a decade. We license silicon intellectual property to semiconductor
companies that build integrated circuits for the DSL industry. Our offerings are
based upon International Telecommunication Union ("ITU") and other relevant
industry standards. Our DSL technology focus is on asymmetric DSL ("ADSL") and
very high speed DSL ("VDSL"). ADSL enables telephone companies to utilize their
existing copper telephone lines to offer broadband services. Numerous ADSL
standards have been adopted by the ITU since 1999, including G.992.1 ADSL and
G.992.2 G.Lite as well as G.992.3 ADSL2 and G.992.5 ADSL2+ which were adopted by
the ITU in 2002 and 2003, respectively. In 2006, the ITU approved the G.993.2
VDSL2 standard. ADSL2+ and VDSL2 further expand the bandwidth utilized by DSL
signals and enable higher data rates than ADSL. The ADSL2+ and VDSL2 standards
deliver improved immunity against noise, support for test and diagnostics
functionality, data rate adaptability and means for power consumption reduction.
With these standards, telephone companies are able to deploy
entertainment-quality services such as television, including Internet Protocol
television ("IPTV") and video-on-demand, and support high-definition formats
such as HDTV. IPTV provides phone companies a means to deliver a superior and
differentiated TV service by offering more channel selections, better quality
and an improved user experience with multiple viewing panes and instantaneous
channel switching. IPTV is expected to drive increased demand for the fastest
versions of DSL service over the next several years. ADSL2+ and VDSL2 are
expected to be increasingly used in worldwide deployments over the next several
years.
We also sell DSL test and diagnostics hardware and software products to
pre-qualify, monitor and troubleshoot DSL service offered by phone companies. We
sell our products to OEM suppliers of automated test equipment, including
manufacturers of test-heads and handheld testers. We also sell our software
products to telephone companies and network equipment suppliers. Our hardware
products interoperate with existing central office ("CO") and customer premises
equipment ("CPE") thereby enabling connectivity for test and diagnostics
applications. We are committed to maintaining interoperability with new DSL CO
and CPE solutions. Our software products support pre-qualification,
provisioning, troubleshooting and maintenance of DSL networks. As phone
companies expand their DSL offerings to include IPTV, video and triple play
services, the need has increased for improved monitoring and troubleshooting of
DSL networks. Our products leverage our expertise in DSL technology and product
developments.
We have been a leading innovator in imaging and biometrics applications for over
a decade. We sell biometrics software components that are used in government
systems worldwide. Our products address a broad range of functionality including
enrollment of fingerprints and facial images, ID personalization and reading,
and networking. We have broad exposure to biometrics applications in criminal
justice, border control and secure credential applications. We primarily sell
our products to OEMs and system integrators. We also sell to end-users such as
government agencies and enterprises. The biometrics industry has benefited from
the emergence of industry standards and supportive legislation since September
11, 2001. The use of multimodal biometrics and facial images is expected to be
on the rise. In addition, we sell software products for medical and digital
imaging applications based upon industry standards such as JPEG 2000 and JPIP.
We have research and development activities underway to develop new forms of
broadband and imaging technologies. We play an active role at standards setting
bodies so that we can anticipate and influence changes in industry requirements.
During 2005 and 2006, approximately 62% and 58%, respectively, of our revenue
came from licensing DSL intellectual property. We license our intellectual
property worldwide through our direct sales force. Our largest semiconductor
customers in 2005 and 2006 were Infineon Technologies, AG and Analog Devices,
Inc., which on February 17, 2006 sold its ADSL business relating to Aware
technology to Ikanos Communications, Inc. ("Ikanos") and Ikanos has replaced
Analog Devices, Inc. as an Aware licensee.
The remainder of our revenue came from the sale of software and hardware
products. Our software product sales consisted primarily of sales of software
tools for biometric applications. We also had sales of medical imaging
3
software tools and software for DSL test and diagnostics applications. Our
hardware products consisted primarily of hardware modules for DSL test and
diagnostics applications.
We are headquartered in Bedford, Massachusetts. Our telephone number is (781)
276-4000, and our website is www.aware.com. Incorporated in Massachusetts in
1986, we employed 117 people as of December 31, 2006. Our stock is traded on the
Nasdaq Global Market under the symbol AWRE.
Our website provides a link to a third-party website through which our annual,
quarterly and current reports, and amendments to those reports, are available
free of charge. We believe these reports are made available as soon as
reasonably practicable after we electronically file them with, or furnish them
to, the SEC. We do not maintain or provide any information directly to the
third-party website, and we are not responsible for its accuracy.
INDUSTRY BACKGROUND
DSL INDUSTRY BACKGROUND. DSL technology allows telephone companies to offer
high-speed data services over their existing telephone wires. Telephone
companies began tests and trials of ADSL technology in the mid 1990s. Commercial
deployment of ADSL services began in modest volumes in 1999, and during the last
five years, the rate of deployment of ADSL services accelerated dramatically,
particularly outside of the United States. According to announcements by major
telephone companies and information compiled by Point Topic Ltd., a company that
provides analysis of broadband access to the Internet, approximately 12 million,
17 million, 28 million, 36 million, 41 million and 43 million new ADSL
subscribers were added in 2001, 2002, 2003, 2004, 2005 and 2006, respectively.
As of the third quarter of 2006, there were approximately 172 million global DSL
subscribers worldwide, of which approximately 28 million were in North America.
There were 68 million in Europe/Middle East/Africa, approximately 67 million
were in the Asia Pacific region and the remainder was in Latin America.
As the demand for faster residential broadband service continues to grow,
telephone companies are upgrading their networks to increase the data rates that
are delivered to their residential customers. With higher data rates phone
companies can offer IPTV, video and triple play services. These upgrades require
large financial expenditures and involve the deployment of fiber optic-based
communications to points deeper in the access networks that are closer to
residential customers than today's central office locations. The resulting
fiber-to-the-node ("FTTN") networks require that new equipment platforms be
installed at fiber-fed points. These equipment platforms utilize the existing
telephone wire infrastructure and new ADSL2+ or VDSL2 standards to provide
increased data rates.
ADSL service now serves a broad global footprint; service based upon ADSL is now
offered in over 80 countries throughout the world. It is expected that ADSL
service offerings will increasingly use ADSL2+ technology because it enables
higher data rates and improved functionality.
VDSL service has been deployed in Japan and VDSL2 service deployments are
underway in several other countries, including Belgium, Switzerland and Germany.
Deutsche Telekom commenced a 50 Mbps VDSL2-based service to a large number of
cities in 2006, the largest VDSL2 deployment in the world-to-date. Japan, Korea
and the United States are expected to roll-out VDSL2 networks during 2007.
In order to activate DSL service, one end of a telephone wire must be connected
to DSL equipment in a central office or remote location controlled by telephone
companies and the other end must be connected to a device in the customer's
premises. DSL central office and remote location equipment includes DSL access
multiplexers ("DSLAMs"), next generation digital loop carriers ("NGDLCs"), and
broadband loop carriers ("BLCs"). These are available from numerous
telecommunications equipment suppliers. Some of the leading suppliers of DSL
equipment include Alcatel-Lucent, Huawei, ECI Telecom, NEC Corporation, Siemens
AG, Sumitomo Corporation, and UTStarcomm. Devices in the customer's premise are
known as DSL customer premises equipment ("CPE") and include modems, routers and
devices that support integrated voice and data, known as integrated access
devices. Thomson Multimedia, Siemens, D-Link, Sumitomo, Sagem, Westell, Zyxel
and Cisco are leading manufacturers of ADSL CPE.
Equipment manufacturers are able to purchase DSL chipsets for telephone company
equipment or CPE from a number of suppliers, including Broadcom Corporation
("Broadcom"), Centillium Communications, Inc. ("Centillium"), Conexant Systems,
Inc. ("Conexant"), Ikanos Communications, Infineon Technologies AG ("Infineon"),
PMC-Sierra Inc. , ST Microelectronics N.V. ("ST"), and Texas Instruments
Incorporated ("TI").
4
With over 1 billion phone lines installed worldwide, DSL has penetrated less
than 17% of the available market. According to estimates by Infonetics Research
published in March 2007, the DSL chipset market future growth projections are
that:
o Telephone companies are expected to add 98 million, 105 million,
111 million and 118 million new DSL ports to their networks in
2007, 2008, 2009 and 2010 respectively.
o Telephone companies are expected to add 13.6 million, 18.4
million, 25.4 million and 34.2 million VDSL ports to their
networks in 2007, 2008, 2009 and 2010 respectively.
o ADSL CPE units of 73 million, 74 million, 73 million and 71
million are expected to sell in 2007, 2008, 2009 and 2010
respectively.
o VDSL CPE units of 3 million, 5 million, 9 million and 14 million
are expected to sell in 2007, 2008, 2009 and 2010 respectively.
DSL TECHNOLOGY BACKGROUND. DSL technology expands the usable bandwidth of copper
wire so that telephone companies can offer high-speed data services over their
existing telephone networks. DSL is a point-to-point technology that connects
the end user to a central location in the telephone company's network such as a
central office or remote location controlled by the telephone company. DSL
equipment is required at each end of the telephone line. New ADSL2, ADSL2+ and
VDSL2 technologies will enable transmit speeds between multiple megabits
("Mbps") and 100 Mbps. Actual transmission speeds depend on the length and
condition of the existing wire.
An ADSL system typically divides the bandwidth on a copper wire into three
segments. The first segment is used for plain old telephone service ("POTS") or
ISDN. The second segment is used to transmit data "upstream" from the user to a
central location in the phone network. The third segment is used to transmit
data to the user (the "downstream" direction).
The ADSL industry relies on international standards bodies to specify the
technology used for ADSL services. Standards bodies that contribute
specifications include the American National Standards Institute ("ANSI"), the
ITU, the European Telecommunications Standards Institute ("ETSI") and other
organizations. The prevalence and influence of industry standards on the ADSL
industry make it similar to other communications and networking technologies
such as Code Division Multiple Access ("CDMA"), Universal Serial Bus ("USB"),
Global System for Mobile telecommunications ("GSM"), Global Positioning System
("GPS"), Wireless Local Area Networking ("WLAN"), and chip-connection technology
for Dynamic Random Access Memory ("DRAM"). For the infrastructure and services
that use these technologies, standards and patents play a significant role in
the formation of the commercial landscape.
Full-rate ADSL was first standardized in 1995 by ANSI as T1.413, and then by the
ITU in 1999 as G.992.1. Full-rate ADSL can transmit data at speeds up to 8 Mbps
downstream and up to 640 Kbps upstream.
In 1999, the ITU also standardized a lower speed version of ADSL, known as
G.Lite or G.992.2. G.Lite can transmit data at speeds up to 1.5 Mbps downstream
and up to 512 Kbps upstream without using special filtering equipment required
by full-rate ADSL. G.Lite was intended to make the installation of ADSL faster
and less expensive for telephone companies; however, most ADSL service offerings
today are based on full-rate ADSL.
In 2002, the ITU approved a new set of ADSL standards known as ADSL2 or G.992.3
and G.992.4. These standards provide numerous improvements over previous ADSL
standards, including line diagnostics, power management, power down and power
cutback, reduced framing and on-line configuration. In 2003, the ITU approved
ADSL2+ or G.992.5. ADSL2+ builds upon the ADSL2 standard by increasing
achievable data rates to speeds up to 24 Mbps upstream on phone lines as long as
3,000 feet (20 Mbps out to 5,000 feet). While the signal bandwidth of previous
ADSL standards was about 1 MHz, ADSL2+ specifies signals with more than 2 MHz of
bandwidth.
ITU standards for bonded ADSL, G.998.1 and G.998.2, were approved in January
2005. These standards specify multi-pair ADSL bonding technology for residential
and business services. Data rates are increased by a factor equal to the number
of lines that are bonded. If two pairs are bonded, upstream and downstream data
rates are doubled.
VDSL2 is the fastest version of DSL. In February 2006, the ITU approved the
G.993.2 VDSL2 standard. This standard supports bandwidths from 8 MHz to 30 MHz
and specifies data rates up to 100 Mbps. VDSL2 supports
5
multiple profiles, each requiring support for multiple upstream and downstream
bands. VDSL2 also supports the functionality improvements found in ADSL2 and
ADSL2+.
DSL TEST AND DIAGNOSTICS INDUSTRY BACKGROUND. The ADSL2+ and VDSL2 standards are
the first DSL standards to incorporate test functionality for analyzing and
diagnosing DSL networks. As deployments using these technologies become more
pervasive, this functionality will improve phone companies' ability to test and
diagnose their networks.
As IPTV, video-based and triple play services become more widely offered through
DSL networks, the need for improved pre-qualification, provisioning and
maintenance is increasing. Television and video services require a higher degree
of reliability and robustness than data services.
Service assurance solutions have been put in place for telephone companies'
traditional voice services and initial ADSL deployments. We expect an increased
interest by phone companies for new service assurance solutions for ADSL2+ and
VDSL2 networks and IPTV and video-based services.
Use of automated test equipment ("ATE") is a typical means for testing and
diagnosing the DSL lines and services that are offered by telephone companies to
consumers and businesses. The DSL ATE infrastructure typically involves the use
of a centrally located test-head platform. At this location, information is
gathered from the telephone network and used for provisioning or troubleshooting
DSL service.
Information about the DSL network is also gathered using hand-held testers. The
information gathered in ATE and handhelds is generally made available to
telephone companies' operations organizations through a complex software
network. This information assists telephone companies in pre-qualifying,
analyzing and diagnosing problems encountered during service deployment or
during operation.
Test and diagnostics functions are also performed by DSL network equipment (e.g.
DSLAMs) or DSL CPE, though typically to a lesser extent than those performed by
dedicated test equipment.
Leading suppliers of ATE hardware and software, handheld devices and operations
software include Spirent, Teradyne, Tollgrade, Acterna, Sunrise, Fluke, and
others.
BIOMETRICS INDUSTRY BACKGROUND. Biometric identification systems have
traditionally used fingerprints as the primary biometric to identify individuals
and continue to be pervasive in government and commercial applications. These
systems gather fingerprints at enrollment stations and access control locations,
and utilize transaction processing hardware and software and matching systems
for identification. The emergence of digital fingerprint compression and
formatting over the last decade has transformed these to electronic systems
capable of faster transaction processing and matching. These electronic systems
are also capable of being upgraded to utilize biometrics other than or in
addition to digital fingerprints, such as facial images.
The emergence and adoption of industry standards for border control and secure
credential applications has increased the reach and use of biometrics in
security applications. Legislation is driving many government programs now
underway that require the use of biometric information in documents such as
e-passports and personal identification cards. Personal identity verification
("PIV") systems are being employed by government agencies to standardize federal
employee and contractor IDs and utilize them to control access to government
facilities and information systems. The National Institute for Standards and
Technology developed the FIPS 201 standard for PIV as mandated by HSPD-12. Other
biometrics applications such as border management, and upgrades to state and
local AFIS systems used for fingerprint enrollments are also expected to present
opportunities for vendors of biometrics products in the next several years. The
use of biometric security systems by regulated segments of the financial,
transportation and healthcare industries has also increased.
Vendors of the hardware and/or software component of biometric enrollment
stations include Lockheed Martin, Crossmatch, Unisys, SAIC, L1 Identity
Solutions, Northrop Grumman, and NEC. Fingerprint matching and/or biometric
transaction management systems are provided by companies such as Motorola,
Sagem, NEC, Cogent, Identix, and numerous system integrators. As biometric
security systems gain acceptance in new areas, the market opportunity for
suppliers of hardware and software solutions is expected to grow. The biometrics
security systems market is also expected to grow as the use of new biometrics,
other than or in addition to fingerprints, gain favor.
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AWARE DSL INTELLECTUAL PROPERTY
Aware has been a pioneer of DSL technology since the mid-1990s. We license our
StratiPHY2+(TM) and StratiPHY3(TM) silicon intellectual property platforms to
semiconductor companies to manufacture and sell chipsets that are compliant with
the ITU standards for ADSL, ADSL2, ADSL2+, VDSL1 and VDSL2. StratiPHY2+ supports
ADSL2 and ADSL2+ standards for CPE applications. We have been first to
demonstrate bonded ADSL2+ that doubles ADSL data rates as well as reach-extended
ADSL2 that increases the distance over which phone companies can deliver service
by 20% or more. Our StratiPHY-Bonded(TM) ADSL2+ platform complies with the ITU
G.bond standard. StratiPHY3 supports ADSL2, ADSL2+, VDSL1 and VDSL2 standards.
StratiPHY3 can be configured to run in central office as well as customer
premises equipment mode.
The StratiPHY2+, StratiPHY-Bonded and StratiPHY3 platforms include patent
rights, copyrighted materials and trade secrets. Copyrighted materials include
digital chip design technology, available in Verilog or VHDL languages, and
software, available in assembly and C-code. We license our copyrighted materials
in source code as well as object code form. We have also manufactured limited
quantities of digital chips using our StratiPHY designs. StratiPHY2+ and
StratiPHY3 chips support all legacy and new ADSL standards in a single
integrated circuit. StratiPHY2+ is applicable to customer premises solutions and
StratiPHY3 is applicable to central office or customer premises solutions and
also supports VDSL and VDSL2 standards.
Customers develop integrated circuits based upon our technology for fabrication
in their own or third party manufacturing processes. Customers manufacture our
digital chip or integrate our technology into chips that also contain other
functionality. We also offer engineering services to our customers for the
development and support of their chips or chipsets. Our largest customers for
DSL intellectual property have been ADI and Infineon.
AWARE DSL TEST AND DIAGNOSTICS PRODUCTS
We have developed test and diagnostics hardware and software products based upon
our Dr. DSL(R) technology. These products are designed to improve the ability of
service providers to pre-qualify, provision, monitor, and troubleshoot DSL
networks by enabling them to collect important information and diagnose problems
regarding their service offerings. The primary goal of these products is to
reduce the costs associated with service set-up and maintenance. Specific
product features include loop length measurement, bridged tap measurement,
crosstalk disturber detection and management, subscriber self-installation, and
in-home diagnostics.
Customers use our Dr. DSL hardware modules for modem emulation to achieve
connectivity within DSL networks. With these products, customers can
interoperate with a broad array of telephone company DSL equipment as well as
DSL CPE. Our principal hardware products include:
o Modem Models 150 and 350- Standard-compliant CPE transceiver emulation
modems for ADSL or ADSL2+ networks
o Modem Models 450 and 550- Standard-compliant transceiver CO and CPE
emulation modems for ADSL/2/2+ and VDSL2 CO and CPE networks.
o DSL test and development systems - System-level products for ADSL/2/2+
and VDSL2 performance and interoperability testing.
We primarily sell our hardware products to OEMs who supply DSL automated test
equipment and DSL handheld testers.
Customers use our DSL software products to provision and troubleshoot their
networks and service offerings. Our Dr. DSL software modules perform
pre-qualification, fault detection, line diagnostics and line analysis
functionality. Our Dr. DSL Line Diagnostics Platform is a server-based platform
that collects single-ended line test (SELT), dual- ended line test ("DELT") and
metallic loop test ("MLT") data and enables telephone companies to perform
analysis and diagnostics of traditional POTS and traditional and advanced DSL
services, including IPTV and advanced triple play services.
We primarily sell our Dr. DSL software products to automated test equipment,
outside plant equipment, and DSL network equipment suppliers. We also sell to
telephone companies.
7
AWARE BIOMETRICS AND IMAGING PRODUCTS
Aware has been a pioneer in the development of wavelet-based image compression
technology since the late 1980s.
Aware provides standards-compliant biometrics software tools that enable
integrators, solution providers, and government agencies to compress, analyze,
optimize, format, and transport biometric images and data according to domestic
and international standards.
We have developed software products for biometrics applications that support
industry standards.
These products address:
o Data formatting and interchange software components that support NIST,
ISO, INCITS, ICAO, and FIPS 201 standards and enable interoperability.
o Image compression software components for fingerprint and facial image
compression such as WSQ and JPEG2000.
o Biometric ID cards. Our PIVSuite(TM) family of software development kits
support registration, identity proofing, ID card personalization and
issuance applications in compliance with FIPS 201.
o Image processing for biometric quality analysis, capture and transaction
processing applications.
o Networking software for building and deploying multimodal biometric data
workflow solutions. Our Biometrics Workflow Platform (BWP) supports the
collection of biometrics from a distributed network, and subsequent
aggregation, analysis, processing and integration of this data into
larger systems.
We sell our biometrics software products primarily to integrators, OEMs and
government agencies., We supply a broad range of fingerprint and facial
biometric functionality, including enrollment, ID personalization and reading,
and networking. Our solutions address border control and management, secure
credentialing, and fingerprint background check applications.
We also sell medical imaging and digital imaging software solutions.
We have a large number of OEM customers in the biometrics, medical and digital
imaging markets.
AWARE STRATEGY
We are a technology innovation company. We promote our technology through
participation in industry standard setting organizations and lead the market in
the development of products that support industry standards. We have done so for
more than ten years in the DSL and biometrics industries. We sell our products
through an OEM business model, allowing us to expand the reach of our products
through the success of our customers.
Key elements of our strategy include:
LEAD IN THE DEVELOPMENT OF DSL STANDARDS BASED TECHNOLOGIES. We actively promote
our technology at standards bodies with the goal of including it in new
specifications. The use of technology that is compliant with industry standards
is prevalent in telecommunications applications and in the DSL industry. Through
the standardization of our technology, we believe that we expand the size of the
DSL opportunity for the company. ADSL2+ and VDSL2 standards are at the center of
new DSL offerings for IPTV, video and triple play services worldwide. By
developing technology based upon industry standards, we deliver solutions to our
customers that have broad market reach.
DEVELOP HIGH PERFORMANCE, EASY-TO-USE, INTEROPERABLE, FLEXIBLE DSL SILICON
INTERFACE TECHNOLOGY. Our StratiPHY platforms support multiple DSL standards in
cost effective intellectual property offerings. Our StratiPHY technology meets
or exceeds industry performance and functionality requirements. We have
established interoperability agreements with leaders in the DSL equipment and
semiconductor industries to achieve and maintain high levels of interoperability
across multiple vendors' solutions. We have also developed chips, reference
designs and development platforms to allow rapid evaluation and testing of our
solutions.
8
COMMERCIALIZE OUR DSL SILICON PRODUCTS THROUGH A LICENSING BUSINESS MODEL. By
licensing our technology, our customers leverage our StratiPHY2+ and StratiPHY3
developments, reduce their R&D and support costs and deliver DSL functionality
rapidly to the market. We leverage our customers' sales, distribution and
manufacturing capabilities. Our objective is to establish StratiPHY2+ and
StratiPHY3 as predominant broadband WAN silicon-level interfaces through the
success of our customers' products.
COMMERCIALIZE HARDWARE AND SOFTWARE SOLUTIONS FOR DSL TEST AND DIAGNOSTICS
APPLICATIONS THROUGH AN OEM BUSINESS MODEL. We have developed hardware modules
and software solutions for pre-qualifying, provisioning, and troubleshooting DSL
networks. These leverage our DSL silicon interface expertise and the test
functionality inherent in ADSL2+ and VDSL2 standard-compliant solutions. We sell
to automated test equipment manufacturers, network equipment manufacturers and
service providers. By selling primarily through OEMs, we gain broad exposure to
growth in spending by phone companies on DSL service assurance. This spending is
expected to increase as new technologies such as ADSL2+ and VDSL2 and new
service offering such as IPTV and video become more pervasive.
LEAD IN THE DEVELOPMENT OF STANDARDS-BASED IMAGING TECHNOLOGIES. Aware has been
a pioneer in the development of wavelet-based solutions for image compression.
We have been involved in standards setting organizations for fingerprint and
medical imaging applications, as well as e-passport and secure credential
applications.
COMMERCIALIZE SOFTWARE COMPONENTS AND SERVER-BASED SOLUTIONS FOR BIOMETRICS
APPLICATIONS THROUGH AN OEM CHANNEL. We have developed software components for
fingerprint enrollment, border control and secure credential applications. We
have also developed the biometrics workflow platform (BWP), a server-based
software product for enrollment of biometric data for personal identity
verification and other applications. We sell primarily to OEM suppliers and
systems integrators. We have broad exposure to the biometrics market through our
customer base.
RESEARCH AND DEVELOPMENT
DSL semiconductor technology must track the rapidly changing requirements of the
DSL industry. Our research and development activities are focused on shrinking
the size of integrated circuits based upon our technology, improving performance
and functionality and incorporating new technology to increase the value of our
technology offerings. During 2006, we introduced an analog front end solution
for DSL, and a solution for bonded-ADSL2+.
We also have research and development activities focused on improving the
functionality of our DSL test and diagnostics hardware and software products to
support phone company requirements for pre-qualifying, monitoring and
troubleshooting advanced DSL services, including VDSL2 networks and IPTV
deployments. During 2006, we introduced new hardware modules and new software
components and a server-based software product for DSL test and diagnostic
applications.
We also have research and development activities focused on improving our
software product functionality and broadening our exposure to biometrics,
medical and digital imaging applications. During 2006, we introduced new
software components for PIV and e-passport applications, as well as a new
server-based platform for PIV enrollment applications.
As of December 31, 2006, we had an engineering staff of 86 employees,
representing 74% of our total employee staff. During the years ended December
31, 2006, 2005, and 2004, research and development expenses charged to
operations were $11.2 million, $10.2 million, and $10.0 million, respectively.
In addition, because our license agreements often call for us to provide
engineering development services to our customers, a portion of our total
engineering costs has been allocated to cost of contract revenue. We expect that
we will continue to invest substantial funds in research and development
activities.
SALES AND MARKETING
Our principal sales and marketing strategy is to license our DSL intellectual
property to semiconductor manufacturers. We believe that decisions involving the
selection of our technology are frequently made at senior levels within a
prospective customer's organization. Consequently, we rely significantly on
presentations by our senior management to key employees at prospective
customers. As of December 31, 2006, we had ten employees in our DSL licensing
and test and diagnostics sales and marketing organization.
9
Customers who are selling or developing integrated circuits based upon
StratiPHY2plus include: Atmel Corporation ("Atmel"), Ikanos Communications, Inc.
("Ikanos"), Infineon, and Thomson SA ("Thomson"). On February 17, 2006, Analog
Devices, Inc. ("ADI") sold its ADSL business relating to Aware technology to
Ikanos and Ikanos has replaced ADI as an Aware licensee.
Customers who are selling or developing integrated circuits based upon
StratiPHY3 include Infineon and Thomson.
In 2006, we derived approximately 20% and 26% of our total revenue from the
ADI/Ikanos combination and Infineon, respectively. In 2005, we derived
approximately 20% and 30% of our total revenue from ADI and Infineon,
respectively. In 2004, we derived approximately 28%, and 28% of our total
revenue from ADI, and Infineon, respectively. All revenue in 2006, 2005, and
2004 was derived from unaffiliated customers.
We sell our test and diagnostics products primarily to OEMs and to a lesser
extent to service providers.
We sell our biometrics and digital imaging software products primarily to OEMs
and systems integrators. As of December 31, 2006, there were four employees in
our biometrics and digital imaging software sales organization.
COMPETITION
We compete by offering comprehensive packages of standards-based broadband
technology. Our success as an intellectual property supplier depends on the
willingness and ability of semiconductor manufacturers to design, build and sell
integrated circuits based on our intellectual property. The semiconductor
industry is intensely competitive and has been characterized by:
o rapid price erosion;
o rapid technological change;
o short product life cycles;
o cyclical market patterns; and
o increasing foreign and domestic competition.
As an intellectual property supplier to the semiconductor industry, we face
competition from internal development teams within potential semiconductor
customers. We must convince potential licensees to license from us rather than
develop technology internally. Furthermore, semiconductor customers, who have
licensed our intellectual property, may choose to abandon joint development
projects with us and develop chipsets themselves without using our technology.
In addition to competition from internal development teams, we may compete
against other independent suppliers of intellectual property for DSL.
The market for DSL chipsets is also intensely competitive. Our success within
the DSL industry requires that DSL equipment manufacturers buy chipsets from our
semiconductor licensees, and that telephone companies buy DSL equipment from
those equipment manufacturers. Our customers' chipsets compete with products
from other vendors of standards-based DSL chipsets, including Broadcom,
Conexant, ST and TI.
DSL services also compete with broadband technologies that use other network
architectures to provide high-speed data service. These technologies include
cable modems using cable networks, wireless solutions using wireless networks
and fiber-to-the-home services. To date, ADSL services have been more successful
than high-speed cable services outside of the United States; however cable
services serve a larger number of broadband subscribers than ADSL inside the
United States. We cannot give you assurances that these alternative network
architectures will not be more successful than ADSL or VDSL.
The markets for our test and diagnostics hardware and software products are
competitive and uncertain. We cannot assure you that phone companies will
purchase significant quantities of products to test and diagnose their DSL
networks, nor that if they do they will use our products. Our success as a
supplier of hardware and software products for DSL test and diagnostics depends
on the willingness and ability of OEM customers to design, build and sell
automated test heads, hand-held testers, and in some instances DSLAMs that
incorporate or work with our products.
10
The markets for our biometrics, medical and digital imaging software products
are competitive and uncertain. We cannot assure you that the biometrics industry
will grow. We cannot assure you that our products will succeed in the market. We
cannot assure you that we will be able to compete effectively or that
competitive pressures will not seriously harm our business.
Our licensing and OEM customers and their competitors have significantly greater
financial, technological, manufacturing, marketing and personnel resources than
we do. We cannot assure you that our OEM customers will continue to purchase
products from us or that we will be able to compete effectively or that
competitive pressures will not seriously harm our business.
PATENTS AND INTELLECTUAL PROPERTY
We rely on a combination of nondisclosure agreements and other contractual
provisions, as well as patent, trademark, trade secret and copyright law to
protect our proprietary rights. We have an active program to protect our
proprietary technology through the filing of patents. As of December 31, 2006,
we had 35 issued patents and 76 pending patent applications pertaining to
telecommunications and signal processing technology. We also had 13 issued
patents and 8 pending patent applications pertaining to image compression, video
compression, audio compression, seismic data compression and optical
applications.
Although we have patented certain aspects of our technology, we rely primarily
on trade secrets to protect our intellectual property. We attempt to protect our
trade secrets and other proprietary information through agreements with our
licensees, suppliers, employees and consultants, and through security measures.
Each of our employees is required to sign a non-disclosure and non-competition
agreement. Although we intend to protect our rights vigorously, we cannot assure
you that these measures will be successful. In addition, effective intellectual
property protection may be unavailable or limited in certain foreign countries.
Third parties may assert exclusive patent, copyright and other intellectual
property rights to technologies that are important to us. In the past, we have
received letters from third parties suggesting that we may be obligated to
license such intellectual property rights. If we were found to have infringed
any third party's patents, we could be subject to substantial damages and an
injunction preventing us from conducting our business.
MANUFACTURING
Sales of hardware products constitute a relatively small portion of our total
revenue. We do not intend to produce hardware products in any material quantity
for the foreseeable future. Consequently, we rely on third party contract
manufacturers to assemble and test substantially all of our products. Our
internal manufacturing capacity is limited to final test and assembly of certain
products. Other than DSL chipsets, which are available from our customers, we
believe that other components for our hardware products are available from a
number of suppliers.
EMPLOYEES
At December 31, 2006, we employed 117 people, including 86 in engineering, 14 in
sales and marketing, 3 in manufacturing and 14 in finance and administration. Of
these employees, 112 were based in Massachusetts. None of our employees is
represented by a labor union. We consider our employee relations to be good.
We believe that our future success will depend in large part on the service of
our technical and senior management personnel and upon our ability to retain
highly qualified technical, sales and marketing and managerial personnel. We
cannot assure you that we will be able to retain our key managerial and
technical employees or that we will be able to attract and retain additional
highly qualified personnel in the future.
11
ITEM 1A. RISK FACTORS
SOME OF THE INFORMATION IN THIS FORM 10-K CONTAINS FORWARD-LOOKING STATEMENTS
THAT INVOLVE SUBSTANTIAL RISKS AND UNCERTAINTIES. YOU CAN IDENTIFY THESE
STATEMENTS BY FORWARD-LOOKING WORDS SUCH AS "MAY," "WILL," "EXPECT,"
"ANTICIPATE," "BELIEVE," "ESTIMATE," "CONTINUE" AND SIMILAR WORDS. YOU SHOULD
READ STATEMENTS THAT CONTAIN THESE WORDS CAREFULLY BECAUSE THEY: (1) DISCUSS OUR
FUTURE EXPECTATIONS; (2) CONTAIN PROJECTIONS OF OUR FUTURE OPERATING RESULTS OR
FINANCIAL CONDITION; OR (3) STATE OTHER "FORWARD-LOOKING" INFORMATION. HOWEVER,
WE MAY NOT BE ABLE TO PREDICT FUTURE EVENTS ACCURATELY. THE RISK FACTORS LISTED
IN THIS SECTION, AS WELL AS ANY CAUTIONARY LANGUAGE IN THIS FORM 10-K, PROVIDE
EXAMPLES OF RISKS, UNCERTAINTIES AND EVENTS THAT MAY CAUSE OUR ACTUAL RESULTS TO
DIFFER MATERIALLY FROM THE EXPECTATIONS WE DESCRIBE IN OUR FORWARD-LOOKING
STATEMENTS. YOU SHOULD BE AWARE THAT THE OCCURRENCE OF ANY OF THE EVENTS
DESCRIBED IN THESE RISK FACTORS AND ELSEWHERE IN THIS FORM 10-K COULD MATERIALLY
AND ADVERSELY AFFECT OUR BUSINESS. WE ASSUME NO OBLIGATION TO UPDATE ANY
FORWARD-LOOKING STATEMENTS.
OUR QUARTERLY RESULTS ARE UNPREDICTABLE AND MAY FLUCTUATE SIGNIFICANTLY
Our quarterly revenue and operating results are difficult to predict and may
fluctuate significantly from quarter-to-quarter. Because our revenue components
fluctuate and are difficult to predict, and our expenses are largely independent
of revenues in any particular period, it is difficult for us to accurately
forecast revenues and profitability. When appropriate, we recognize contract
revenues ratably over the period during which we expect to deliver technology
and provide engineering services. While this means that contract revenues from
certain current agreements 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 contracts or licensees is
difficult because contract negotiation is a lengthy process, frequently spanning
a year or more, and the fiscal period in which a new license agreement will be
entered into, if at all, and the financial terms of such an agreement are
difficult to predict. Contract revenues also include fees for engineering
services, which are dependent upon the varying level of assistance desired by
licensees and, therefore, the revenue from these services is also difficult to
predict.
It is also difficult for us to make accurate forecasts of royalty revenues.
Royalties are recognized in the quarter in which we receive a report from a
licensee regarding the shipment of licensed integrated circuits in the prior
quarter, and are dependent upon fluctuating sales volumes and/or prices of chips
containing our technology, all of which are beyond our ability to control or
assess in advance.
Our business is subject to a variety of additional risks, which could materially
adversely affect quarterly and annual operating results, including:
o market acceptance of broadband technologies we supply by
semiconductor or equipment companies;
o the extent and timing of new license transactions with
semiconductor companies;
o changes in our and our licensees' development schedules and
levels of expenditure on research and development;
o the loss of a strategic relationship or termination of a project
by a licensee;
o equipment companies' acceptance of integrated circuits produced
by our licensees;
o the loss by a licensee of a strategic relationship with an
equipment company customer;
o announcements or introductions of new technologies or products
by us or our competitors;
o delays or problems in the introduction or performance of
enhancements or of future generations of our technology;
o failures or problems in our hardware or software products;
o price pressure in the biometrics or test and diagnostics markets
from our competitors;
o delays in the adoption of new industry standards or changes in
market perception of the value of new or existing standards;
o competitive pressures resulting in lower contract revenues or
royalty rates;
o competitive pressures resulting in lower software or hardware
product revenues;
o personnel changes, particularly those involving engineering and
technical personnel;
o costs associated with protecting our intellectual property;
o the potential that licensees could fail to make payments under
their current contracts;
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o 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;
o VDSL market-related issues, including lower VDSL chipset unit
demand brought on by excess channel inventory and lower average
selling prices for VDSL chipsets as a result of market
surpluses;
o Hardware manufacturing issues, including yield problems in our
hardware platforms, and inventory build up and obsolescence.
o regulatory developments; and
o general economic trends and other factors.
As a result of these factors, we believe that period-to-period comparisons of
our revenue levels and operating results are not necessarily meaningful. You
should not rely on our quarterly revenue and operating results to predict our
future performance.
WE EXPERIENCED NET LOSSES
We had a net annual loss during 2001, 2002, 2003, 2004 and 2005. We may
experience losses in the future if:
o the semiconductor and telecommunications markets decline;
o our existing customers do not increase their revenues from sales
of chipsets with our technology;
o new or existing customers do not choose to license our
intellectual property for new chipset products; or
o new or existing customers do not choose to use our software or
hardware products.
WE HAVE A UNIQUE BUSINESS MODEL
The success of our DSL licensing products 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:
o 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;
o 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;
o we must persuade potential licensees to bear development costs
associated with our technology applications and to make the
necessary investment to successfully manufacture chipsets and
products using our technology; and
o 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. They are not prohibited from competing
against us.
Our business could be seriously harmed if:
o we cannot obtain suitable licensees;
o our licensees fail to achieve significant sales of chipsets or
products incorporating our technology; or
o we otherwise fail to implement our business strategy
successfully.
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THERE HAS BEEN AND MAY CONTINUE TO BE AN OVERSUPPLY OF DSL CHIPSETS, AND THERE
IS INTENSE COMPETITION FOR DSL 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. In 2000, 2001, and 2002, the ADSL industry
had 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. ASPs have also been under pressure because of intense
competition in the ADSL chipset marketplace. 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 or
VDSL chipsets, and the corresponding decreases in per unit royalties received by
us, can be sudden and dramatic. Pricing pressures may continue during the first
quarter of 2007 and beyond. Our royalty revenue may decline over the long term.
WE DEPEND SUBSTANTIALLY UPON A LIMITED NUMBER OF LICENSEES
There are 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 licensing relationships, our
business could be seriously harmed. 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 A SMALL NUMBER OF CUSTOMERS
In 2004, 2005 and 2006, we derived 28%, 20% and 20%, respectively, of our total
revenue from ADI and 28%, 30%, and 26% respectively, of our total revenue from
Infineon. ADI and Infineon have developed many generations of ADSL chipsets
based upon our technology. On February 17, 2006 ADI sold its ADSL business
relating to Aware technology to Ikanos Communications, Inc. ("Ikanos") and
Ikanos replaced ADI as an Aware licensee. Our royalty revenue in the near term
is highly dependent upon the respective market share and pricing of Ikanos' and
Infineon's ADSL chipsets. The ADSL market has experienced significant price
erosion, which has adversely affected ADSL chipset revenues, which in turn has
adversely affected our royalty revenue. To the extent that Ikanos loses ADSL2+
market share or Infineon loses market share, is unable to gain market share, is
unable to transition its product to support new ADSL2, ADSL2+ and VDSL2
standards, or experiences further price erosion in its DSL chipsets, our royalty
revenue could decline.
OUR SUCCESS REQUIRES ACCEPTANCE OF OUR TECHNOLOGY BY EQUIPMENT COMPANIES
Due to our business strategy, our success is dependent on our ability to
generate significant royalties from our licensing arrangements with
semiconductor manufacturers. Our ability to generate significant royalties is
materially affected by the willingness of equipment companies to purchase
integrated circuits that incorporate our technology from our licensees. There
are other competitive solutions available for equipment companies seeking to
offer broadband communications products. We face the risk that equipment
manufacturers will choose those alternative solutions. Generally, our ability to
influence equipment companies' decisions whether to purchase integrated circuits
that incorporate 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:
o competition from other businesses in the same industry;
o market acceptance of its products;
o its engineering, sales and marketing, and management
capabilities;
o technical challenges of developing its products unrelated to our
technology; and
o its financial and other resources.
14
Even if equipment companies incorporate 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 DSL SERVICE IN VOLUME
The success of our DSL licensing business depends upon telephone companies
installing DSL service in significant volumes. Factors that affect the volume
deployment of DSL service include:
o the desire of telephone companies to install ADSL or VDSL
service, which is dependent on the development of a viable
business model for ADSL or VDSL service, including the
capability to market, sell, install and maintain the service;
o the pricing of ADSL or VDSL services by telephone companies;
o the success of internet protocol TV ("IPTV") or video-based
services as viable consumer service offerings;
o the transition by telephone companies to new ADSL technologies,
such as ADSL2, ADSL2+ and VDSL2
o the quality of telephone companies' networks;
o deployment by phone companies of fiber-to-the-home or broadband
wireless services;
o government regulations; and
o the willingness of residential telephone customers to demand DSL
service in the face of competitive service offerings, such as
cable modems, fiber-based service or broadband wireless access.
If telephone companies do not install DSL service in significant volumes, or if
telephone companies install broadband service based on other technology such as
cable or fiber-to-the-home, our business will be seriously harmed.
OUR INTELLECTUAL PROPERTY IS SUBJECT TO LIMITED PROTECTION
Because we are a technology provider, our ability to protect our intellectual
property and to operate without infringing the intellectual property rights of
others is critical to our success. We regard our technology as proprietary, and
we have a number of patents and pending patent applications. We also rely on a
combination of trade secrets, copyright and trademark law and non-disclosure
agreements to protect our unpatented intellectual property. Despite these
precautions, it may be possible for a third party to copy or otherwise obtain
and use our technology without authorization.
As part of our licensing arrangements, we typically work closely with our
semiconductor and equipment manufacturer licensees, many of whom are also our
potential competitors, and provide them with proprietary know-how necessary for
their development of customized chipsets based on our ADSL technology. Although
our license agreements contain non-disclosure provisions and other terms
protecting our proprietary know-how and technology rights, it is possible that,
despite these precautions, some of our licensees might obtain from us
proprietary information that they could use to compete with us in the
marketplace. Although we intend to defend our intellectual property as
necessary, the steps we have taken may be inadequate to prevent
misappropriation.
In the future, we may choose to bring legal action to enforce our intellectual
property rights. Any such litigation could be costly and time-consuming for us,
even if we were to prevail. Moreover, even if we are successful in protecting
our proprietary information, our competitors may independently develop
technologies substantially equivalent or superior to our technology. The
misappropriation of our technology or the development of competitive technology
could seriously harm our business.
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.
15
OUR BUSINESS IS SUBJECT TO RAPID TECHNOLOGICAL CHANGE
The semiconductor and telecommunications industries 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 DSL technology for a substantial
portion of our revenue for the foreseeable future. Therefore, we face risks that
others could introduce competing technology that renders our DSL technology less
desirable or obsolete. Also, the announcement of new technologies could cause
our licensees or their customers to delay or defer entering into arrangements
for the use of our existing technology. Either of these events could seriously
harm our business. The biometrics industry is also subject to rapid
technological change and uncertainty.
We expect that our business will depend to a significant extent on our ability
to introduce enhancements and new generations of our DSL and biometrics
technology and products as well as new technologies and products 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 and product developments. These
developments are complex and require long development cycles. Moreover, we may
have to make substantial investments in technological innovations and product
developments 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 and OEM
customers. In the past, we have spent significant amounts on development
projects that did not produce any marketable technologies or products, and we
cannot assure you that it will not occur again.
WE FACE INTENSE COMPETITION FROM A WIDE RANGE OF COMPETITORS
Our success as an intellectual property supplier depends on the willingness and
ability of semiconductor manufacturers to design, build and sell integrated
circuits based on our intellectual property. The semiconductor industry is
intensely competitive and has been characterized by price erosion, rapid
technological change, short product life cycles, cyclical market patterns and
increasing foreign and domestic competition.
As an intellectual property supplier to the semiconductor industry, we face
intense competition from internal development teams within potential
semiconductor customers. We must convince potential licensees to license from us
rather than develop technology internally. Furthermore, semiconductor customers,
who have licensed our intellectual property, may choose to abandon joint
development projects with us and develop chipsets themselves without using our
technology. In addition to competition from internal development teams, we
compete against other independent suppliers of intellectual property. We
anticipate intense competition from suppliers of intellectual property for ADSL.
The market for DSL chipsets is also intensely competitive. Our success within
the DSL industry requires that DSL equipment manufacturers buy chipsets from our
semiconductor licensees, and that telephone companies buy DSL equipment from
those equipment manufacturers. Our customers' chipsets compete with products
from other vendors of standards-based and DSL chipsets, including Broadcom,
Centillium, Conexant, ST Microelectronics and Texas Instruments.
ADSL and VDSL 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 several types of symmetric high speed DSL, including
HDSL, SDSL and G.SHDSL. Alternative technologies that use other network
architectures to provide high-speed data service include cable modems using
cable networks, wireless solutions using wireless networks, and optical
solutions using fiber optics technology. These alternative broadband
transmission technologies may be more successful than ADSL or VDSL and we may
not be able to participate in the markets involving these alternative
technologies.
Many of our current and prospective DSL licensees, as well as chipset
competitors that compete with our semiconductor licensees, including Broadcom,
Conexant, 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.
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WE ARE DEPENDENT ON A SINGLE SOURCE CONTRACT MANUFACTURER FOR THE MANUFACTURE OF
OUR DSL HARDWARE PRODUCTS, THE LOSS OF WHICH WOULD HARM OUR BUSINESS
We currently depend on one contract manufacturer to manufacture our DSL hardware
products. If this company was to terminate its arrangement with us or fail to
provide the required capacity and quality on a timely basis, we would be unable
to manufacture our products until replacement contract manufacturing services
could be obtained. To qualify a new contract manufacturer, familiarize it with
our products, quality standards and other requirements, and commence production
is a costly and time-consuming process. We cannot assure you that we would be
able to establish alternative manufacturing relationships on acceptable terms.
Although we make reasonable efforts to ensure that our contract manufacturer
performs to our standards, our reliance on a single source limits our control
over quality assurance and delivery schedules. Defects in workmanship,
unacceptable yields, and manufacturing disruptions and difficulties may impair
our ability to manage inventory and cause delays in shipments and cancellation
of orders that may adversely affect our relationships with current and
prospective customers. As a result, our revenues and operations may be harmed.
OUR MANUFACTURING SYSTEMS MAY NOT BE ADEQUATE FOR DSL TEST AND DIAGNOSTICS
HARDWARE PRODUCT OFFERINGS
Our current manufacturing systems adequately address hardware products we are
currently manufacturing in limited volumes. Our manufacturing systems have not
been extensively tested under anticipated, more complex hardware products or in
volumes higher than that of our current hardware products. If our manufacturing
systems are inadequate or have other problems, our revenues and operating
results may be harmed.
WE ARE DEPENDENT ON SINGLE SOURCE SUPPLIERS FOR COMPONENTS IN OUR DSL HARDWARE
PRODUCTS
We rely on single source suppliers for components and materials used in our DSL
Hardware products. Our dependence on single source suppliers involves several
risks, including limited control over pricing, availability, quality and
delivery schedules. Any delays in delivery of such components or shortages of
such components could cause delays in the shipment of our products, which could
significantly harm our business. Because of our reliance on these vendors, we
may also be subject to increases in component costs. These increases could
significantly harm our business. If any one or more of our single source
suppliers cease to provide us with sufficient quantities of our components in a
timely manner or on terms acceptable to us, we would have to seek alternative
sources of supply. We could incur delays while we locate and engage alternative
qualified suppliers and we might be unable to engage alternative suppliers on
favorable terms. We could incur substantial hardware and software redesign costs
if we are required to replace the components. Any such disruption or increased
expenses could harm our commercialization efforts and adversely affect our
ability to generate revenues.
BIOMETRICS BUSINESS RISKS
Our biometrics business is subject to a variety of additional risks, which could
materially adversely affect quarterly and annual operating results, including:
o market acceptance of our biometric technologies and products;
o changes in contracting practices of government or law
enforcement agencies;
o the failure of the biometrics market to experience continued
growth;
o announcements or introductions of new technologies or products
or our competitors;
o delays or problems in the introduction or performance of
enhancements or of future generations of our technology;
o failures or problems in our biometric software products;
o delays in the adoption of new industry biometric standards or
changes in market perception of the value of new or existing
standards;
o growth of proprietary biometric systems which do not conform to
industry standards;
o competitive pressures resulting in lower software product
revenues;
o personnel changes, particularly those involving engineering,
technical and sales and marketing personnel;
o costs associated with protecting our intellectual property;
o litigation by third parties for alleged infringement of their
proprietary rights;
o the potential that licensees could fail to make payments under
their current contracts;
17
o regulatory developments; and
o general economic trends and other factors.
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:
o quarterly fluctuations in our operating results;
o changes in future financial guidance that we may provide to
investors and public market analysts;
o changes in our relationships with our licensees;
o announcements of technological innovations or new products by
us, our licensees or our competitors;
o changes in DSL or biometrics market growth rates as well as
investor perceptions regarding the investment opportunity that
companies participating in the DSL or biometrics industry afford
them;
o changes in earnings estimates by public market analysts;
o key personnel losses;
o sales of our common stock; and
o 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.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2. PROPERTIES
We believe that our existing facilities are adequate for our current needs and
that additional space sufficient to meet our needs for the foreseeable future
will be available on reasonable terms. We currently occupy approximately:
18
1. 72,000 square feet of office space in Bedford, Massachusetts, which
serves as our headquarters. This site is used for our research and
development, sales and marketing, and administrative activities. We own
this facility.
2. 530 square feet of research and development space in Lafayette,
California. This facility is currently leased for a 3-year term, which
expires on August 31, 2007.
3. 722 square feet of research and development space in San Jose,
California. This facility is currently leased for a 26-month term, which
expires on August 31, 2008.
ITEM 3. LEGAL PROCEEDINGS
From time-to-time we are involved in litigation incidental to the conduct of our
business. We are not party to any lawsuit or proceeding that, in our opinion, is
likely to seriously harm our business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the fourth
quarter ended December 31, 2006.
19
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock is the only class of stock we have outstanding, and it trades
on the Nasdaq Global Market under the symbol AWRE. The following table sets
forth the high and the low sales prices of our common stock as reported on the
Nasdaq Global Market for the periods indicated from January 1, 2005 to December
31, 2006.
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
-----------------------------------------------------------------------------
2006
High...................... $6.30 $6.32 $5.90 $5.71
Low....................... 4.32 5.31 4.76 4.60
2005
High...................... $6.37 $6.80 $7.24 $7.60
Low....................... 4.13 3.77 4.49 4.36
As of March 5, 2007, we had approximately 139 shareholders of record. This
number does not include shareholders from whom shares were held in a "nominee"
or "street" name. We have never paid cash dividends on our common stock and we
anticipate that we will continue to reinvest any earnings to finance future
operations.
We did not sell any equity securities that were not registered under the
Securities Act of 1933 during the three months ended December 31, 2006.
20
PERFORMANCE GRAPH
The following performance graph compares the performance of Aware's cumulative
stockholder return with that of a broad market index, the Nasdaq Stock Market
Index for U.S. Companies, and a published industry index, the RDG Technology
Composite Index. The cumulative stockholder returns for shares of Aware's common
stock and for the market and industry indices are calculated assuming $100 was
invested on December 31, 2001. Aware paid no cash dividends during the periods
shown. The performance of the market and industry indices is shown on a total
return, or dividends reinvested, basis.
[PERFORMANCE GRAPH APPEARS HERE]
VALUE OF INVESTMENT ($)
-------------------------------------------------------------
12/31/01 12/31/02 12/31/03 12/31/04 12/31/05 12/31/06
-------- -------- -------- -------- -------- --------
Aware, Inc.......................... $100.00 $26.27 $35.01 $58.43 $53.61 $64.22
Nasdaq Stock Market - U.S........... 100.00 68.85 101.86 112.16 115.32 127.52
RDG Technology Composite............ 100.00 62.73 93.23 96.17 98.10 106.94
21
ITEM 6. SELECTED FINANCIAL DATA
In the table below, we provide you with our selected consolidated financial
data. We have prepared this information using our audited consolidated financial
statements for the years ended December 31, 2006, 2005, 2004, 2003, and 2002.
When you read this selected financial data, it is important that you read it
along with Management's Discussion and Analysis of Financial Condition and
Results of Operations, our historical consolidated financial statements, and the
related notes to the financial statements, which can be found in Item 8.
Year ended December 31, 2006 2005 2004 2003 2002
------------------------------------------------------------------------------------------------------------
(in thousands, except per share data)
Statements of Operations Data
-----------------------------
Revenue............................... $ 24,056 $15,667 $16,485 $10,843 $13,844
Loss from operations ................. (399) (3,618) (1,925) (8,635) (12,529)
Net income (loss)..................... 1,034 (2,468) (1,367) (8,038) (18,728)
Net income (loss) per share - basic .. $ 0.04 ($ 0.11) ($ 0.06) ($ 0.35) ($ 0.83)
Net income (loss) per share - diluted. $ 0.04 ($ 0.11) ($ 0.06) ($ 0.35) ($ 0.83)
Balance Sheet Data
------------------
Cash and short-term investments ...... $ 37,834 $36,763 $34,965 $35,051 $33,302
Working capital ...................... 41,372 39,124 37,168 36,727 33,481
Total assets ......................... 54,586 49,741 50,183 51,024 59,237
Total liabilities .................... 3,216 2,238 1,427 1,384 1,659
Total stockholders' equity ........... 51,370 47,503 48,756 49,640 57,578
22
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
The following table sets forth, for the years indicated, certain line items from
our consolidated statements of operations stated as a percentage of total
revenue:
Year ended December 31,
----------------------------
2006 2005 2004
----------------------------
Revenue:
Product sales .............................. 32% 35% 29%
Contract revenue ........................... 52 43 46
Royalties .................................. 16 22 25
----------------------------
Total revenue ............................ 100 100 100
Costs and expenses:
Cost of product sales ...................... 4 3 5
Cost of contract revenue ................... 22 21 16
Research and development ................... 47 65 61
Selling and marketing ...................... 14 17 14
General and administrative ................. 15 17 15
----------------------------
Total costs and expenses ................ 102 123 111
Loss from operations .......................... (2) (23) (11)
Interest income ............................... 8 7 3
----------------------------
Income (loss) before provision for income taxes 6 (16) (8)
Provision for income taxes .................... 2 - -
----------------------------
Net income (loss) ............................. 4% (16)% (8)%
============================
PRODUCT SALES
Product sales consist primarily of revenue from the sale of hardware and
software products. Hardware products include ADSL test and development systems,
modules, and modems. Software products consist of standard off-the-shelf
software products for biometric, medical imaging and digital imaging
applications, as well as DSL test and diagnostics software.
Product sales increased 40% from $5.4 million in 2005 to $7.6 million in 2006.
As a percentage of total revenue, product sales decreased from 35% in 2005 to
32% in 2006. The dollar increase was primarily due to a $1.2 million increase in
revenue from the sale of software products and a $1.0 million increase from the
sale of hardware products.
Product sales increased 14% from $4.8 million in 2004 to $5.4 million in 2005.
As a percentage of total revenue, product sales increased from 29% in 2004 to
35% in 2005. The dollar increase was primarily due to a $1.7 million increase in
revenue from the sale of software products, which was partially offset by a $1.0
million decrease in revenue from the sale of hardware products.
CONTRACT REVENUE
Contract revenue consists of patent, license and engineering service fees that
we receive under agreements relating to Aware's patents, Aware's DSL technology
and Aware's DSL test and diagnostic technology.
Contract revenue increased 87% from $6.7 million in 2005 to $12.6 million in
2006. As a percentage of total revenue, contract revenue increased from 43% in
2005 to 52% in 2006. The dollar increase in 2006 was due to $2.5
23
million recognized from the transfer of certain technology licenses as a result
of the acquisition of a customer's business, and an increase of $3.3 million due
to patent, license and engineering service fees that we receive under agreements
with our customers, including a patent licensing agreement with a new customer.
Contract revenue decreased 11% from $7.6 million in 2004 to $6.7 million in
2005. As a percentage of total revenue, contract revenue decreased from 46% in
2004 to 43% in 2005. The dollar decrease in 2005 was from $2.0 million lower
revenue from existing customers which was partially offset by $1.1 million of
revenue from new customers.
While we believe that the transition to ADSL2+ and VDSL2 technology increases
the value proposition of our technology, some existing and prospective DSL
chipset licensees have continued to be reluctant to begin new development
projects given a difficult and uncertain environment in the semiconductor and
telecommunications industries, and 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.
ROYALTIES
Royalties consist of royalty payments that we receive under licensing
agreements. We receive royalties from customers for the right to use our patents
and technology in their chipsets or solutions.
Royalties increased 10% from $3.5 million in 2005 to $3.9 million in 2006. As a
percentage of total revenue, royalties decreased from 22% in 2005 to 16% in
2006. The dollar increase in royalties was due to a $0.5 million increase in DSL
royalties, which was partially offset by a $0.1 million decrease in biometrics
and medical imaging royalties.
Royalties decreased 15% from $4.2 million in 2004 to $3.5 million in 2005. As a
percentage of total revenue, royalties decreased from 25% in 2004 to 22% in
2005. The dollar decrease in royalties was due to a $0.5 million decrease in
ADSL royalties and a $0.2 million decrease in biometrics and medical imaging
royalties.
Our royalty revenue comes predominantly from ADSL chipset sales by Ikanos and
Infineon. On February 17, 2006, ADI sold its ADSL business relating to Aware
technology to Ikanos and Ikanos has replaced ADI as an Aware licensee. 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 steadily decline. We are
uncertain how the transition to ADSL2+ and VDSL2 will impact our customers in
the near term, how quickly sales of our customers' chipsets will increase and
whether such increases will continue to contribute meaningful royalties to us.
COST OF PRODUCT SALES
Since the cost of software product sales is minimal, cost of product sales
consists primarily of the cost of hardware product sales.
Cost of product sales increased 94% from $0.5 million in 2005 to $0.9 million in
2006. As a percentage of product sales, cost of product sales increased from 9%
in 2005 to 12% in 2006. Cost of product sales increased in 2006 due to an
increase in hardware product sales. The dollar increase in overall product
margins was principally due to an increase in software sales that have minimal
cost of sales.
Cost of product sales decreased 45% from $0.9 million in 2004 to $0.5 million in
2005. As a percentage of product sales, cost of product sales decreased from 18%
in 2004 to 9% in 2005. Cost of product sales decreased in 2005 due to a decrease
in hardware product sales. The increase in overall product margins was due to a
larger proportion of software sales in the product sales revenue mix.
COST OF CONTRACT REVENUE
Cost of contract revenue consists primarily of compensation costs 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
24
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 increased 58% from $3.3 million in 2005 to $5.2 million
in 2006. As a percentage of contract revenue, cost of contract revenue decreased
from 49% in 2005 to 41% in 2006. The dollar increase in cost of contract revenue
was primarily due to more customer projects in 2006 as compared with 2005. Our
cost of contract revenue is based on the level of effort we expend on customer
projects. Since the number of customer projects increased, the cost of contract
revenue increased as well.
Cost of contract revenue increased 22% from $2.7 million in 2004 to $3.3 million
in 2005. As a percentage of contract revenue, cost of contract revenue increased
from 35% in 2004 to 49% in 2005. The dollar increase in cost of contract revenue
was due to an increase in engineering services contracts and an increase in cost
of contract revenues associated with StratiPHY3 licensing contracts.
RESEARCH AND DEVELOPMENT EXPENSE
Research and development expense consists primarily of compensation costs for
engineers and expenses for consultants, recruiting, supplies, equipment,
depreciation and facilities related to engineering projects to improve our
broadband intellectual property offerings, as well as our software and hardware
product technology. Research and development expense increased 10% from $10.2
million in 2005 to $11.2 million in 2006. As a percentage of total revenue,
research and development expense decreased from 65% in 2005 to 47% in 2006. The
dollar increase was primarily from higher compensation and fringe benefit costs
of $1.4 million, stock-based compensation expense of $1.0 million, professional
service fees of $0.3 million, and other operating costs of $0.1 million. These
cost increases were partially offset by $1.8 million decreased spending
resulting from a shift of engineers to customer projects, where spending is
classified as cost of contract revenue. This shift occurred because we had more
customer projects in 2006 than in 2005. Our research and development spending
was principally focused on improving our ADSL, ADSL2 and ADSL2+ StratiPHY2+(TM)
technology and chips, developing and improving our VDSL2 StratiPHY3 technology
and chips, developing analog front end technology for DSL solutions, developing
test and diagnostics hardware and software and developing imaging and biometrics
software.
Research and development expense increased 2% from $10.0 million in 2004 to
$10.2 million in 2005. As a percentage of total revenue, research and
development expense increased from 61% in 2004 to 65% in 2005. The dollar
increase was primarily from higher compensation and fringe benefit costs of $0.4
million, and higher chip and board design and development costs of $0.8 million.
These cost increases were partially offset by $0.8 million decreased spending
resulting from a shift of engineers to customer projects, where spending is
classified as cost of contract revenue. This shift occurred because we had more
customer projects in 2005 than in 2004. The dollar increase was also reduced by
$0.3 million lower depreciation expense.
SELLING AND MARKETING EXPENSE
Selling and marketing expense consists primarily of compensation costs for sales
and marketing personnel, travel, advertising and promotion, recruiting, and
facilities expense. Sales and marketing expense increased 23% from $2.7 million
in 2005 to $3.4 million in 2006. As a percentage of total revenue, sales and
marketing expense decreased from 17% in 2005 to 14% in 2006. The dollar increase
was mainly attributable to stock-based compensation expense of $0.3 million and
other compensation costs of $0.3 million.
Sales and marketing expense increased 15% from $2.4 million in 2004 to $2.7
million in 2005. As a percentage of total revenue, sales and marketing expense
increased from 14% in 2004 to 17% in 2005. The dollar and percentage increases
were primarily due to $0.3 million higher spending on compensation and fringe
benefit costs.
GENERAL AND ADMINISTRATIVE EXPENSE
General and administrative expense consists primarily of compensation costs for
administrative personnel, facility costs, bad debt, audit, legal, stock exchange
and insurance expenses. General and administrative expense increased 43% from
$2.6 million in 2005 to $3.8 million in 2006. As a percentage of total revenue,
general and administrative expense decreased from 17% in 2005 to 16% in 2006.
The dollar increase was mainly attributable to stock-based compensation expense
of $0.6 million, and increases in other compensation expense of $0.3 million,
professional fees of $0.2 million, and director's fees and expenses of $0.1
million.
25
General and administrative expense increased 6% from $2.5 million in 2004 to
$2.6 million in 2005. As a percentage of total revenue, general and
administrative expense increased from 15% in 2004 to 17% in 2005. The dollar and
percentage increases were primarily due to $0.2 million higher spending on
compensation and fringe benefit costs partially offset by a $0.1 million
decrease in professional fees and insurance.
INTEREST INCOME
Interest income increased 60% or $690,000 from $1.2 million in 2005 to $1.8
million in 2006. The dollar increase was primarily due to higher interest rates
earned on our investments throughout 2006.
Interest income increased 106% or $593,000 from $0.6 million in 2004 to $1.2
million in 2005. The dollar increase was primarily due to higher interest rates
earned on our investments throughout 2005.
INCOME TAXES
We evaluate, on a quarterly basis, the positive and negative evidence affecting
the realizability of our deferred tax assets. As a result of incurring operating
losses since 2001, we determined that it is more likely than not that our
deferred tax assets may not be realized, and since the fourth quarter of 2002
have established a full valuation allowance for our net deferred tax assets.
Accordingly, we have not recorded a deferred tax benefit for the operating
losses incurred in the years ended December 31, 2005 and 2006.
We did not record a provision for income taxes in 2006 due to a net operating
loss and the uncertainty of the timing of profitability in future periods,
except for $0.4 million of taxes paid in non-U.S. jurisdictions that assess a
source withholding tax.
As of December 31, 2006, we had federal net operating loss and research and
experimentation credit carry forwards of approximately $49.9 million and $11.4
million respectively, which may be available to offset future federal income tax
liabilities and expire at various dates from 2007 through 2026. In addition, at
December 31, 2006, we had approximately $8.3 million and $5.8 million of state
net operating losses and state research and development and investment tax carry
forwards, respectively, which expire at various dates from 2007 through 2021.
Ownership changes, if any, as defined in the Internal Revenue Code, may limit
the amount of net operating loss carryforwards that can be utilized annually to
offset future taxable income.
Of the total net operating loss and research and development tax credit
carryforwards for which a valuation allowance was recorded, approximately $22.5
million is attributable to the exercise of stock options and the tax benefit
will be credited to additional paid-in capital, if realized in the future.
LIQUIDITY AND CAPITAL RESOURCES
Since our inception in March 1986, we have financed our activities primarily
through the sale of stock. In the years ended December 31, 2006, 2005 and 2004,
we received net proceeds from the issuance of stock under employee stock plans
of $0.9 million, $1.2 million and $0.5 million, respectively. In the year ended
December 31, 2006, our operating activities provided net cash of $2.8 million.
Cash provided from our operating activities was primarily the result of net
income of $1.0 million adjusted for non-cash items related to depreciation and
amortization of $0.7 million, and stock-based compensation expense of $1.9
million, which was offset by working capital requirements of $0.8 million. In
the years ended December 31, 2005 and 2004, our operating activities used net
cash of $2.0 million, and $0.9 million, respectively. Cash used in our operating
activities was primarily the result of operating losses and working capital
requirements.
In the years ended December 31, 2006, 2005, and 2004, we made capital
expenditures of $0.7 million, $0.4 million, and $0.3 million, respectively.
Capital expenditures in all three years primarily consisted of spending on
computer hardware and software, laboratory equipment, and furniture used
principally in engineering activities. We have no material commitments for
capital expenditures. In the year ended December 31, 2005 we purchased $0.3
million of other assets.
At December 31, 2006, we had cash, cash equivalents, short-term investments and
investments of $39.8 million. While we can not assure you that we will not
require additional financing, or that such financing will be available to us, we
believe that our cash, cash equivalents, short-term investments and investments
will be sufficient to fund our operations for at least the next twelve months.
26
To date, inflation has not had a material impact on our financial results. There
can be no assurance, however, that inflation will not adversely affect our
financial results in the future.
OFF-BALANCE SHEET ARRANGEMENTS
We do not have any financial partnerships with unconsolidated entities, such as
entities often referred to as structured finance, special purpose entities or
variable interest entities which are often established for the purpose of
facilitating off-balance sheet arrangements or other contractually narrow or
limited purposes. Accordingly, we are not exposed to any financing, liquidity,
market or credit risk that could arise if we had such relationships.
CONTRACTUAL OBLIGATIONS
We have various contractual obligations impacting our liquidity. The following
represents our contractual obligations as of December 31, 2006 (in thousands):
Payments Due By Period
--------------------------------------------------------------------------
Less than More than
CONTRACTUAL OBLIGATIONS Total 1 year 1-3 years 3-5 years 5 years
----------------------- ----------- ------------ ----------- ----------- ------------
Operating leases $ 34 $ 25 $9 $- $-
Purchase orders 472 472 - - -
----------- ------------ ----------- ----------- ------------
Total $506 $497 $9 $- $-
=========== ============ =========== =========== ============
CRITICAL ACCOUNTING POLICIES
We consider certain accounting policies related to revenue recognition, income
taxes and the allowance for doubtful accounts to be critical policies.
REVENUE RECOGNITION. We derive our revenue from three sources (i) product
revenue, which includes revenue from the sale of hardware and software products
for the automated test equipment market and software products for the
biometrics, medical and digital imaging markets, (ii) contract revenue, which
includes patent, license and engineering service fees that we receive under
customer agreements, and (iii) royalties that we receive under customer
agreements.
As prescribed by Securities and Exchange Commission Staff Accounting Bulletin
No. 104, "Revenue Recognition", we recognize revenue when there is persuasive
evidence of an arrangement, the sales price is fixed or determinable, collection
of the related receivable is reasonably assured, and delivery has occurred or
services have been rendered. We also apply the principles set forth in AICPA
Statement of Position No. 97-2, "Software Revenue Recognition", when recognizing
software revenue. Our revenue recognition policies are described more fully in
Note 2, Summary of Significant Accounting Policies, in the Notes to our
Consolidated Financial Statements.
As described below, we make significant judgments and estimates during the
process of determining revenue for any particular accounting period.
In determining revenue recognition, we assess whether fees associated with
revenue transactions are fixed or determinable and whether or not collection is
reasonably assured. We make a judgment whether fees are fixed or determinable
based on the payment terms associated with that transaction. We assess
collection based on a number of factors, including past transaction history with
the customer and the credit-worthiness of the customer. If we determine that
collection of a fee is not reasonably assured, we defer the fee and recognize
revenue at the time collection becomes reasonably assured.
In addition to these general revenue recognition judgments, we make specific
judgments and estimates with respect to the recognition of contract revenue.
When our agreements include the delivery of licensing rights and technology as
well as the provision of engineering services, we combine the total patent,
license and engineering service fees to
27
be paid under the agreement. These total fees are recognized ratably over the
expected product development period, subject to the limitation that the
cumulative revenue recognized through the end of any period may not exceed
cumulative contract payments to date. We review assumptions regarding the
product development period on a regular basis and make adjustments as required.
Consistent with the principles of SAB 104, we believe that this method
represents the appropriate systematic method for revenue recognition for this
type of contract.
After customers enter into development and license agreements, they often engage
us to provide additional engineering work that is beyond the scope of their
original agreement. When customers request additional services, both parties
agree to engineering fees that are based on the level of effort required. We
recognize revenue from these agreements either as engineering services are
performed or as milestones are achieved.
STOCK-BASED COMPENSATION. On January 1, 2006, we adopted the provisions of the
Financial Accounting Standards Board ("FASB") Statement of Financial Accounting
Standards 123(revised 2004), "Share-Based Payment," ("SFAS 123(R)") and its
related implementation guidance, which establishes accounting for equity
instruments exchanged for employee services. Under the provisions of SFAS
123(R), stock-based compensation cost is measured at the grant date, based on
the fair value of the award, and is recognized as an expense over the employee's
requisite service period (generally the vesting period of the equity award). We
elected to adopt the modified prospective transition method as provided by SFAS
123(R) and, accordingly, financial statement amounts for the prior periods have
not been restated to reflect the fair value method of expensing stock-based
compensation.
We estimate the fair value of stock options using the Black-Scholes valuation
model. This valuation model takes into account the exercise price of the award,
as well as a variety of significant assumptions. These assumptions used to
estimate the fair value of stock options include the expected term, the expected
volatility of our stock over the expected term, the risk-free interest rate over
the expected term, and our expected annual dividend yield. We believe that the
valuation technique and the approach utilized to develop the underlying
assumptions are appropriate in calculating the fair values of stock options we
grant to employees and directors which are subject to SFAS 123(R) requirements.
Estimates of fair value are not intended to predict actual future events or the
value ultimately realized by persons who receive equity awards.
Prior to January 1, 2006, we accounted for stock-based compensation to employees
in accordance with Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees," ("APB 25"). We also had previously adopted the
provisions of Statement of Financial Accounting Standards No. 123, "Accounting
for Stock-Based Compensation" ("SFAS 123"), which required disclosure only of
stock-based compensation and its impact on net income (loss) and net income
(loss) per share.
INCOME TAXES. As part of the process of preparing our consolidated financial
statements we are required to estimate our actual current tax expense. We must
also estimate temporary and permanent differences that result from differing
treatment of certain items for tax and accounting purposes. These differences
result in deferred tax assets and liabilities, which are included in our
consolidated balance sheet. We must then assess the likelihood that our deferred
tax assets will be recovered from future taxable income and to the extent that
we believe that recovery is not likely, we must establish a valuation allowance.
To the extent we establish a valuation allowance or increase this allowance in a
period for deferred tax assets, which have been recognized, we must include an
expense with the tax provision in the statement of operations.
Significant management judgment is required in determining our provision for
income taxes, our deferred tax assets, and any valuation allowance recorded
against our net deferred tax assets. Our deferred tax assets relate to net
operating losses and research and development tax credits that we are carrying
forward into future tax periods. As of December 31, 2006, we had a total of
$43.8 million of deferred tax assets for which we had recorded a full valuation
allowance.
Of the total valuation allowance, approximately $22.5 million relates to net
operating loss and research and development tax credit carryforwards that are
attributable to the exercise of stock options and the tax benefit will be
credited to additional paid-in capital, if realized in the future.
ALLOWANCE FOR DOUBTFUL ACCOUNTS. We make judgments as to our ability to collect
outstanding receivables and provide allowances for receivables when collection
becomes doubtful. Provisions are made based upon a specific review of all
significant outstanding invoices. If the judgments we make to determine the
allowance for doubtful
28
accounts do not reflect the future ability to collect outstanding receivables,
additional provisions for doubtful accounts may be required.
RECENT ACCOUNTING PRONOUNCEMENTS
RECENT ACCOUNTING PRONOUNCEMENTS - In July 2006, the Financial Accounting
Standards Board ("FASB") issued Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes", an interpretation of FASB Statement No. 109 ("FIN
48"). FIN 48 clarifies the accounting for uncertainty in income tax positions
taken or expected to be taken in tax returns that effect amounts reported in a
company's financial statements in accordance with FASB Statement No. 109,
"Accounting for Income Taxes." FIN 48 establishes a threshold condition that a
tax position must meet for any part of the benefit of that position to be
recognized in the financial statements. FIN 48 also provides guidance concerning
derecognition, measurement, classification, interest and penalties and
disclosure of tax positions. FIN 48 is effective for fiscal years beginning
after December 15, 2006. We are currently evaluating the effects of FIN 48 on
our financial statements.
In September 2006, the FASB issued Statement No. 157, "Fair Value Measurements"
("SFAS 157"). The Statement provides guidance for using fair value to measure
assets and liabilities. This Statement references fair value as the price that
would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants in the market in which the reporting
entity transacts. The Statement applies whenever other standards require (or
permit) assets or liabilities to be measured at fair value. The Statement does
not expand the use of fair value in any new circumstances. It is effective for
financial statements issued for fiscal years beginning after November 15, 2007,
and interim periods within those fiscal years. The adoption of SFAS 157 is not
expected to have a material impact on our financial position, results of
operations or cash flows.
In September 2006, the Securities and Exchange Commission, ("SEC"), Staff issued
Staff Accounting Bulletin No. 108 ("SAB 108") addressing how the effects of
prior-year uncorrected financial statement misstatements should be considered in
current-year financial statements. SAB 108 requires registrants to quantify
misstatements using both balance-sheet and income-statement approaches and to
evaluate whether either approach results in quantifying an error that is
material in light of relative quantitative and qualitative factors. SAB 108 does
not change the SEC staff's previous guidance in Staff Accounting Bulletin No.
99, "Materiality", on evaluating the materiality of misstatements.
SAB 108 addresses the mechanics of correcting misstatements that include the
effects from prior years. Additionally, SAB 108 requires registrants to apply
the new guidance for the first time that it identifies material errors in
existence at the beginning of the first fiscal year ending after November 15,
2006 by correcting those errors through a one-time cumulative effect adjustment
to beginning-of-year retained earnings. The adoption of SAB 108 did not have a
material effect on our financial position, results of operations or cash flows.
In February 2007, the FASB issued Statement of Financial Accounting Standards
No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities,
including an amendment of FASB Statements No. 115" ("SFAS 159"). SFAS 159
permits entities to choose, at specified election dates, to measure eligible
items at fair value (the "fair value option"). A business entity shall report
unrealized gains and losses on items for which the fair value option has been
elected in earnings at each subsequent reporting period. This accounting
standard is effective as of the beginning of an entity's first fiscal year that
begins after November 15, 2007. The effect, if any, of adopting SFAS 159 on our
financial position and results of operations has not been finalized.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to market risk relates primarily to our investment portfolio, and
the effect that changes in interest rates would have on that portfolio. Our
investment portfolio has included:
o Cash and cash equivalents, which consist of financial
instruments with original maturities of three months or less;
o Short-term investments, which consist of financial instruments
with remaining maturities of twelve months or less, and auction
rate securities that typically have interest reset dates of
twenty-eight days; and
o Investments, which consist of financial instruments that mature
in three years or less.
29
All of our investments meet the high quality standards specified in our
investment policy. This policy dictates the maturity period and limits the
amount of credit exposure to any one issue, issuer, and type of instrument.
The interest rates on our auction rate securities are typically reset by auction
every twenty-eight days. Although our auction rate securities have been readily
marketable, if an auction were to fail, we may not be able to sell these
securities on the planned reset date thereby increasing our holding period.
We do not use derivative financial instruments for speculative or trading
purposes. As of December 31, 2006, we had invested $37.8 million in cash, cash
equivalents and short-term investments that matured in twelve months or less.
Due to the short duration of these financial instruments, we do not expect that
an increase in interest rates would result in any material loss to our
investment portfolio.
As of December 31, 2006, we had invested $2.0 million in long-term investments
that matured in one to two years. These long-term securities are invested in
high quality corporate securities. Despite the high quality of these securities,
they may be subject to interest rate risk. This means that if interest rates
increase, the principal amount of our investment would probably decline. A large
increase in interest rates may cause a material loss to our long-term
investments. The following table (dollars in thousands) presents hypothetical
changes in the fair value of our long-term investments at December 31, 2006. The
modeling technique measures the change in fair value arising from selected
potential changes in interest rates. Movements in interest rates of plus or
minus 50 basis points (BP) and 100 BP reflect immediate hypothetical shifts in
the fair value of these investments.
Valuation of securities Valuation of securities
given an interest rate given an interest rate
decrease of No change increase of
------------------------- in interest -------------------------
Type of security (100BP) (50 BP) rates 100 BP 50 BP
---------------------------------------------------------------------------------------------------------------
Long-term investments with
maturities of one to two years.... $1,997 $1,982 $1,968 $1,940 $1,954
30
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of Aware, Inc.:
We have completed integrated audits of Aware, Inc.'s consolidated financial
statements and of its internal control over financial reporting as of December
31, 2006 in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Our opinions, based on our audits, are
presented below.
CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE
In our opinion, the consolidated financial statements listed in the index
appearing under Item 15(a)(1) present fairly, in all material respects, the
financial position of Aware, Inc. and its subsidiary at December 31, 2006 and
2005, and the results of their operations and their cash flows for each of the
three years in the period ended December 31, 2006 in conformity with accounting
principles generally accepted in the United States of America. In addition, in
our opinion, the financial statement schedule listed in the index appearing
under Item 15(a)(2) presents fairly, in all material respects, the information
set forth therein when read in conjunction with the related consolidated
financial statements. These financial statements and financial statement
schedule are the responsibility of the Company's management. Our responsibility
is to express an opinion on these financial statements and financial statement
schedule based on our audits. We conducted our audits of these statements in
accordance with the standards of the Public Company Accounting Oversight Board
(United States). 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 of financial statements includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
As discussed in Note 6 to the financial statements, the Company changed its
method of accounting for share-based payments on January 1, 2006.
INTERNAL CONTROL OVER FINANCIAL REPORTING
Also, in our opinion, management's assessment, included in Management's Report
on Internal Control Over Financial Reporting appearing under Item 9A, that the
Company maintained effective internal control over financial reporting as of
December 31, 2006 based on criteria established in INTERNAL CONTROL - INTEGRATED
FRAMEWORK issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO), is fairly stated, in all material respects, based on those
criteria. Furthermore, in our opinion, the Company maintained, in all material
respects, effective internal control over financial reporting as of December 31,
2006, based on criteria established in INTERNAL CONTROL - INTEGRATED FRAMEWORK
issued by the COSO. The Company's management is responsible for maintaining
effective internal control over financial reporting and for its assessment of
the effectiveness of internal control over financial reporting. Our
responsibility is to express opinions on management's assessment and on the
effectiveness of the Company's internal control over financial reporting based
on our audit. We conducted our audit of internal control over financial
reporting in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. An audit of internal control over financial reporting includes
obtaining an understanding of internal control over financial reporting,
evaluating management's assessment, testing and evaluating the design and
operating effectiveness of internal control, and performing such other
procedures as we consider necessary in the circumstances. We believe that our
audit provides a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (i) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (ii)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with
31
generally accepted accounting principles, and that receipts and expenditures of
the company are being made only in accordance with authorizations of management
and directors of the company; and (iii) provide reasonable assurance regarding
prevention or timely detection of unauthorized acquisition, use, or disposition
of the company's assets that could have a material effect on the financial
statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
PRICEWATERHOUSECOOPERS LLP
Boston, Massachusetts
March 14, 2007
32
AWARE, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
DECEMBER 31,
--------------------
2006 2005
-------- --------
ASSETS
Current assets:
Cash and cash equivalents ........................................ $ 8,571 $ 13,068
Short-term investments ........................................... 29,263 23,695
Accounts receivable (less allowance for doubtful
accounts of $97 in 2006 and 2005) ............................. 4,738 3,749
Inventories ...................................................... 819 86
Prepaid expenses and other current assets ........................ 867 764
-------- --------
Total current assets ....................................... 44,258 41,362
-------- --------
Property and equipment, net ........................................... 8,123 8,075
Investments ........................................................... 1,968 -
Other assets, net ..................................................... 237 304
-------- --------
Total assets ............................................... $ 54,586 $ 49,741
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ................................................. $ 692 $ 607
Accrued expenses ................................................. 153 159
Accrued compensation ............................................. 1,043 722
Accrued professional ............................................. 198 212
Deferred revenue ................................................. 800 538
-------- --------
Total current liabilities ................................ 2,886 2,238
-------- --------
Long-term deferred revenue ............................................ 330 -
Commitments and contingent liabilities (Note 7)
Stockholders' equity:
Preferred stock, $1.00 par value; 1,000,000 shares authorized,
none outstanding ............................................ - -
Common stock, $.01 par value; shares authorized,
70,000,000 in 2006 and 2005; issued
and outstanding, 23,642,753 in 2006 and 23,281,575 in 2005 236 233
Additional paid-in capital ...................................... 81,923 79,093
Accumulated deficit ............................................. (30,789) (31,823)
-------- --------
Total stockholders' equity ............................... 51,370 47,503
-------- --------
Total liabilities and stockholders' equity ............... $ 54,586 $ 49,741
======== ========
The accompanying notes are an integral part of the consolidated financial statements.
33
AWARE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
YEARS ENDED DECEMBER 31,
--------------------------------------
2006 2005 2004
--------------------------------------
Revenue:
Product sales ............................. $ 7,610 $ 5,431 $ 4,759
Contract revenue .......................... 12,569 6,719 7,575
Royalties ................................. 3,877 3,517 4,151
--------------------------------------
Total revenue ......................... 24,056 15,667 16,485
--------------------------------------
Costs and expenses:
Cost of product sales ..................... 918 474 862
Cost of contract revenue .................. 5,182 3,270 2,683
Research and development .................. 11,231 10,170 10,013
Selling and marketing ..................... 3,359 2,738 2,379
General and administrative ................ 3,765 2,633 2,473
--------------------------------------
Total costs and expenses ............. 24,455 19,285 18,410
--------------------------------------
Loss from operations .......................... (399) (3,618) (1,925)
Interest income ............................... 1,840 1,150 558
--------------------------------------
Income (loss) before provision for income taxes 1,441 (2,468) (1,367)
Provision for income taxes .................... 407 - -
--------------------------------------
Net income (loss) ............................. $ 1,034 ($ 2,468) ($ 1,367)
======================================
Net income (loss) per share - basic ........... $ 0.04 ($ 0.11) ($ 0.06)
Net income (loss) per share - diluted ......... $ 0.04 ($ 0.11) ($ 0.06)
Weighted average shares - basic ............... 23,474 23,076 22,785
Weighted average shares - diluted ............. 24,965 23,076 22,785
The accompanying notes are an integral part of the consolidated financial statements.
34
AWARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEARS ENDED DECEMBER 31,
--------------------------------------
2006 2005 2004
--------------------------------------
Cash flows from operating activities:
Net income (loss) ......................................... $ 1,034 ($ 2,468) ($ 1,367)
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Depreciation and amortization .......................... 686 614 969
Provision for doubtful accounts ........................ - - (50)
Stock-based compensation ............................... 1,937 - -
Increase (decrease) from changes in assets and
liabilities:
Accounts receivable .................................. (989) (679) (571)
Inventories .......................................... (733) 57 (95)
Prepaid expenses and other current assets ............ (103) (347) 146
Accounts payable ..................................... 85 246 100
Accrued expenses ..................................... 301 142 299
Deferred revenue ..................................... 592 423 (356)
--------------------------------------
Net cash provided by (used in) operating activities 2,810 (2,012) (925)
--------------------------------------
Cash flows from investing activities:
Purchases of property and equipment ...................... (666) (368) (256)
Purchase of other assets ................................. - (338) -
Sales of investments ..................................... 15,984 21,977 33,051
Purchases of investments ................................. (23,521) (14,888) (27,175)
--------------------------------------
Net cash provided by (used in) investing activities (8,203) 6,383 5,620
--------------------------------------
Cash flows from financing activities:
Proceeds from issuance of common stock ................... 896 1,215 483
--------------------------------------
Net cash provided by financing activities ......... 896 1,215 483
--------------------------------------
Increase (decrease) in cash and cash equivalents ............. (4,497) 5,586 5,178
Cash and cash equivalents, beginning of year ................. 13,068 7,482 2,304
--------------------------------------
Cash and cash equivalents, end of year ....................... $ 8,571 $ 13,068 $ 7,482
======================================
The accompanying notes are an integral part of the consolidated financial statements.
35
AWARE, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
Common Stock Additional Total
-------------------------- Paid-In Accumulated Stockholders
Shares Amount Capital Deficit Equity
-------------------------------------------------------------------
Balance at December 31, 2003 ....... 22,750 $ 228 $ 77,400 ($27,988) $ 49,640
Exercise of common stock options 110 1 349 350
Issuance of common stock under
employee stock purchase plan 49 - 133 133
Net loss ....................... (1,367) (1,367)
-------------------------------------------------------------------
Balance at December 31, 2004 ....... 22,909 229 77,882 (29,355) 48,756
Exercise of common stock options 340 4 1,062 1,066
Issuance of common stock under
employee stock purchase plan 33 - 149 149
Net loss ....................... (2,468) (2,468)
-------------------------------------------------------------------
Balance at December 31, 2005 ....... 23,282 233 79,093 (31,823) 47,503
Exercise of common stock options 293 3 881 884
Issuance of unrestricted stock . 66 - 367 367
Issuance of common stock under
employee stock purchase plan 2 - 12 12
Stock-based compensation expense - - 1,570 1,570
Net income ..................... 1,034 1,034
-------------------------------------------------------------------
Balance at December 31, 2006 ....... 23,643 $ 236 $ 81,923 ($30,789) $ 51,370
===================================================================
The accompanying notes are an integral part of the consolidated financial statements.
36
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF BUSINESS
We are a worldwide leader in the development and marketing of
intellectual property for broadband communications. Our principal
offering to date has been Asymmetric Digital Subscriber Line ("ADSL")
technology for the telecommunications industry. ADSL enables telephone
companies to use their existing copper telephone lines to offer
broadband services. We license our broadband technology on a
nonexclusive and worldwide basis to semiconductor companies that
manufacture and sell integrated circuits that incorporate our technology
to equipment companies who incorporate those integrated circuits into
their products. We also offer ADSL hardware and software products and
biometrics, medical and digital imaging software products.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION - The consolidated financial statements include
the accounts of Aware, Inc. and its subsidiary. All significant
intercompany transactions have been eliminated.
CASH AND CASH EQUIVALENTS - Cash and cash equivalents consist primarily
of demand deposits, money market funds, commercial paper, and discount
notes in highly liquid short-term instruments with original maturities
of three months or less from the date of purchase and are stated at
cost, which approximates market.
INVESTMENTS - At December 31, 2006 and 2005, we categorized all
securities as "available-for-sale," since we may liquidate these
investments currently. In calculating realized gains and losses, cost is
determined using specific identification. Unrealized gains and losses on
available-for-sale securities are excluded from earnings and reported in
a separate component of stockholders' equity if material. At December
31, 2006, 2005 and 2004, unrealized gains and losses were not material.
Gross realized gains on available for sale securities was $10 in 2006,
$0 in 2005 and $665 in 2004. Gross realized losses on available for sale
securities was $3,387 in 2006, $0 in 2005 and 2004.
At December 31, 2006 and December 31, 2005, we held $19.1 million and
$17.1 million, respectively, of auction variable rate notes classified
as available-for-sale securities. Our investments in these securities
are recorded at cost, which approximates fair market value due to their
variable interest rates, which typically reset every 28 days, and,
despite the long-term nature of their stated contractual maturities, we
have the ability to quickly liquidate these securities. As a result, we
had no cumulative gross unrealized holding gains (losses) or gross
realized gains (losses) from these investments. All income generated
from these investments was recorded as interest income.
The amortized cost of securities, which approximates fair value,
consists of the following at December 31, 2006 and 2005 (in thousands):
SHORT-TERM INVESTMENTS 2006 2005
---------------------- ---------- -----------
Auction variable rate notes........ $19,095 $17,082
Corporate debt securities.......... 4,781 1,262
U.S. agency securities............. 5,387 5,351
---------- -----------
Total............................ $29,263 $23,695
========== ===========
INVESTMENTS 2006 2005
----------- ---------- -----------
Corporate debt securities.......... $1,968 $ -
---------- -----------
Total............................ $1,968 $ -
========== ===========
Short-term investments mature within three to twelve months, and
investments mature within one to two years.
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.
37
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. Upon retirement or sale, the costs of the assets disposed of and
the related accumulated depreciation are removed from the accounts and
any resulting gain or loss is included in the determination of income or
loss. Expenditures for repairs and maintenance are charged to expense as
incurred.
The estimated useful lives of assets used by us are:
Building and improvements.............................. 30 years
Building improvements.................................. 5 to 20 years
Furniture and fixtures................................. 5 years
Computer, office & manufacturing equipment............. 3 years
Purchased software..................................... 3 years
IMPAIRMENT OF LONG-LIVED ASSETS - We review long-lived assets for
impairment whenever events or changes in business circumstances indicate
that the carrying amount of the assets may not be fully recoverable or
that the useful lives of these assets are no longer appropriate. Each
impairment test is based on a comparison of the undiscounted cash flows
to the recorded value of the asset. If an impairment is indicated, the
asset is written down to its estimated fair value on a discounted cash
flow basis. The cash flow estimates used to determine the impairment, if
any, reflect our best estimates using appropriate assumptions and
projections at that time. We believe that no significant impairment of
our long-lived assets has occurred as of December 31, 2006 and 2005.
REVENUE RECOGNITION - Revenue is recognized in accordance with Staff
Bulletin No. 104, "Revenue Recognition," ("SAB 104") and related
interpretations. Accordingly, our general revenue recognition policy is
to recognize revenue when there is persuasive evidence of an
arrangement, the sales price is fixed or determinable, collection of the
related receivable is reasonably assured, and delivery has occurred or
services have been rendered.
We derive our revenue from three sources (i) product revenue, which
includes revenue from the sale of ADSL hardware and software products
and biometrics medical and digital imaging software products, (ii)
contract revenue, which includes patent, license and engineering service
fees that we receive under customer agreements, and (iii) royalties that
we receive under customer agreements. In addition to the above general
revenue recognition principles prescribed by SAB 104, our specific
revenue recognition policies for each revenue source are more fully
described below.
PRODUCT SALES. Product sales consist primarily of revenue from the sale
of: (i) hardware products, and (ii) software products.
o Hardware products, including ADSL modules and ADSL test
and development systems are standalone products that are
sold independently of our technology licensing products.
The terms of sales generally do not contain provisions
that obligate us to provide additional products or
services after shipment. Additionally, we do not grant
return rights other than normal warranty rights of
return. We recognize revenue: (i) upon shipment when
products are shipped FOB shipping point, and (ii) upon
delivery at the customer's location when products are
shipped FOB destination.
o Software products consists of standard off-the-shelf
software that are generally sold to OEM customers for
integration into their products. The terms of sale
generally do not contain provisions that obligate us to
provide additional products or services after shipment,
other than technical telephone support for a brief
period of time post sale. The cost of providing
technical support is inconsequential because of the
limited scope of the support. Additionally, we do not
grant return rights other than normal warranty
38
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
rights of return, and we generally do not customize
software for customers. We also sell maintenance
contracts that entitle customers to product updates.
We recognize software revenue by applying the principles
set forth in SAB 104 and American Institute of Certified
Public Accountants ("AICPA") Statement of Position No.
97-2, "Software Revenue Recognition". Accordingly, we
recognize revenue for software licenses: (i) upon
shipment when products are shipped FOB shipping point,
and (ii) upon delivery at the customer's location when
products are shipped FOB destination. We recognize
revenue for maintenance contracts ratably over the
related contract period.
CONTRACT REVENUE. We enter into nonexclusive development and license
agreements with semiconductor licensees that generally require us to
deliver technology and/or provide engineering services. In return, we
receive one or more of the following forms of consideration: (i) patent
and license fees; (ii) engineering service fees; and (iii) royalty
payments.
License fees, patent fees or engineering services fees are typically
paid and the revenue is recognized during the product development period
as technology is delivered or as engineering services milestones are
achieved. Engineering milestones have historically been formulated to
correlate with the estimated level of effort and related costs. We
classify license, patent and engineering service fees as contract
revenue.
When our agreements include both the delivery of licensing rights and
technology and the provision of engineering services, we combine the
total patent, license and engineering service fees to be paid under the
agreement. These total fees are recognized ratably over the expected
product development period, subject to the limitation that the
cumulative revenue recognized through the end of any period may not
exceed cumulative contract payments to date. We review assumptions
regarding the product development period on a regular basis and make
adjustments as required. We believe that this method represents the
appropriate systematic method for revenue recognition for this type of
contract.
After customers enter into development and license agreements, they
often engage us to provide additional engineering work that is beyond
the scope of their original agreement. When customers request additional
services, both parties agree to engineering fees that are based on the
level of effort required. We recognize revenue from these agreements
either as engineering services are performed or as milestones are
achieved.
ROYALTY REVENUE. Royalty revenue is generally recognized in the quarter
in which a report is received from a licensee detailing the shipments of
products incorporating our intellectual property. This report is
typically received in the quarter following sales of the licensed
product by the licensee. The terms of our licensing agreements generally
require licensees to give notification to us and to pay royalties within
45 to 60 days of the end of the quarter during which sales of licensed
products take place.
INCOME TAXES - We compute deferred income taxes based on the differences
between the financial statement and tax basis of assets and liabilities
using enacted rates in effect in the years in which the differences are
expected to reverse. We establish a valuation allowance to offset
temporary deductible differences, net operating loss carryforwards and
tax credits when it is more likely than not that the deferred tax assets
will not be realized.
CAPITALIZATION OF SOFTWARE COSTS - We capitalize certain internally
generated software development costs after technological feasibility of
the product has been established. No software costs were capitalized for
the years ended December 31, 2006, 2005 and 2004, because such costs
incurred subsequent to the establishment of technological feasibility,
but prior to commercial availability, were immaterial.
RESEARCH AND DEVELOPMENT COSTS - Costs incurred in the research and
development of the Company's products are expensed as incurred.
CONCENTRATION OF CREDIT RISK - At December 31, 2006 and 2005, we had
cash and investments, in excess of federally insured deposit limits of
approximately $39.7 million and $36.7 million, respectively.
39
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Concentration of credit risk with respect to net accounts receivable
consists of $1.1 million, $0.9 million, and $0.6 million with three
customers at December 31, 2006 and $1.4 million, $0.6 million, and $0.3
million with three customers at December 31, 2005.
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.
Effective January 1, 2006, we adopted the provisions of the Financial
Accounting Standards Board ("FASB") Statement of Financial Accounting
Standards No. 123(revised 2004), "Share-Based Payment," ("SFAS 123(R)"),
which establishes accounting for equity instruments exchanged for
employee services. Under the provisions of SFAS 123(R), stock-based
compensation cost is measured at the grant date, based on the fair value
of the award, and is recognized as an expense over the employee's
requisite service period (generally the vesting period of the equity
award). We use the Black-Scholes valuation model to estimate the fair
value of service condition awards. This valuation model takes into
account the exercise price of the award, as well as a variety of
significant assumptions. These assumptions used to estimate the fair
value of stock options include the expected term, the expected
volatility of our stock over the expected term, the risk-free interest
rate over the expected term, and our expected annual dividend yield. We
recognize compensation costs on a straight-line basis over the requisite
service period. Prior to January 1, 2006, we accounted for share-based
compensation to employees in accordance with APB 25 and related
interpretations. We also followed the disclosure requirements of
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" ("SFAS 123"). We elected to adopt the modified
prospective transition method as provided by SFAS 123(R) and,
accordingly, financial statement amounts for the prior periods presented
in this Form 10-K have not been restated to reflect the fair value
method of expensing stock-based compensation.
COMPUTATION OF EARNINGS PER SHARE - Basic earnings per share is computed
by dividing income available to common shareholders by the weighted
average number of common shares outstanding. Diluted earnings per share
is computed by dividing income available to common shareholders by the
weighted average number of common shares outstanding plus additional
common shares that would have been outstanding if dilutive potential
common shares had been issued. For the purposes of this calculation,
stock options are considered common stock equivalents in periods in
which they have a dilutive effect. Stock options that are antidilutive
are excluded from the calculation.
USE OF ESTIMATES - The preparation of our financial statements in
conformity with generally accepted accounting principles requires us to
make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported
amount of revenues and expenses during the reporting period. Significant
estimates include revenue recognition, reserves for doubtful accounts,
reserves for excess and obsolete inventory, useful lives of fixed
assets, valuation allowance for deferred income tax assets, and accrued
liabilities. Actual results could differ from those estimates.
FAIR VALUE OF FINANCIAL INSTRUMENTS - The carrying amounts of cash and
cash equivalents, short-term investments, accounts receivable, accounts
payable and accrued expenses approximate fair value because of their
short-term nature.
COMPREHENSIVE INCOME (LOSS) - Comprehensive income (loss) is defined as
the change in equity of a business enterprise during a period from
transactions and other events and circumstances from non-owner sources,
including foreign currency translation adjustments and unrealized gains
and losses on marketable securities. For the years ended December 31,
2006, 2005 and 2004, comprehensive income (loss) was not materially
different from net income (loss).
ADVERTISING COSTS - Advertising costs are expensed as incurred and were
not material for 2006, 2005 and 2004.
RECENT ACCOUNTING PRONOUNCEMENTS - In July 2006, the FASB issued
Interpretation No. 48, "Accounting for Uncertainty in Income Taxes, an
interpretation of FASB Statement No. 109." FIN 48 clarifies the
accounting for uncertainty in income tax positions taken or expected to
be taken in tax returns that effect amounts reported in a company's
financial statements in accordance with SFAS No. 109, "Accounting for
Income Taxes." FIN 48 establishes a threshold condition that a tax
position must meet for any part of the benefit of that position to
40
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
be recognized in the financial statements. FIN 48 also provides guidance
concerning derecognition, measurement, classification, interest and
penalties and disclosure of tax positions. FIN 48 is effective for
fiscal years beginning after December 15, 2006. We are currently
evaluating the effects of FIN 48 on our financial statements.
In September 2006, the FASB issued Statement No. 157, "Fair Value
Measurements" ("SFAS 157"). The Statement provides guidance for using
fair value to measure assets and liabilities. This Statement references
fair value as the price that would be received to sell an asset or paid
to transfer a liability in an orderly transaction between market
participants in the market in which the reporting entity transacts. The
Statement applies whenever other standards require (or permit) assets or
liabilities to be measured at fair value. The Statement does not expand
the use of fair value in any new circumstances. It is effective for
financial statements issued for fiscal years beginning after November
15, 2007, and interim periods within those fiscal years. The adoption of
SFAS 157 is not expected to have a material impact on our financial
position, results of operations or cash flows.
In September 2006, the Securities and Exchange Commission, ("SEC"),
Staff issued Staff Accounting Bulletin No. 108 ("SAB 108") addressing
how the effects of prior-year uncorrected financial statement
misstatements should be considered in current-year financial statements.
SAB 108 requires registrants to quantify misstatements using both
balance-sheet and income-statement approaches and to evaluate whether
either approach results in quantifying an error that is material in
light of relative quantitative and qualitative factors. SAB 108 does not
change the SEC staff's previous guidance in Staff Accounting Bulletin
No. 99, "Materialty" on evaluating the materiality of misstatements.
SAB 108 addresses the mechanics of correcting misstatements that include
the effects from prior years. Additionally, SAB 108 requires registrants
to apply the new guidance for the first time that it identifies material
errors in existence at the beginning of the first fiscal year ending
after November 15, 2006 by correcting those errors through a one-time
cumulative effect adjustment to beginning-of-year retained earnings. The
adoption of SAB 108 did not have a material effect on our financial
position, results of operations or cash flows.
In February 2007, the FASB issued Statement of Financial Accounting
Standards No. 159, "The Fair Value Option for Financial Assets and
Financial Liabilities, including an amendment of FASB Statements No.
115" ("SFAS 159"). SFAS 159 permits entities to choose, at specified
election dates, to measure eligible items at fair value (the "fair value
option"). A business entity shall report unrealized gains and losses on
items for which the fair value option has been elected in earnings at
each subsequent reporting period. This accounting standard is effective
as of the beginning of an entity's first fiscal year that begins after
November 15, 2007. The effect, if any, of adopting SFAS 159 on our
financial position and results of operations has not been finalized.
SEGMENTS - We organize ourselves as one segment reporting to the chief
operating decision-maker. We have sales outside of the United States,
which are described in Note 8. All long-lived assets are maintained in
the United States.
3. INVENTORIES
Inventories consisted of the following at December 31 (in thousands):
2006 2005
----------- -----------
Raw materials............................. $819 $86
=========== ===========
41
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following at December 31 (in
thousands):
2006 2005
-------- --------
Land ......................................... $ 1,080 $ 1,080
Building and improvements .................... 8,837 8,837
Computer equipment ........................... 6,684 6,199
Purchased software ........................... 3,090 2,935
Furniture and fixtures ....................... 938 938
Office equipment ............................. 354 349
Manufacturing equipment ...................... 289 268
-------- --------
Total ..................................... 21,272 20,606
Less accumulated depreciation and amortization (13,149) (12,531)
-------- --------
Property and equipment, net ............... $ 8,123 $ 8,075
======== ========
Depreciation expense amounted to $0.6 million, $0.6 million and $0.9
million in each of the years ended December 31, 2006, 2005, and 2004,
respectively.
5. INCOME TAXES
Deferred tax assets are attributable to the following at December 31 (in
thousands):
2006 2005
-------- --------
Federal net operating loss carryforwards .................. $ 16,983 $ 16,986
Research and development and other tax credit carryforwards 15,674 14,089
State net operating loss carryforwards .................... 520 382
Capitalized research and development costs ................ 9,456 10,907
Other ..................................................... 1,139 613
-------- --------
Total .................................................. 43,772 42,977
Less valuation allowance .................................. (43,772) (42,977)
-------- --------
Deferred tax assets, net ............................... $ - $ -
======== ========
A reconciliation of the U.S. federal statutory rate to the effective tax
rate is as follows:
Year ended December 31,
----------------------------
2006 2005 2004
------ ------ ------
Federal statutory rate ........... 34% (34%) (34%)
State rate, net of federal benefit 5 (10) (7)
Foreign tax expense .............. 27 - -
Tax credits ...................... (97) (53) (77)
Change in valuation allowance .... 43 97 98
Nondeductible compensation expense 16 - -
Other ............................ 1 - 20
------ ------ ------
Effective tax rate ............ 29% 0% 0%
====== ====== ======
In 2006, we increased the valuation allowance by $0.8 million to $43.8
million primarily as a result of additional net operating losses and tax
credits. The valuation allowance was recorded against deferred tax
assets because we determined that it was more likely than not that all
of the deferred tax assets may not be realized.
42
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
We have incurred net operating losses in 2006, 2005, and 2004. At
December 31, 2006 and 2005, these cumulative factors resulted in our
continued decision that it is more likely than not that all of our
deferred tax assets may not be realized. If we generate sustained future
taxable income against which these tax attributes may be applied, some
portion or all of the valuation allowance would be reversed. If the
valuation allowance is reversed approximately $22.5 million would be
recorded as a credit to additional paid in capital reflecting the
benefit of deductions from the exercise of stock options.
We did not record a provision for income taxes in 2006 due to a net
operating loss and the uncertainty of the timing of profitability in
future periods, except for $0.4 million of taxes paid in non-U.S.
jurisdictions that assess a source withholding tax.
As of December 31, 2006, we had federal net operating loss and research
and experimentation credit carryforwards of approximately $49.9 million
and $11.4 million respectively, which may be available to offset future
federal income tax liabilities and expire at various dates from 2007
through 2026. In addition, at December 31, 2006, we had approximately
$8.3 million and $5.8 million of state net operating losses and state
research and development and investment tax carryforwards, respectively,
which expire at various dates from 2007 through 2021. Ownership changes,
if any, as defined in the Internal Revenue Code, may limit the amount of
net operating loss carryforwards that can be utilized annually to offset
future taxable income.
6. EQUITY AND STOCK COMPENSATION PLANS
As discussed in Note 2, we adopted SFAS 123(R) on January 1, 2006. Prior
to January 1, 2006, the Company accounted for share-based compensation
to employees in accordance with APB 25 and related interpretations. The
adoption of SFAS 123(R) had a significant impact on our results of
operations.
At December 31, 2006, we have four stock-based compensation plans, which
are described below:
FIXED STOCK OPTION PLANS - We have three fixed option plans. Under the
1990 Incentive and Nonstatutory Stock Option Plan ("1990 Plan"), we may
grant incentive stock options or nonqualified stock options to our
employees and directors for up to 2,873,002 shares of common stock.
Under the 1996 Stock Option Plan ("1996 Plan"), we may grant incentive
stock options or nonqualified stock options to our employees and
directors for up to 6,100,000 shares of common stock. Under the 2001
Nonqualified Stock Plan ("2001 Plan"), we may grant nonqualified stock
options or stock awards to our employees and directors for up to
8,000,000 shares of common stock. Under all three plans, options are
granted at an exercise price as determined by the Board of Directors and
have terms ranging from four to a maximum of ten years. Our options
generally vest over three to five years, although we have granted
options that are 50% or fully vested on the date of grant. As of
December 31, 2006, there were 4,616,107 shares available for grant under
the 2001 Plan, and no shares available under the 1996 and 1990 Plans. In
February 2005, we granted fully vested stock options to our directors
and certain of our officers to purchase an aggregate of 1,658,500 shares
of our common stock. The options were granted with exercise prices equal
to the fair market value of our common stock on the dates of grant.
During 2006, the Company awarded unrestricted stock to its employees
under the 2001 Plan. A total of 65,464 shares were distributed
representing $367,000 of stock-based compensation expense.
The following table presents stock-based employee compensation expenses
included in the Company's consolidated statements of operations (in
thousands):
2006
---------
Cost of product sales $ 15
Cost of contract revenue 149
Research and development 904
Selling and marketing 289
General and administrative 580
---------
Stock-based compensation expense $1,937
=========
43
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As a result of adopting SFAS 123(R), the Company's net income for the
year ended December 31, 2006 was lower by $1,570,000 than if it had
continued to account for stock-based compensation under APB 25. Basic
and diluted earnings per share for the year ended December 31, 2006 was
also lower by $0.07 and $0.06, respectively, due to the adoption of SFAS
123(R).
The Company estimates the fair value of stock options using the
Black-Scholes valuation model. This valuation model takes into account
the exercise price of the award, as well as a variety of significant
assumptions. These assumptions used to estimate the fair value of stock
options include the expected term, the expected volatility of the
Company's stock over the expected term, the risk-free interest rate over
the expected term, and the Company's expected annual dividend yield. The
Company believes that the valuation technique and the approach utilized
to develop the underlying assumptions are appropriate in calculating the
fair values of the Company's stock options granted in the year ended
December 31, 2006. Estimates of fair value are not intended to predict
actual future events or the value ultimately realized by persons who
receive equity awards.
Assumptions used to determine the fair value of options granted during
the year ended December 31, 2006, using the Black-Scholes valuation
model were:
YEAR ENDED
DECEMBER 31, 2006
----------------------
Expected term(1) 3.25-6.25 years
Expected volatility factor(2) 60-67%
Risk-free interest rate(3) 4.55-4.99%
Expected annual dividend yield --
--------------------------------------------------------------------------------
(1) The expected term for each grant was determined as the midpoint between
the vesting date and the end of the contractual term, also known as the
"simplified method" for estimating the expected term described by Staff
Accounting Bulletin No. 107 ("SAB 107").
(2) The expected volatility for each grant is estimated based on an average
of historical volatility for a period equal to the expected term of the
stock option.
(3) The risk-free interest rate for each grant is based on the U.S. Treasury
yield curve in effect at the time of grant for a period equal to the
expected term of the stock option.
We do not estimate our forfeiture rates as the actual forfeiture rate is known
at the end of each reporting period due to the timing of our stock option
vesting.
A summary of the transactions of our three fixed stock option plans for the
years ended December 31, 2006, 2005, and 2004 are presented below:
2006 2005 2004
-------------------------- --------------------------- -------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
-------------------------- --------------------------- -------------------------
Outstanding at beginning of year 6,284,606 $ 4.73 4,509,808 $ 3.95 3,467,929 $ 4.38
Granted ........................ 697,000 5.24 2,161,500 6.10 1,305,500 2.96
Exercised ...................... (293,394) 3.01 (339,884) 3.13 (110,087) 3.18
Forfeited or cancelled ......... (198,400) 6.66 (46,818) 4.05 (153,534) 5.83
-------------------------- --------------------------- -------------------------
Outstanding at end of year ..... 6,489,812 $ 4.80 6,284,606 $ 4.73 4,509,808 $ 3.95
========================== =========================== =========================
Options exercisable at year end 5,688,735 $ 4.72 5,598,113 $ 4.78 3,409,927 $ 4.23
44
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All options granted during the years ended December 31, 2006, 2005 and
2004 had exercise prices equal to the fair market value of the Company's
common stock on the date of grant, and the weighted average grant date
fair values of options granted were $2.85, $4.25 and $2.16,
respectively.
At December 31, 2006, the weighted average remaining contractual term
for both options outstanding and options exercisable was 7 years.
At December 31, 2006, the aggregate intrinsic value of options
outstanding and options exercisable was $31,179,000 and $26,859,000,
respectively. The intrinsic value of a stock option is the amount by
which the market value of the underlying stock exceeds the exercise
price of the option. The aggregate intrinsic value of options exercised
during the year ended December 31, 2006 was $800,000.
The following table summarizes the stock options outstanding at December
31, 2006:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------------- -----------------------
WEIGHTED WEIGHTED AVERAGE WEIGHTED
AVERAGE REMAINING AVERAGE
EXERCISE PRICE EXERCISE CONTRACTUAL EXERCISE
RANGE NUMBER PRICE TERM (IN YEARS) NUMBER PRICE
-------------- ---------------------------------------- -----------------------
$0 to $5 3,589,458 $ 3.18 6.95 3,565,313 $ 3.17
$5 to $10 2,811,687 5.93 7.14 2,034,755 6.12
$10 to $20 2,417 12.75 0.39 2,417 12.75
$20 to $30 16,750 20.38 3.80 16,750 20.38
$30 to $40 45,000 33.56 2.46 45,000 33.56
$40 to $50 14,500 44.02 3.21 14,500 44.02
$50 to $70 10,000 58.06 2.75 10,000 58.06
--------------------------------------- -----------------------
6,489,812 $ 4.80 6.98 5,688,735 $ 4.72
======================================== =======================
At December 31, 2006, unrecognized compensation expense related to
non-vested stock options was $2,029,000, which is expected to be
recognized over a weighted average period of 2 years.
Prior to January 1, 2006, the Company accounted for stock-based
compensation to employees in accordance with APB 25. The Company also
had previously adopted the provisions of SFAS 123, which required
disclosure only of stock-based compensation and its impact on net income
(loss) and net income (loss) per share. The following table illustrates
the effects on net loss and net loss per share for the years ended
December 31, 2005 and December 31, 2004 as if the Company had applied
the fair value recognition provisions of SFAS 123 to stock-based
employee awards (in thousands):
YEAR ENDED YEAR ENDED
DECEMBER 31,2005 DECEMBER 31, 2004
----------------- ------------------
Net loss as reported ($ 2,468) ($ 1,367)
Add: Stock-based employee compensation expense included in loss
Less: Total stock-based employee compensation expense
determined under the fair value method (10,113) (8,277)
----------------- ------------------
Pro forma net loss ($12,581) ($ 9,644)
----------------- ------------------
Net loss per share:
Basic and diluted -- as reported ($ 0.11) ($ 0.06)
Basic and diluted -- pro-forma ($ 0.55) ($ 0.42)
45
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In determining the stock-based compensation expense to be disclosed
under SFAS 123, the Company was required to estimate the fair value of
stock awards granted to employees using the Black-Scholes valuation
model. However, differences between the requirements of SFAS 123(R) and
SFAS 123 resulted in a different set of assumptions determined by the
Company to be used in its valuation model. Assumptions used to determine
the fair value of options granted under SFAS 123 during the years ended
December 31, 2005 and December 31, 2004 were:
YEAR ENDED YEAR ENDED
DECEMBER 31, 2005 DECEMBER 31, 2004
------------------ -----------------
Expected term 3-5 years 5 years
Volatility 67-87% 93%
Risk-free interest rate 4.05% 3.74%
Dividend yield -- --
The Company issues common stock from previously authorized but unissued
shares to satisfy option exercises and purchases under the Company's
Employee Stock Purchase Plan.
EMPLOYEE STOCK PURCHASE PLAN - In June 1996, we adopted an Employee
Stock Purchase Plan (the "ESPP Plan") under which eligible employees
could 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. On November 29, 2005 we amended the ESPP Plan
to provide that eligible employees may purchase common stock at a price
equal to 95% of the fair market value of the common stock as of the end
of each six-month offering period. There is no stock-based compensation
expense related to the Company's Employee Stock Purchase Plan because it
is not considered a compensatory plan. The plan does not have a
look-back feature, and has a minimal discount of 5% of the fair market
value of the common stock as of the end of each six-month offering
period. Participation in the ESPP Plan is limited to 6% of an employee's
compensation, may be terminated at any time by the employee and
automatically ends on termination of employment. A total of 350,000
shares of common stock have been reserved for issuance. As of December
31, 2006 there were 137,487 shares available for future issuance under
the ESPP Plan. We issued 2,320, 32,873 and 48,437 common shares under
the ESPP Plan in 2006, 2005 and 2004, respectively.
STOCKHOLDER RIGHTS PLAN - In October 2001, our board of directors
adopted a stockholder rights plan and declared a dividend distribution
of one share purchase right (a "Right") for each outstanding share of
our common stock to stockholders of record at the close of business on
October 15, 2001. Each share of common stock issued after that date also
will carry with it one Right, subject to certain exceptions. Each Right,
when it becomes exercisable, will entitle the record holder to purchase
from us one ten-thousandth of a share of series A preferred stock at an
exercise price of $40.00 subject to adjustment.
The Rights become exercisable upon the earliest of the following dates:
(i) the date on which we first publicly announce that a person or group
has become an acquiring person, or (ii) the date, if any, that our board
of directors may designate following the commencement of, or first
public disclosure of an intent to commence, a tender or exchange offer
which could result in the potential buyer becoming a beneficial owner of
15% or more of our outstanding common stock. Under these circumstances,
holders of Rights will be entitled to purchase, for the exercise price,
the preferred stock equivalent of common stock having a market value of
two times the exercise price. The Rights expire on October 2, 2011, and
may be redeemed by us for $.001 per Right.
7. COMMITMENTS AND CONTINGENT LIABILITIES
LEASE COMMITMENTS - We own our principal office and research facility in
Bedford, Massachusetts, which we have occupied since November 1997. We
conduct a portion of our activities in leased facilities in Lafayette
and San Jose, California under non-cancelable operating leases that
expires in 2007 and 2008, respectively. The following is a schedule of
future minimum rental payments (in thousands):
46
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31,
-----------------------
2007..................................... $25
2008..................................... 9
-----------
Total minimum lease payments.......... $34
===========
Rental expense was approximately $26,000, $26,000 and $35,000 in 2006,
2005 and 2004, respectively.
LITIGATION - There are no material pending legal proceedings to which we
are a party or to which any of our properties are subject which, either
individually or in the aggregate, are expected to have a material
adverse effect on our business, financial position or results of
operations.
GUARANTEES AND INDEMNIFICATION OBLIGATIONS - We enter into licensing
agreements in the ordinary course of business that require us: i) to
perform under the terms of the contracts, ii) to protect the
confidentiality of our customers' intellectual property, and iii) to
indemnify customers, including indemnification against third party
claims alleging infringement of intellectual property rights. We also
have agreements with each of our directors and executive officers to
indemnify such directors or executive officers, to the extent legally
permissible, against all liabilities reasonably incurred in connection
with any action in which such individual may be involved by reason of
such individual being or having been a director or officer of the
Company.
Given the nature of the above obligations and agreements, we are unable
to make a reasonable estimate of the maximum potential amount that we
could be required to pay. Historically, we have not made any significant
payments on the above guarantees and indemnifications and no amount has
been accrued in the accompanying consolidated financial statements with
respect to these guarantees and indemnifications.
8. BUSINESS SEGMENTS AND MAJOR CUSTOMERS
We manage the business as one segment and conduct our operations in the
United States.
We sell our products and technology to domestic and international
customers. Revenues were generated from the following geographic regions
(in thousands):
Year ended December 31,
-----------------------------------------------
2006 2005 2004
------------ ------------ ------------
United States........ $12,797 $9,202 $10,101
Germany.............. 6,630 4,926 4,910
Rest of world........ 4,629 1,539 1,474
------------ ------------ ------------
$24,056 $15,667 $16,485
============ ============ ============
The portion of total revenue that was derived from major customers was
as follows:
Year ended December 31,
-----------------------------------------------
2006 2005 2004
------------ ------------ ------------
Customer A.......... 20% 20% 28%
Customer B.......... 26% 30% 28%
9. EMPLOYEE BENEFIT PLAN
In 1994, we established a qualified 401(k) Retirement Plan (the "Plan")
under which employees are allowed to contribute certain percentages of
their pay, up to the maximum allowed under Section 401(k) of the
Internal Revenue Code. Our contributions to the Plan are at the
discretion of the Board of Directors. Our contributions were
approximately $316,000, $289,000 and $274,000 in 2006, 2005 and 2004,
respectively.
47
AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. NET INCOME (LOSS) PER SHARE
Net income (loss) per share is calculated as follows (in thousands,
except per share data):
Year ended December 31,
-------------------------------------
2006 2005 2004
-------- -------- --------
Net income (loss).............................. $ 1,034 ($ 2,468) ($ 1,367)
Weighted average common shares outstanding..... 23,474 23,076 22,785
Additional dilutive common stock equivalents... 1,491 - -
-------- -------- --------
Diluted shares outstanding..................... 24,965 23,076 22,785
======== ======== ========
Net income (loss) per share - basic............ $ 0.04 ($ 0.11) ($ 0.06)
Net income (loss) per share - diluted.......... $ 0.04 ($ 0.11) ($ 0.06)
For the years ended December 31, 2005 and 2004, potential common stock
equivalents of 1,824,826, and 356,411, respectively, were not included
in the per share calculation for diluted EPS, because we had a net loss
and the effect of their inclusion would be anti-dilutive. For the years
ended December 31, 2006, 2005 and 2004, options to purchase 2,423,242,
2,340,167 and 280,605 shares of common stock at average weighted prices
of $7.18, $7.36 and $16.06 per share, respectively, were outstanding,
but were not included in the computation of diluted EPS because the
options' exercise prices were greater than the average market price of
the common shares and thus would be anti-dilutive.
11. QUARTERLY RESULTS OF OPERATIONS - UNAUDITED
The following table presents unaudited quarterly operating results for
each of our quarters in the two-year period ended December 31, 2006 (in
thousands, except per share data):
2006 Quarters Ended
------------------------------------------------------------
March 31 June 30 September 30 December 31
------------------------------------------------------------
Revenue ................................ $ 6,134 $ 4,790 $ 6,682 $ 6,450
Gross profit ........................... 4,736 3,463 5,033 4,724
Income (loss) from operations .......... 128 (1,669) 680 462
Net income (loss) ...................... 522 (1,210) 840 882
Net income (loss) per share - basic .... $ 0.02 ($ 0.05) $ 0.04 $ 0.04
Net income (loss) per share - diluted .. $ 0.02 ($ 0.05) $ 0.03 $ 0.04
2005 Quarters Ended
------------------------------------------------------------
March 31 June 30 September 30 December 31
------------------------------------------------------------
Revenue ................................ $ 4,224 $ 2,683 $ 5,087 $ 3,673
Gross profit ........................... 3,324 1,903 4,104 2,592
Income (loss) from operations .......... (531) (1,794) 252 (1,545)
Net income (loss) ...................... (314) (1,522) 561 (1,193)
Net income (loss) per share - basic .... ($ 0.01) ($ 0.07) $ 0.02 ($ 0.05)
Net income (loss) per share - diluted .. ($ 0.01) ($ 0.07) $ 0.02 ($ 0.05)
Quarterly income (loss) per share totals differ from annual income (loss) per
share due to dilution and rounding.
48
FINANCIAL STATEMENT SCHEDULE
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS - YEARS ENDED DECEMBER 31, 2006,
2005, AND 2004 (IN THOUSANDS)
--------------------------------------------------------------------------------------------
COL. A COL. B COL. C(1) COL. C(2) COL. D COL. E
--------------------------------------------------------------------------------------------
ADDITIONS
------------------------
BALANCE AT CHARGED TO CHARGED DEDUCTIONS BALANCE
BEGINNING COSTS AND TO OTHER CHARGED TO AT END
OF PERIOD EXPENSES ACCOUNTS RESERVES OF PERIOD
--------------------------------------------------------------------------------------------
Allowance for doubtful
accounts receivable:
2006 ........... $ 97 - - - $ 97
2005 ........... $110 - - $ 13 $ 97
2004 ........... $927 ($50) - $767 $110
Inventory reserves:
2006 ........... $284 $29 - - $313
2005 ........... $284 - - - $284
2004 ........... $284 - - - $284
49
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A. CONTROLS AND PROCEDURES
CONCLUSION REGARDING THE EFFECTIVENESS OF DISCLOSURE CONTROLS AND PROCEDURES
Under the supervision and with the participation of our management, including
our chief executive officer and chief financial officer, we conducted an
evaluation of our disclosure controls and procedures, as such term is defined
under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as
amended (the Exchange Act). Based on this evaluation, our chief executive
officer and chief financial officer concluded that our disclosure controls and
procedures were effective as of the end of the period covered by this annual
report.
EVALUATION OF CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
Under the supervision and with the participation of our management, including
our chief executive officer and chief financial officer, we concluded that there
were no changes in our internal control over financial reporting that occurred
during the quarterly period ended December 31, 2006 that have materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting.
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Our management is responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Exchange Act Rule
13a-15(f). Under the supervision and with the participation of our management,
including our principal executive officer and principal financial officer, we
conducted an evaluation of the effectiveness of our internal control over
financial reporting based on the framework in INTERNAL CONTROL - INTEGRATED
FRAMEWORK issued by the Committee of Sponsoring Organizations of the Treadway
Commission. Based on our evaluation under the framework in INTERNAL CONTROL --
INTEGRATED FRAMEWORK, our management concluded that our internal control over
financial reporting was effective as of December 31, 2006.
Our management's assessment of the effectiveness of the Company's internal
control over financial reporting as of December 31, 2006 has been audited by
PricewaterhouseCoopers LLP, an independent registered public accounting firm, as
stated in their report which is included herein.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by Item 10 of Form 10-K is incorporated by reference
from the information contained in the sections captioned "DIRECTORS AND
EXECUTIVE OFFICERS", "CORPORATE GOVERNANCE" and "SECTION 16(A) BENEFICIAL
OWNERSHIP REPORTING COMPLIANCE" in the Proxy Statement that will be delivered to
our shareholders in connection with our May 23, 2007 Annual Meeting of
Shareholders.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 of Form 10-K is incorporated by reference
from the information contained in the section captioned "EXECUTIVE COMPENSATION:
COMPENSATION DISCUSSION AND ANALYSIS" in the Proxy Statement that will be
delivered to our shareholders in connection with our May 23, 2007 Annual Meeting
of Shareholders.
50
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The information required by Item 12 of Form 10-K is incorporated by reference
from the information contained in the section captioned "SECURITY OWNERSHIP OF
CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS" in the
Proxy Statement that will be delivered to our shareholders in connection with
our May 23, 2007 Annual Meeting of Shareholders.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
The information, if any, required by Item 13 of Form 10-K is incorporated by
reference from the information contained in the sections captioned "CORPORATE
GOVERNANCE" and "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS" in the Proxy
Statement that will be delivered to our shareholders in connection with our May
23, 2007 Annual Meeting of Shareholders.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by Item 14 of Form 10-K is incorporated by reference
from the information contained in the section captioned "INDEPENDENT
ACCOUNTANTS" in the Proxy Statement that will be delivered to our shareholders
in connection with our May 23, 2007 Annual Meeting of Shareholders.
51
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
The following documents are filed as part of this report:
(a)Financial Statements and Exhibits:
PAGE
----
(1)Report of Independent Registered Public Accounting Firm..............31
Consolidated Balance Sheets as of December 31, 2006 and 2005............33
Consolidated Statements of Operations for each of the three
years in the period ended December 31, 2006..........................34
Consolidated Statements of Cash Flows for each of the
three years in the period ended December 31, 2006....................35
Consolidated Statements of Stockholders' Equity for each of
the three years in the period ended December 31, 2006................36
Notes to Consolidated Financial Statements..............................37
(2)Schedule II - Valuation and Qualifying Accounts......................49
(3)Exhibits:
Exhibits have been filed separately with the United States Securities
and Exchange Commission in connection with this Annual Report on Form
10-K or have been incorporated into this Report by reference. Copies of
such exhibits may be obtained from us upon request.
EXHIBIT NO. DESCRIPTION OF EXHIBIT
----------- ----------------------
3.1 Amended and Restated Articles of Organization (filed as Exhibit
3.2 to the Company's Registration Statement on Form S-1, File
No. 333-6807 and incorporated herein by reference).
3.2 Articles of Amendment to the Articles of Organization (filed as
Exhibit 3.3 to the Company's Form 10-Q for the quarter ended
September 30, 2002 and incorporated herein by reference).
3.3 Amended and Restated By-Laws (filed as Exhibit 3.3 to the
Company's Form 10-Q for the quarter ended June 30, 1996 and
incorporated herein by reference).
4.1 Rights Agreement dated as of October 2, 2001 between Aware, Inc.
and Equiserve Trust Company, N.A., as Rights Agent (filed as
Exhibit 4(a) to the Company's Form 8-K filed with the Securities
and Exchange Commission on October 3, 2001 and incorporated
herein by reference).
4.2 Terms of Series A Participating Cumulative Preferred Stock of
Aware, Inc. (attached as Exhibit A to the Rights Agreement filed
as Exhibit 4.1 hereto).
4.3 Form of Right Certificate (attached as Exhibit B to the Rights
Agreement filed as Exhibit 4.1 hereto).
10.1* 1990 Incentive and Non-Statutory Stock Option Plan (filed as
Exhibit 10.2 to the Company's Registration Statement on Form
S-1, File No. 333-6807 and incorporated herein by reference).
10.2* 1996 Stock Option Plan, as amended and restated (filed as Annex
A to the Company's Definitive Proxy Statement filed with the
Securities and Exchange Commission on April 11, 2000 and
incorporated herein by reference).
10.3* 1996 Employee Stock Purchase Plan, as amended and restated
(filed as Exhibit 99.1 to the Company's Current Report on Form
8-K filed with the Securities and Exchange Commission on
November 11, 2005 and incorporated herein by reference).
10.4* Form of Director and Officer Indemnification Agreement (filed as
Exhibit 10.4 to the Company's Form 10-K for the year ended
December 31, 2002 and incorporated herein by reference).
10.5* 2001 Nonqualified Stock Plan (filed as Exhibit 99(d)(4) to the
Company's Schedule TO filed with the Securities and Exchange
Commission on March 3, 2003 and incorporated herein by
reference).
52
10.6* Form of Nonqualified Stock Option Agreement under the 2001
Nonqualified Stock Plan.
21.1 Subsidiaries of Registrant.
23.1 Consent of Independent Registered Public Accounting Firm.
31.1 Certification of Chief Executive Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer and Chief Financial
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
*Management contract or compensatory plan.
53
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
AWARE, INC.
By: /s/ Michael A. Tzannes
-------------------------------------------
Michael A. Tzannes, Chief Executive Officer
Date: March 14, 2007
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 14th day of March 2007.
SIGNATURE TITLE
--------- -----
/s/ Michael A. Tzannes Chief Executive Officer and Director
---------------------------- (Principal Executive Officer)
Michael A. Tzannes
/s/ Edmund C. Reiter President and Director
----------------------------
Edmund C. Reiter
/s/ Keith E. Farris Chief Financial Officer
---------------------------- (Principal Financial and Accounting Officer)
Keith E. Farris
/s/ John K. Kerr Chairman of the Board of Directors
----------------------------
John K. Kerr
/s/ Frederick D. D'Alessio Director
----------------------------
Frederick D. D'Alessio
/s/ G. David Forney, Jr. Director
----------------------------
G. David Forney, Jr.
/s/ Adrian F. Kruse Director
----------------------------
Adrian F. Kruse
/s/ Mark G. McGrath Director
----------------------------
Mark G. McGrath
54