----

----

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

|   | 40 Middlesex Turnpike, Bedford,      Massachusetts  01730 |   |
|--------|---------------------------------------------------------------------|--------|
|   | (Address of      Principal Executive Offices)                       |   |
|   | (Zip      Code)                                                     |   |

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

|                                                                                                        | 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 per      share          |                                                                  |   | The Nasdaq Stock Market      LLC |
|                                                                                                        | Securities      registered pursuant to Section 12(g) of the Act: None |   |

----

| PART      I   |
|---------------|
|          |   |   |
| Item      1.  | Business                                                                                                              | 3 |
| Item      1A. | Risk      Factors                                                                                                              | 13 |
| Item      1B. | Unresolved      Staff      Comments                                                                                                              | 20 |
| Item      2.  | Properties                                                                                                              | 21 |
| Item      3.  | Legal      Proceedings                                                                                                              | 21 |
| Item      4.  | Submission      of Matters to a Vote of Security      Holders                                                                                                              | 21 |
|          |   |   |
| PART      II  |
|          |   |   |
| Item      5.  | Market      for Registrant’s Common Equity, Related Stockholder Matters and Issuer      Purchases of Equity Securities  | 22 |
| Item      6.  | Selected      Financial Data  | 25 |
| Item      7.  | Management’s      Discussion and Analysis of Financial Condition and Results of      Operations | 26 |
| Item      7A. | Quantitative      and Qualitative Disclosures About Market      Risk                                                                                                              | 33 |
| Item      8.  | Consolidated      Financial Statements and Supplementary      Data                                                                                                              | 34 |
| Item      9.  | Changes      in and Disagreements with Accountants on Accounting and Financial      Disclosure                                                                                                              | 52 |
| Item      9A. | Controls      and      Procedures                                                                                                              | 52 |
| Item      9B. | Other      Information                                                                                                              | 52 |
|          |   |   |
| PART      III |
|          |   |   |
| Item      10. | Directors,      Executive Officers and Corporate      Governance                                                                                                              | 53 |
| Item      11. | Executive      Compensation                                                                                                              | 53 |
| Item      12. | Security      Ownership of Certain Beneficial Owners and Management and Related      Stockholder Matters | 53 |
| Item      13. | Certain      Relationships and Related Transactions, and Director      Independence | 53 |
| Item      14. | Principal      Accountant Fees and Services | 53 |
|          |
| PART      IV  |
|          |   |   |
| Item      15. | Exhibits      and Financial Statement Schedules | 54 |
|          |   |   |

| Signatures | 56 |
|------------|----|

----

----

|   | · | Telephone      companies are expected to add 88 million, 79 million, 74 million and 64      million new DSL ports to their networks in 2007, 2008, 2009 and 2010      respectively. |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | · | Telephone      companies are expected to add 26 million, 37 million, 48 million and 65      million VDSL ports to their networks in 2007, 2008, 2009 and 2010      respectively. |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | · | DSL      CPE units of 74 million, 71 million, 64 million and 56 million are      expected to sell in 2007, 2008, 2009 and 2010  respectively. |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------|

|   | · | VDSL      CPE units of 2.4 million, 5.3 million, 8.7 million and 13.6 million are      expected to sell in 2007, 2008, 2009 and 2010  respectively. |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------|

----

----

----

|   | · | Modem      Models 150 and 350– Standard-compliant CPE transceiver emulation modems      for ADSL or ADSL2+ networks |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------|

|   | · | Modem      Models 450 and 550– Standard-compliant transceiver CO and CPE emulation      modems for ADSL/2/2+ and VDSL2 CO and CPE  networks. |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------|

|   | · | Customer      specific product form factors that incorporate our modules for test head      environments. |
|--------|--------|-----------------------------------------------------------------------------------------------------------|

|   | · | DSL      test and development systems - System-level products for ADSL/2/2+ and      VDSL2 performance and interoperability  testing. |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------|

----

|   | · | Data      formatting and interchange software components that support NIST, ISO,      INCITS, ICAO, and FIPS 201 standards and enable      interoperability. |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | · | Image      compression software components for fingerprint and facial image      compression such as WSQ and  JPEG2000. |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------|

|   | · | Biometric      ID cards.  Our PIVSuiteTM family of software development kits      (SDKs) support registration, identity proofing, ID card personalization      and issuance applications in compliance with FIPS      201.  CaptureSuiteTM is a family of SDKs for automatic capture      and processing offingerprints. |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | · | Image      processing for biometric quality analysis, capture and transaction      processingapplications. |
|--------|--------|------------------------------------------------------------------------------------------------------------|

|   | · | Networking      software for building and deploying multimodal biometric data workflow      solutions.  Our Biometrics Services Platform (BioSPTM)      is a service-oriented platform for biometrics data processing and      integration applications. BioSP supports the collection of biometrics from      a distributed network, and subsequent aggregation, analysis, processing      and integration of this data into larger    systems. |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

----

----

|   | · | rapid      price erosion; |
|--------|--------|---------------------------|

|   | · | rapid      technological change; |
|--------|--------|----------------------------------|

|   | · | short      product life cycles; |
|--------|--------|---------------------------------|

|   | · | cyclical      market patterns; and |
|--------|--------|------------------------------------|

|   | · | increasing      foreign and domestic competition. |
|--------|--------|---------------------------------------------------|

----

----

----

|   | · | market      acceptance of broadband technologies we supply by semiconductor or      equipment companies; |
|--------|--------|----------------------------------------------------------------------------------------------------------|

|   | · | the      extent and timing of new transactions with semiconductor      companies; |
|--------|--------|-----------------------------------------------------------------------------------|

|   | · | changes      in our and our customers’ development schedules and levels of expenditure      on research and development; |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------|

|   | · | the      loss of a strategic relationship or termination of a project by a      customer; |
|--------|--------|-------------------------------------------------------------------------------------------|

|   | · | equipment      companies' acceptance of integrated circuits produced by our      customers; |
|--------|--------|---------------------------------------------------------------------------------------------|

|   | · | the      loss by a customer of a strategic relationship with an equipment company      customer; |
|--------|--------|--------------------------------------------------------------------------------------------------|

|   | · | announcements      or introductions of new technologies or products by us or our      competitors; |
|--------|--------|----------------------------------------------------------------------------------------------------|

|   | · | delays      or problems in the introduction or performance of enhancements or of      future generations of ourtechnology; |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------|

|   | · | failures      or problems in our hardware or software  products; |
|--------|--------|------------------------------------------------------------------|

|   | · | price      pressure in the biometrics or test and diagnostics markets from our      competitors; |
|--------|--------|--------------------------------------------------------------------------------------------------|

|   | · | delays      in the adoption of new industry standards or changes in market perception      of the value of new or existingstandards; |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------|

|   | · | competitive      pressures resulting in lower contract revenues or royalty      rates; |
|--------|--------|----------------------------------------------------------------------------------------|

|   | · | competitive      pressures resulting in lower software or hardware product      revenues; |
|--------|--------|-------------------------------------------------------------------------------------------|

|   | · | personnel      changes, particularly those involving engineering and technical      personnel; |
|--------|--------|------------------------------------------------------------------------------------------------|

----

|  | · | costs      associated with protecting our intellectual  property; |
|--|--------|-------------------------------------------------------------------|

|   | · | the      potential that customers could fail to make payments under their current      contracts; |
|--------|--------|---------------------------------------------------------------------------------------------------|

|   | · | 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 marketsurpluses; |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | · | 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 marketsurpluses; |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | · | hardware      manufacturing issues, including yield problems in our hardware platforms,      and inventory buildup andobsolescence; |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------|

|   | · | product      gross margin may be affected by various factors including, but not limited      to, product mix, product life cycle, and provision for excess and obsolete      inventory; |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | · | significant      fluctuations in demand for our hardware  products; |
|--------|--------|---------------------------------------------------------------------|

|   | · | regulatory      developments; and |
|--------|--------|-----------------------------------|

|   | · | general      economic trends and other factors. |
|--------|--------|-------------------------------------------------|

|   | · | the      test and diagnostics, semiconductor, telecommunications or biometrics      markets decline; |
|--------|--------|------------------------------------------------------------------------------------------------------|

|   | · | new      and/or existing customers do not choose to use our software or hardware      products; or |
|--------|--------|----------------------------------------------------------------------------------------------------|

|   | · | new      and/or existing customers do not choose to use our intellectual property      for new chipset products or do not increase their revenues from sales of      chipsets with our technology. |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

----

----

|   | · | we      must typically undergo a lengthy and expensive process of building a      relationship with a potential customer before there is any assurance of an      agreement with such party; |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | · | 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; |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | · | we      must persuade potential customers 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 |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | · | we      must successfully transfer technical know-how to  customers. |
|--------|--------|----------------------------------------------------------------------|

----

 completion of hardware and software designand

----

----

|   | — | market      acceptance of our biometric technologies and  products; |
|--------|---------|---------------------------------------------------------------------|

|   | — | changes      in contracting practices of government or law enforcement      agencies; |
|--------|---------|---------------------------------------------------------------------------------------|

|   | — | the      failure of the biometrics market to experience continued      growth; |
|--------|---------|--------------------------------------------------------------------------------|

|   | — | announcements      or introductions of new technologies or products by our      competitors; |
|--------|---------|----------------------------------------------------------------------------------------------|

|   | — | delays      or problems in the introduction or performance of enhancements or of      future generations of ourtechnology; |
|--------|---------|----------------------------------------------------------------------------------------------------------------------------|

|   | — | failures      or problems in our biometric softwareproducts; |
|--------|---------|--------------------------------------------------------------|

|   | — | the      risk that current or potential customers might decide to develop their own      software rather than buy it fromus; |
|--------|---------|------------------------------------------------------------------------------------------------------------------------------|

|   | — | delays      in the adoption of new industry biometric standards or changes in market      perception of the value of new or existing  standards; |
|--------|---------|--------------------------------------------------------------------------------------------------------------------------------------------------|

|   | — | growth      of proprietary biometric systems which do not conform to industry      standards; |
|--------|---------|-----------------------------------------------------------------------------------------------|

|   | — | competitive      pressures resulting in lower software product  revenues; |
|--------|---------|---------------------------------------------------------------------------|

|   | — | personnel      changes, particularly those involving engineering, technical and sales and      marketing personnel; |
|--------|---------|---------------------------------------------------------------------------------------------------------------------|

|   | — | costs      associated with protecting our intellectual  property; |
|--------|---------|-------------------------------------------------------------------|

|   | — | litigation      by third parties for alleged infringement of their proprietary      rights; |
|--------|---------|---------------------------------------------------------------------------------------------|

|   | — | the      potential that customers could fail to make payments under their current      contracts; |
|--------|---------|---------------------------------------------------------------------------------------------------|

|   | — | regulatory      developments; and |
|--------|---------|-----------------------------------|

|   | — | general      economic trends and other factors. |
|--------|---------|-------------------------------------------------|

Consistent with the Sarbanes-Oxley Act and the rules andregulations of the SEC, management's assessment of our internal controls overfinancial reporting and the audit opinion of our independent registeredaccounting firm as to the effectiveness of our controls is required inconnection with our filing of our Annual Report on Form 10-K. If we are unableto timely identify, implement and conclude that we have effective internalcontrols over financial reporting or if our independent auditors are unable toconclude that our internal controls over financial reporting are effective,investors could lose confidence in the reliability of our financial statements,which could result in a decrease in the value of our common stock. Ourassessment of our internal controls over financial reporting may also uncoverweaknesses or other issues with these controls that could also result in adverseinvestor reaction.

----

|   | · | quarterly      fluctuations in our operatingresults; |
|--------|--------|------------------------------------------------------|

|   | · | changes      in future financial guidance that we may provide to investors and public      market analysts; |
|--------|--------|-------------------------------------------------------------------------------------------------------------|

|   | · | changes      in our relationships with ourcustomers; |
|--------|--------|------------------------------------------------------|

|   | · | announcements      of technological innovations or new products by us, our customers or our      competitors; |
|--------|--------|---------------------------------------------------------------------------------------------------------------|

|   | · | 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 affordthem; |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | · | changes      in earnings estimates by public marketanalysts; |
|--------|--------|--------------------------------------------------------------|

|   | · | key      personnel losses; |
|--------|--------|----------------------------|

|   | · | sales      of our common stock; and |
|--------|--------|-------------------------------------|

|   | · | developments      or announcements with respect to industry standards, patents or      proprietary rights. |
|--------|--------|------------------------------------------------------------------------------------------------------------|

----

| 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 thisfacility. |
|----|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| 2. | 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. |
|----|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| 3. | 411      square feet of research and development space in Orinda,      California.  This facility is currently leased for a 3-year      term, which expires on August 31,2010. |
|----|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

----

|                                                                                                                                                                                                                                     |   | First   |   |   | Second  |   |   | Third   |   |   | Fourth  |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------|--------|--------|---------|--------|--------|---------|--------|--------|---------|--------|
|                                                                                                                                                                                                                                     |   | Quarter |   |   | Quarter |   |   | Quarter |   |   | Quarter |   |
| 2007                                                                                                                                                                                                                                     |   |    |   |   |    |   |   |    |   |   |    |   |
|    High                                    |   | $       | 6.25   |   |    | $      | 6.50   |    |   | $      | 6.74    |   |   | $ | 5.48 |   |
|    Low                                     |   |    | 4.95   |   |    |   | 4.98   |    |   |   | 3.67    |   |   |   | 4.01 |   |
|                                                                                                                                                                                                                                     |   |    |   |   |    |   |   |    |   |   |    |   |   |   |   |   |
| 2006                                                                                                                                                                                                                                     |   |    |   |   |    |   |   |    |   |   |    |   |   |   |   |   |
|    High                                    |   | $       | 6.30   |   |    | $      | 6.32   |    |   | $      | 5.90    |   |   | $ | 5.71 |   |
|    Low                                     |   |    | 4.32   |   |    |   | 5.31   |    |   |   | 4.76    |   |   |   | 4.60 |   |

----

|                                                                                                                                                                                                                                                                                                                                                       | Value      of Investment ($) |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------------------------|
|                                                                                                                                                                                                                                                                                                                                                       | 12/31/02                     | 12/31/03 | 12/31/04 | 12/31/05 | 12/31/06 | 12/31/07 |
| Aware,      Inc.                                                                       | $100.00                      | $133.30 |   $222.48 |  $204.13 | $244.50 | $192.66 |
| Nasdaq      Composite      Index.                                                      | 100.00                       | 149.75 | 164.64 | 168.60 | 187.83 | 205.22 |
| RDG      Technology      Composite                                                     | 100.00                       | 150.27 | 153.63 | 158.57 | 173.85 | 204.38 |

----

| Period                                               |   | (a)Total      Number ofShares      Purchased |   | (b)Average      PricePaid      per Share |   | (c)Total      Number of Shares Purchased as Part of Publicly Announced Plans or      Programs(1) |   | (d)Maximum      Number (or Approximate Dollar Value) of Shares that May Yet Be      PurchasedUnder      the Plansor      Programs |       |
|-----------------------------------------------------------|--------|----------------------------------------------|--------|------------------------------------------|--------|--------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------|------------|
|  October      1, 2007, to December 31, 2007 30, 2007 |   | -                                            |   |                                     | -      |                                                                                             | -      |                                                                                                                                   | $4,961,830 |   |

----

|  Year      ended December 31,                                                                                                                                                                                                                                                                                      |   | 2007                                       |   |   | 2006   |   |   | 2005   |   |   | 2004   |   |   | 2003   |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|
|                                                                                                                                                                                                                                                                                                                    |   | (in      thousands, except per share data) |   |
|                                                                                                                                                                                                                                                                                                                    |   |                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Statements of Operations    Data                                                                                                                                                                                                                                                                                        |   |                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Revenue                                                                                                                                                                                                                                                                                                                 |   | $                                          | 26,437 |   |   | $      | 24,056 |   |   | $      | 15,667 |   |   | $      | 16,485 |   |   | $ | 10,843 |   |
| Loss      from operations                                                                                                                                                                                                                                                                                               |   |                                       | (1,830 | )      |   |   | (399   | )      |   |   | (3,618 | )      |   |   | (1,925 | ) |   |   | (8,635 | ) |
| Net      income (loss)                                                                                                                                                                                                                                                                                                  |   |                                       | 160    |   |   |   | 1,034  |   |   |   | (2,468 | )      |   |   | (1,367 | ) |   |   | (8,038 | ) |
| Net      income (loss) per share – basic                                                                                                                                                                                                                                                                          |   | $                                          | 0.01   |   |   | $      | 0.04   |   |   | $      | (0.11  | )      |   | $      | (0.06  | ) |   | $ | (0.35 | ) |
| Net      income (loss) per share – diluted                                                                                                                                                                                                                                                                        |   | $                                          | 0.01   |   |   | $      | 0.04   |   |   | $      | (0.11  | )      |   | $      | (0.06  | ) |   | $ | (0.35 | ) |
|                                                                                                                                                                                                                                                                                                                    |   |                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Balance Sheet Data                                                                                                                                                                                                                                                                                                      |   |                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash      and short-term investments                                                                                                                                                                                                                                                                                    |   | $                                          | 38,055 |   |   | $      | 37,834 |   |   | $      | 36,763 |   |   | $      | 34,965 |   |   | $ | 35,051 |   |
| Working      capital                                                                                                                                                                                                                                                                                                    |   |                                       | 45,031 |   |   |   | 41,372 |   |   |   | 39,124 |   |   |   | 37,168 |   |   |   | 36,727 |   |
| Total      assets                                                  |   |                                       | 56,383 |   |   |   | 54,586 |   |   |   | 49,741 |   |   |   | 50,183 |   |   |   | 51,024 |   |
| Total      liabilities                                                                                                                                                                                                                                                                                                  |   |                                       | 3,147  |   |   |   | 3,216  |   |   |   | 2,238  |   |   |   | 1,427  |   |   |   | 1,384 |   |
| Total      stockholders’ equity                                                                                                                                                                                                                                                                                   |   |                                       | 53,236 |   |   |   | 51,370 |   |   |   | 47,503 |   |   |   | 48,756 |   |   |   | 49,640 |   |
|                                                                                                                                                                                                                                                                                                                    |   |                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |

----

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |   | Year      ended December 31, |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------|--------|
| Revenue:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |   | 2007                         |   |   | 2006 |   |   | 2005 |   |
|    Product      sales                                                                                                      |   |                         | 66     | % |   |   | 32 | % |   |   | 35 | % |
|    Contract      revenue                                                                                                   |   |                         | 24     |   |   |   | 52 |   |   |   | 43 |   |
|    Royalties                                                                                                               |   |                         | 10     |   |   |   | 16 |   |   |   | 22 |   |
|      Total      revenue                                                                                          |   |                         | 100    |   |   |   | 100 |   |   |   | 100 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |   |                         |   |   |   |   |   |   |   |   |   |   |
| Costs      and expenses:                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |   |                         |   |   |   |   |   |   |   |   |   |   |
|    Cost      of product      sales                                                                                         |   |                         | 15     |   |   |   | 4 |   |   |   | 3 |   |
|    Cost      of contract      revenue                                                                                      |   |                         | 21     |   |   |   | 22 |   |   |   | 21 |   |
|    Research      and      development                                                                                      |   |                         | 41     |   |   |   | 44 |   |   |   | 62 |   |
|    Selling      and      marketing                                                                                         |   |                         | 14     |   |   |   | 14 |   |   |   | 17 |   |
|    General      and      administrative                                                                                    |   |                         | 16     |   |   |   | 18 |   |   |   | 20 |   |
|       Total      costs and      expenses                                                                    |   |                         | 107    |   |   |   | 102 |   |   |   | 123 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |   |                         |   |   |   |   |   |   |   |   |   |   |
| Loss      from      operations                                                                                                            |   |                         | (7     | ) |   |   | (2 | ) |   |   | (23 | ) |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |   |                         |   |   |   |   |   |   |   |   |   |   |
| Interest      income                                                                                                                      |   |                         | 8      |   |   |   | 8 |   |   |   | 7 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |   |                         |   |   |   |   |   |   |   |   |   |   |
| Income      (loss) before provision for income taxes                                                                                                                                                                                                                                                                                                                                                                                                                                     |   |                         | 1      |   |   |   | 6 |   |   |   | (16 | ) |
| Provision      for income      taxes                                                                                                      |   |                         | -      |   |   |   | 2 |   |   |   | - |   |
| Net      income      (loss)                                                                                                               |   |                         | 1      | % |   |   | 4 | % |   |   | (16 | )% |

----

----

----

----

|                          |   | Payments      Due By Period |   |
|-------------------------------|--------|-----------------------------|--------|
|  Contractual Obligations |   | Total                       |   |   | Less      than1      year |   |   | 1-3      years |   |   | 3-5      years |   |   | More      than5      years |   |
|  Operating      leases   |   | $                           | 34     |   |   | $ | 18 |   |   | $ | 16 |   |   | $ | - |   |   | $ | - |   |
| Purchase      orders          |   |                        | 949    |   |   |   | 949 |   |   |   | - |   |   |   | - |   |   |   | - |   |
| Total                         |   | $                           | 983    |   |   | $ | 967 |   |   | $ | 16 |   |   | $ | - |   |   | $ | - |   |

----

----

----

|   | · | Cash      and cash equivalents, which consist of financial instruments with original      maturities of three months or less; |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------|

|   | · | 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 |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | · | Investments,      which consist of financial instruments that mature in three years or      less. |
|--------|--------|---------------------------------------------------------------------------------------------------|

|                                            | Valuation      of securitiesgiven      an interest ratedecrease      of |         |  No      changein      interestrates |   | Valuation      of securitiesgiven      an interest rateincrease      of |
|-------------------------------------------------|-------------------------------------------------------------------------|--------------|-------------------------------------------|--------|-------------------------------------------------------------------------|
| Type      of security                           | (100BP)                                                                 | (50      BP) |                                      |   | 100      BP                                                             | 50      BP |
| Long-term      investments with                 |                                                                    |         |                                      |   |                                                                    |   |   |
|   maturities      of one to two years | $487                                                                    | $490         |                                      | $494   |                                                                    | $501 | $497 |

----

----

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |   | December      31, |       |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------|------------|
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |   | 2007              |       |   | 2006 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |   |              |       |   |   |   |
| ASSETS                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |              |       |   |   |   |
| Current      assets:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |   |              |       |   |   |   |
|      Cash      and cash      equivalents                                                                                                                                                                  |   | $                 | 1,806      |   |   | $ | 8,571 |   |
|      Short-term      investments                                                                                                                                                                          |   |              | 36,249     |   |   |   | 29,263 |   |
|      Accounts      receivable (less allowance for doubtful                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |   |              |       |   |   |   |   |   |
|         accounts      of $55 in 2007 and $97 in      2006)                                                                                                                                 |   |              | 7,661      |   |   |   | 4,738 |   |
|      Inventories                                                                                                                                                                                          |   |              | 1,424      |   |   |   | 819 |   |
|      Prepaid      expenses and other current      assets                                                                                                                                                  |   |              | 708        |   |   |   | 867 |   |
|            Total      current      assets                                                                                                                                   |   |              | 47,848     |   |   |   | 44,258 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |   |              |       |   |   |   |   |   |
| Property      and equipment,      net                                                                                                                                                                                              |   |              | 7,872      |   |   |   | 8,123 |   |
| Investments                                                                                                                                                                                                                        |   |              | 494        |   |   |   | 1,968 |   |
| Other      assets,      net                                                                                                                                                                                                        |   |              | 169        |   |   |   | 237 |   |
|            Total      assets                                                                                                                                                |   | $                 | 56,383     |   |   | $ | 54,586 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |   |              |       |   |   |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |   |              |       |   |   |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |   |              |       |   |   |   |   |   |
| LIABILITIES      AND STOCKHOLDERS’ EQUITY                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |   |              |       |   |   |   |   |   |
| Current      liabilities:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |   |              |       |   |   |   |   |   |
|      Accounts      payable                                                                                                                                                                                |   | $                 | 939        |   |   | $ | 692 |   |
|      Accrued      expenses                                                                                                                                                                                |   |              | 174        |   |   |   | 153 |   |
|      Accrued      compensation                                                                                                                                                                            |   |              | 1,135      |   |   |   | 1,043 |   |
|      Accrued      professional                                                                                                                                                                            |   |              | 156        |   |   |   | 198 |   |
|      Deferred      revenue                                                                                                                                                                                |   |              | 413        |   |   |   | 800 |   |
|              Total      current      liabilities                                                                                                                  |   |              | 2,817      |   |   |   | 2,886 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |   |              |       |   |   |   |   |   |
| Long-term      deferred      revenue                                                                                                                                                                                               |   |              | 330        |   |   |   | 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 2007 and 2006; issued and      outstanding, 23,854,708 in 2007 and 23,642,753 in 2006                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |   |              |   239 |   |   |   |   236 |   |
|       Additional      paid-in      capital                                                                                                                                                           |   |              | 83,626     |   |   |   | 81,923 |   |
|       Accumulated      deficit                                                                                                                                                                       |   |              | (30,629    | ) |   |   | (30,789 | ) |
|              Total      stockholders’      equity                                                                                                           |   |              | 53,236     |   |   |   | 51,370 |   |
|              Total      liabilities and stockholders’      equity                                                                                           |   | $                 | 56,383     |   |   | $ | 54,586 |   |

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

----

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |   | Years      ended December 31, |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------|--------|
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |   | 2007                          |   |   | 2006 |   |   | 2005 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |   |                          |   |   |   |   |   |   |   |
| Revenue:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |   |                          |   |   |   |   |   |   |   |
|     Product      sales                                                                                                                  |   | $                             | 17,491 |   |   | $ | 7,610 |   |   | $ | 5,431 |   |
|     Contract      revenue                                                                                                               |   |                          | 6,337  |   |   |   | 12,569 |   |   |   | 6,719 |   |
|     Royalties                                                                                                                           |   |                          | 2,609  |   |   |   | 3,877 |   |   |   | 3,517 |   |
|         Total      revenue                                                                                          |   |                          | 26,437 |   |   |   | 24,056 |   |   |   | 15,667 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |   |                          |   |   |   |   |   |   |   |   |   |   |
| Costs      and expenses:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |   |                          |   |   |   |   |   |   |   |   |   |   |
|     Cost      of product      sales                                                                                                     |   |                          | 3,998  |   |   |   | 918 |   |   |   | 474 |   |
|     Cost      of contract      revenue                                                                                                  |   |                          | 5,425  |   |   |   | 5,182 |   |   |   | 3,270 |   |
|     Research      and      development                                                                                                  |   |                          | 10,869 |   |   |   | 10,591 |   |   |   | 9,750 |   |
|     Selling      and      marketing                                                                                                     |   |                          | 3,738  |   |   |   | 3,359 |   |   |   | 2,738 |   |
|     General      and      administrative                                                                                                |   |                          | 4,237  |   |   |   | 4,405 |   |   |   | 3,053 |   |
|          Total      costs and      expenses                                                                    |   |                          | 28,267 |   |   |   | 24,455 |   |   |   | 19,285 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |   |                          |   |   |   |   |   |   |   |   |   |   |
| Loss      from      operations                                                                                                                              |   |                          | (1,830 | ) |   |   | (399 | ) |   |   | (3,618 | ) |
| Interest      income                                                                                                                                        |   |                          | 2,016  |   |   |   | 1,840 |   |   |   | 1,150 |   |
| Income      (loss) before provision for income taxes                                                                                                                                                                                                                                                                                                                                                                                                                                                       |   |                          | 186    |   |   |   | 1,441 |   |   |   | (2,468 | ) |
| Provision      for income      taxes                                                                                                                        |   |                          | 26     |   |   |   | 407 |   |   |   | - |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |   |                          |   |   |   |   |   |   |   |   |   |   |
| Net      income      (loss)                                                                                                                                 |   | $                             | 160    |   |   | $ | 1,034 |   |   | $ | (2,468 | ) |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |   |                          |   |   |   |   |   |   |   |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |   |                          |   |   |   |   |   |   |   |   |   |   |
| Net      income (loss) per share –      basic                                                                                                         |   | $                             | 0.01   |   |   | $ | 0.04 |   |   | $ | (0.11 | ) |
| Net      income (loss) per share –      diluted                                                                                                       |   | $                             | 0.01   |   |   | $ | 0.04 |   |   | $ | (0.11 | ) |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |   |                          |   |   |   |   |   |   |   |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |   |                          |   |   |   |   |   |   |   |   |   |   |
| Weighted      average shares –      basic                                                                                                             |   |                          | 23,738 |   |   |   | 23,474 |   |   |   | 23,076 |   |
| Weighted      average shares –      diluted                                                                                                           |   |                          | 25,084 |   |   |   | 24,965 |   |   |   | 23,076 |   |

----

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |   | Years      ended December 31, |    |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------|---------|
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |   | 2007                          |    |   | 2006 |   |   | 2005 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |   |                          |    |   |   |   |   |   |   |
| Cash      flows from operating activities:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |   |                          |    |   |   |   |   |   |   |
|    Net      income      (loss)                                                                                                                                                                 |   | $                             | 160     |   |   | $ | 1,034 |   |   | $ | (2,468 | ) |
|    Adjustments      to reconcile net income (loss) to net cash   provided      by (used in) operating activities:                                                                                                                                                                                                                                                                                                                                                                                                                                                 |   |                          |    |   |   |   |   |   |   |   |   |   |
|       Depreciation      and      amortization                                                                                                                                   |   |                          | 878     |   |   |   | 686 |   |   |   | 614 |   |
|       Provision      for doubtful accounts                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |   |                          | (20     | ) |   |   | - |   |   |   | - |   |
|       Stock-based      compensation                                                                                                                                             |   |                          | 1,138   |   |   |   | 1,937 |   |   |   | - |   |
|       Increase      (decrease) from changes in assets and liabilities:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |   |                          |    |   |   |   |   |   |   |   |   |   |
| Accounts      receivable                                                                                                                                                                                                                         |   |                          | (2,903  | ) |   |   | (989 | ) |   |   | (679 | ) |
| Inventories                                                                                                                                                                                                                                      |   |                          | (605    | ) |   |   | (733 | ) |   |   | 57 |   |
| Prepaid expenses and other      current assets                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |   |                          | 160     |   |   |   | (103 | ) |   |   | (347 | ) |
| Accounts      payable                                                                                                                                                                                                                            |   |                          | 247     |   |   |   | 85 |   |   |   | 246 |   |
| Accrued      expenses                                                                                                                                                                                                                            |   |                          | 69      |   |   |   | 301 |   |   |   | 142 |   |
| Deferred      revenue                                                                                                                                                                                                                            |   |                          | (386    | ) |   |   | 592 |   |   |   | 423 |   |
|            Net      cash provided by (used in) operating activities                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |   |                          | (1,262  | ) |   |   | 2,810 |   |   |   | (2,012 | ) |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |   |                          |    |   |   |   |   |   |   |   |   |   |
| Cash      flows from investing activities:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |   |                          |    |   |   |   |   |   |   |   |   |   |
|     Purchases      of property and      equipment                                                                                                                                         |   |                          | (559    | ) |   |   | (666 | ) |   |   | (368 | ) |
|     Purchase      of other      assets                                                                                                                                                    |   |                          | -       |   |   |   | - |   |   |   | (338 | ) |
|     Sales      of      investments                                                                                                                                                        |   |                          | 24,497  |   |   |   | 15,984 |   |   |   | 21,977 |   |
|     Purchases      of      investments                                                                                                                                                    |   |                          | (30,009 | ) |   |   | (23,521 | ) |   |   | (14,888 | ) |
|            Net      cash provided by (used in) investing activities                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |   |                          | (6,071  | ) |   |   | (8,203 | ) |   |   | 6,383 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |   |                          |    |   |   |   |   |   |   |   |   |   |
| Cash      flows from financing activities:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |   |                          |    |   |   |   |   |   |   |   |   |   |
|     Proceeds      from issuance of common      stock                                                                                                                                      |   |                          | 647     |   |   |   | 896 |   |   |   | 1,215 |   |
|     Shares      surrendered by employees to pay taxes related to    unrestricted      stock                                                                           |   |                          | (41     | ) |   |   | - |   |   |   | - |   |
|     Repurchase      of common      stock                                                                                                                                                  |   |                          | (38     | ) |   |   | - |   |   |   | - |   |
|            Net      cash provided by financing activities                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |   |                          | 568     |   |   |   | 896 |   |   |   | 1,215 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |   |                          |    |   |   |   |   |   |   |   |   |   |
| Increase      (decrease) in cash and cash equivalents                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |   |                          | (6,765  | ) |   |   | (4,497 | ) |   |   | 5,586 |   |
| Cash      and cash equivalents, beginning of year                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |                          | 8,571   |   |   |   | 13,068 |   |   |   | 7,482 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |   |                          |    |   |   |   |   |   |   |   |   |   |
| Cash      and cash equivalents, end of      year                                                                                                                                                              |   | $                             | 1,806   |   |   | $ | 8,571 |   |   | $ | 13,068 |   |

----

|                                                                                                                                   |   |              |   |   |    |   |   | Additional  |   |   |                |   |   | Total  |    |
|----------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------|--------|--------|---------|--------|--------|-------------|--------|--------|---------------------|--------|--------|--------|---------|
|                                                                                                                                   |   | Common      Stock |   |   | Paid-In |   |   | Accumulated |   |   | Stockholders’ |   |
|                                                                                                                                   |   | Shares            |   |   | Amount  |   |   | Capital     |   |   | Deficit             |   |   | Equity |    |
|                                                                                                                                   |   |              |   |   |    |   |   |        |   |   |                |   |   |   |    |
| 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 |   |
|                                                                                                                                   |   |              |   |   |    |   |   |        |   |   |                |   |   |   |    |   |   |   |   |   |
|     Exercise      of common stock options                                                                          |   |              | 198    |   |    |   | 3      |        |   |   | 632                 |   |   |   |    |   |   |   | 635 |   |
|     Repurchase      of common stock                                                                           |   |              | (9     | )      |    |   | -      |        |   |   | (38                 | )      |   |   |    |   |   |   | (38 | ) |
|     Issuance      of unrestricted stock                                                                            |   |              | 29     |   |    |   | -      |        |   |   | 153                 |   |   |   |    |   |   |   | 153 |   |
|     Shares      surrendered by employees to    pay      taxes related to unrestricted stock    |   |              | (8     | )      |    |   | -      |        |   |   | (41                 | )      |   |   |    |   |   |   | (41 | ) |
|     Issuance      of common stock under       employee      stock purchase plan |   |              | 2      |   |    |   | -      |        |   |   | 12                  |   |   |   |    |   |   |   | 12 |   |
|     Stock-based      compensation expense                                                                          |   |              | -      |   |    |   | -      |        |   |   | 985                 |   |   |   |    |   |   |   | 985 |   |
|     Net      income                                                                                                |   |              |   |   |    |   |   |        |   |   |                |   |   |   | 160     |   |   |   | 160 |   |
|                                                                                                                                   |   |              |   |   |    |   |   |        |   |   |                |   |   |   |    |   |   |   |   |   |
| Balance      at December 31, 2007                                                                                                      |   |              | 23,855 |   |    | $      | 239    |        |   | $      | 83,626              |   |   | $      | (30,629 | ) |   | $ | 53,236 |   |

----

| 1. | NATURE      OF BUSINESS |
|----|-------------------------|

| 2.   | SUMMARY      OF SIGNIFICANT ACCOUNTING POLICIES |
|----------------|-------------------------------------------------|

|   | Short-term investments                                                                                                                                                                                                                                                                                               |   | 2007   |   |   | 2006   |   |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|--------|--------|--------|
|   |   Auction      variable rate notes                                                                                                                                                                                                                                                                         |   | $      | 17,955 |   |   | $      | 19,095 |   |
|   |   Corporate      debt securities                                                                                                                                                                                                                                                                           |   |   | 2,033  |   |   |   | 4,781 |   |
|   |   U.S.      agency      securities                                             |   |   | 16,261 |   |   |   | 5,387 |   |
|   |     Total                                                            |   | $      | 36,249 |   |   | $      | 29,263 |   |

|   | Investments                                                                                                                                                                                                                                                                                           |   | 2007 |   |   | 2006   |   |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------|--------|--------|--------|--------|
|   |   Corporate      debt securities                                                                                                                                                                                                                                                            |   | $    | 494    |   |   | $      | 1,968 |   |
|   |     Total                                             |   | $    | 494    |   |   | $      | 1,968 |   |

----

| 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       |

|   | · | 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. |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | · | Software      products consist of software that is 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 rights of return,      and we generally do not customize software for      customers.   We also sell maintenance contracts that      entitle customers to product updates, which we classify as product      revenue. |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

----

|   |   | 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. |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

----

----

| 3. | INVENTORIES |
|----|-------------|

|   |                           | 2007   |   | 2006 |
|--------|--------------------------------|--------|--------|------|
|   |  Raw      materials  | $1,424 |   | $819 |

| 4.    | PROPERTY      AND EQUIPMENT |
|----------------------|-----------------------------|

|                                                      |   | 2007   |    |   | 2006   |   |
|-----------------------------------------------------------|--------|--------|---------|--------|--------|--------|
| Land                                                 |   | $      | 1,080   |   |   | $      | 1,080 |   |
| Building      and improvements                       |   |   | 8,854   |   |   |   | 8,837 |   |
| Computer      equipment                              |   |   | 7,168   |   |   |   | 6,684 |   |
| Purchased      software                              |   |   | 3,129   |   |   |   | 3,090 |   |
| Furniture      and fixtures                          |   |   | 944     |   |   |   | 938 |   |
| Office      equipment                                |   |   | 364     |   |   |   | 354 |   |
| Manufacturing      equipment                         |   |   | 292     |   |   |   | 289 |   |
|    Total                              |   |   | 21,831  |   |   |   | 21,272 |   |
| Less      accumulated depreciation and amortization  |   |   | (13,959 | )      |   |   | (13,149 | ) |
|    Property      and equipment, net   |   | $      | 7,872   |   |   | $      | 8,123 |   |

----

| 5.    | INCOME      TAXES |
|----------------------|-------------------|

|   |                                                                   |   | 2007   |    |   | 2006   |   |
|--------|------------------------------------------------------------------------|--------|--------|---------|--------|--------|--------|
|   | Federal      net operating loss carryforwards                     |   | $      | 15,662  |   |   | $      | 16,983 |   |
|   | Research      and development and other tax credit carryforwards  |   |   | 16,744  |   |   |   | 15,674 |   |
|   | State      net operating loss carryforwards                       |   |   | 704     |   |   |   | 520 |   |
|   | Capitalized      research and development costs                   |   |   | 8,186   |   |   |   | 9,456 |   |
|   | Other                                                             |   |   | 1,529   |   |   |   | 1,139 |   |
|   |    Total                                           |   |   | 42,825  |   |   |   | 43,772 |   |
|   | Less      valuation allowance                                     |   |   | (42,825 | )      |   |   | (43,772 | ) |
|   |    Deferred      tax assets, net                   |   | $      | -       |   |   | $      | - |   |

|   |                                      |   | Year      ended December 31, |   |
|--------|-------------------------------------------|--------|------------------------------|--------|
|   |                                      |   | 2007                         |   |   | 2006 |   |   | 2005 |   |
|   | Federal      statutory rate               |   |                         | 34     | % |   |   | 34 | % |   |   | (34 | %) |
|   | State      rate, net of federal benefit   |   |                         | (16    | ) |   |   | 4 |   |   |   | (10 | ) |
|   | Foreign      tax expense                  |   |                         | -      |   |   |   | 27 |   |   |   | - |   |
|   | Tax      credits                          |   |                         | (545   | ) |   |   | (97 | ) |   |   | (53 | ) |
|   | Change      in valuation allowance        |   |                         | 504    |   |   |   | 43 |   |   |   | 97 |   |
|   | Nondeductible      compensation expense   |   |                         | 31     |   |   |   | 16 |   |   |   | - |   |
|   | Other                                     |   |                         | 6      |   |   |   | 1 |   |   |   | - |   |
|   |    Effective      tax rate |   |                         | 14     | % |   |   | 28 | % |   |   | 0 | % |

----

| 6.    | EQUITY      AND STOCK COMPENSATION PLANS |
|----------------------|------------------------------------------|

|   |                                                                |   | 2007   |   |   | 2006   |   |
|--------|---------------------------------------------------------------------|--------|--------|--------|--------|--------|--------|
|   | Cost      of product sales                                          |   | $      | 13     |   |   | $      | 15 |   |
|   | Cost      of contract revenue                                       |   |   | 176    |   |   |   | 149 |   |
|   | Research      and development                                       |   |   | 483    |   |   |   | 904 |   |
|   | Selling      and marketing                                          |   |   | 119    |   |   |   | 289 |   |
|   | General      and administrative                                     |   |   | 347    |   |   |   | 580 |   |
|   |      Stock-based      compensation expense |   | $      | 1,138  |   |   | $      | 1,937 |   |

----

|   |                                |   | Year      EndedDecember      31, 2007 |   | Year      EndedDecember      31, 2006 |
|--------|-------------------------------------|--------|---------------------------------------|--------|---------------------------------------|
|   |                                |   |                                  |   |                                  |
|   | Expected      term(1)               |   | 6.25      years                       |   | 3.25-6.25      years                  |
|   | Expected      volatility factor(2)  |   | 51-56%                                |   | 60-67%                                |
|   | Risk-free      interest rate(3)     |   | 3.80-4.73%                            |   | 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.                                                                                                                   |

|                                                                                                                                                                                                                                                                                               |   | 2007               |      |   | 2006                               |   |   | 2005               |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|-----------|--------|------------------------------------|--------|--------|--------------------|--------|
|                                                                                                                                                                                                                                                                                               |   |   Shares |      |   | Weighted AverageExercisePrice |   |   |   Shares |   |   | Weighted AverageExercisePrice |   |   |   Shares |   |   | Weighted AverageExercisePrice |   |
| Outstanding      at beginning of year                                                                                                                                                                                                                                                              |   |               | 6,489,812 |   |                               | $      | 4.80   |               |   |   | 6,284,606 |   |   | $ | 4.73 |   |   |   | 4,509,808 |   |   | $ | 3.95 |   |
| Granted                                                                     |   |               | 737,000   |   |                               |   | 4.79   |               |   |   | 697,000 |   |   |   | 5.24 |   |   |   | 2,161,500 |   |   |   | 6.10 |   |
| Exercised                                                                   |   |               | (197,853  | )      |                               |   | 3.21   |               |   |   | (293,394 | ) |   |   | 3.01 |   |   |   | (339,884 | ) |   |   | 3.13 |   |
| Forfeited      or      cancelled                                            |   |               | (54,254   | )      |                               |   | 5.87   |               |   |   | (198,400 | ) |   |   | 6.66 |   |   |   | (46,818 | ) |   |   | 4.05 |   |
| Outstanding      at end of year                                                                                                                                                                                                                                                                    |   |               | 6,974,705 |   |                               | $      | 4.84   |               |   |   | 6,489,812 |   |   | $ | 4.80 |   |   |   | 6,284,606 |   |   | $ | 4.73 |   |
|                                                                                                                                                                                                                                                                                               |   |               |      |   |                               |   |   |               |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Options      exercisable at year end                                                                                                                                                                                                                                                               |   |               | 5,809,280 |   |                               | $      | 4.80   |               |   |   | 5,688,735 |   |   | $ | 4.72 |   |   |   | 5,598,113 |   |   | $ | 4.78 |   |

----

|   |                     |   | Options      Outstanding |   | Options      Exercisable     |   |
|--------|--------------------------|--------|--------------------------|--------|------------------------------|--------|
|   | Exercise      PriceRange |   | Number                   |   | WeightedAverageExercisePrice |   | Weighted AverageRemainingContractualTerm (in      years) |   | Number |   | WeightedAverageExercisePrice |   |
|   |                     |   |                     |   |                         |   |   |   |   |   |   |   |
|   | $0      to $5            |   | 3,856,105                |   | $                            | 3.35   |   | 6.43 |   | 3,414,089 |   | $ | 3.19 |   |
|   | $5      to $10           |   | 3,032,350                |   |                         | 5.86   |   | 6.26 |   | 2,308,941 |   |   | 6.03 |   |
|   | $10      to $30          |   | 16,750                   |   |                         | 20.38  |   | 2.80 |   | 16,750 |   |   | 20.38 |   |
|   | $30      to $40          |   | 45,000                   |   |                         | 33.56  |   | 1.46 |   | 45,000 |   |   | 33.56 |   |
|   | $40      to $50          |   | 14,500                   |   |                         | 44.02  |   | 2.21 |   | 14,500 |   |   | 44.02 |   |
|   | $50      to $70          |   | 10,000                   |   |                         | 58.06  |   | 1.75 |   | 10,000 |   |   | 58.06 |   |
|   |                     |   | 6,974,705                |   |  $                      | 4.84   |   | 6.30 |   | 5,809,280 |   |  $ | 4.80 |   |

|   |                                                                                                   |   | Year      EndedDecember      31, 2005 |    |
|--------|--------------------------------------------------------------------------------------------------------|--------|---------------------------------------|---------|
|   | Net      loss as reported                                                                              |   | $                                     | (2,468  | ) |
|   | Add:      Stock-based employee compensation expense included in loss                                   |   |                                  |    |   |
|   | Less:      Total stock-based employee compensation expense determined under the fair      value method |   |                                  | (10,113 | ) |
|   | Pro      forma net loss                                                                                |   | $                                     | (12,581 | ) |
|   | Net      loss per share:                                                                               |   |                                  |    |   |
|   |    Basic and      diluted — as reported                                      |   | $                                     | (0.11   | ) |
|   |    Basic      and diluted — pro-forma                                        |   | $                                     | (0.55   | ) |

|   |                         |   | Year      EndedDecember      31, 2005 |    |
|--------|------------------------------|--------|---------------------------------------|---------|
|   | Expected      term           |   | 3-5 years                        |    |
|   | Volatility                   |   |                                  | 67-87   | % |
|   | Risk-free      interest rate |   |                                  | 4.05    | % |
|   | Dividend      yield          |   |                                  | — |   |

----

| 7. | COMMITMENTS      AND CONTINGENT LIABILITIES |
|----|---------------------------------------------|

| Year ended December 31,                                                                                                                                                                                                                                                                                    |   |   |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|
| 2008                                                  |   | $      | 18     |   |
| 2009                                                  |   |   | 9      |   |
| 2010                                                  |   |   | 7      |   |
|    Total      minimum lease payments                                                                                                                                                                                                                                                        |   | $      | 34     |   |

----

| 8. |   BUSINESS      SEGMENTS AND MAJOR CUSTOMERS |
|----|--------------------------------------------------------|

|               |   | Year      ended December 31, |   |
|--------------------|--------|------------------------------|--------|
|               |   | 2007                         |   |   | 2006 |   |   | 2005 |   |
| United      States |   | $                            | 15,508 |   |   | $ | 12,797 |   |   | $ | 9,202 |   |
| Germany            |   |                         | 5,759  |   |   |   | 6,630 |   |   |   | 4,926 |   |
| Rest      of world |   |                         | 5,170  |   |   |   | 4,629 |   |   |   | 1,539 |   |
|               |   | $                            | 26,437 |   |   | $ | 24,056 |   |   | $ | 15,667 |   |

|                                                                                                                                                                                                                                                                                                                                                      |   | Year      ended December 31, |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------|--------|
|                                                                                                                                                                                                                                                                                                                                                      |   | 2007                         |   |   | 2006 |   |   | 2005 |   |
| Customer      A                                                                                                                                                                                                                                                                                                                                      |   |                         | -      |   |   |   | 20 | % |   |   | 20 | % |
| Customer      B                                                        |   |                         | 19     | % |   |   | 26 | % |   |   | 30 | % |
| Customer      C                                                        |   |                         | 16     | % |   |   | 2 | % |   |   | 1 | % |
| Customer      D                                                        |   |                         | 10     | % |   |   | 1 | % |   |   | - |   |

| 9. | EMPLOYEE      BENEFIT PLAN |
|----|----------------------------|

| 10. | NET      INCOME (LOSS) PER SHARE |
|-----|----------------------------------|

----

|                                                                                                                                                                                                                                                                                                                                                                                                                                      |   | Year      ended December 31, |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------|--------|
|                                                                                                                                                                                                                                                                                                                                                                                                                                      |   | 2007                         |   |   | 2006 |   |   | 2005 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                      |   |                         |   |   |   |   |   |   |   |
| Net      income      (loss)                                                                                    |   | $                            | 160    |   |   | $ | 1,034 |   |   | $ | (2,468 | ) |
|                                                                                                                                                                                                                                                                                                                                                                                                                                      |   |                         |   |   |   |   |   |   |   |   |   |   |
| Weighted      average common shares outstanding                                                                                                                                                                                                                                                                                                                                                                                      |   |                         | 23,738 |   |   |   | 23,474 |   |   |   | 23,076 |   |
| Additional      dilutive common stock equivalents                                                                                                                                                                                                                                                                                                                                                                                    |   |                         | 1,346  |   |   |   | 1,491 |   |   |   | - |   |
| Diluted      shares outstanding                                                                                                                                                                                                                                                                                                                                                                                                      |   |                         | 25,084 |   |   |   | 24,965 |   |   |   | 23,076 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                      |   |                         |   |   |   |   |   |   |   |   |   |   |
| Net      income (loss) per share –      basic                                                                 |   | $                            | 0.01   |   |   | $ | 0.04 |   |   | $ | (0.11 | ) |
| Net      income (loss) per share –      diluted                                                               |   | $                            | 0.01   |   |   | $ | 0.04 |   |   | $ | (0.11 | ) |

| 11. | QUARTERLY      RESULTS OF OPERATIONS - UNAUDITED |
|-----|--------------------------------------------------|

|                                             |   | 2007      Quarters Ended |   |
|--------------------------------------------------|--------|--------------------------|--------|
|                                             |   | March      31            |   |   | June      30 |   |   | September      30 |   |   | December      31 |   |
|                                             |   |                     |   |   |   |   |   |   |   |   |   |   |
| Revenue                                          |   | $                        | 5,800  |   |   | $ | 6,429 |   |   | $ | 7,456 |   |   | $ | 6,753 |   |
| Gross      profit                                |   |                     | 3,952  |   |   |   | 3,329 |   |   |   | 5,002 |   |   |   | 4,732 |   |
| Income      (loss) from operations               |   |                     | (593   | ) |   |   | (1,464 | ) |   |   | 529 |   |   |   | (300 | ) |
| Net      income (loss)                           |   |                     | (98    | ) |   |   | (968 | ) |   |   | 1,034 |   |   |   | 193 |   |
|                                             |   |                     |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net      income (loss) per share – basic   |   | $                        | 0.00   |   |   | $ | (0.04 | ) |   | $ | 0.04 |   |   | $ | 0.01 |   |
| Net      income (loss) per share – diluted |   | $                        | 0.00   |   |   | $ | (0.04 | ) |   | $ | 0.04 |   |   | $ | 0.01 |   |

|                                             |   | 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 |   |

----

| 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:                                                                                                                                                           |   |            |   |   |            |   |   |           |   |   |            |   |   |           |   |
|    2007                               |   | $               | 97     |   |            | $      | (20    | )              |   |   | -               |   |   | $              | 22     |   |   | $ | 55 |   |
|    2006                               |   | $               | 97     |   |            |   | -      |           |   |   | -               |   |   |           | -      |   |   | $ | 97 |   |
|    2005                               |   | $               | 110    |   |            |   | -      |           |   |   | -               |   |   |           | 13     |   |   | $ | 97 |   |
|                                                                                                                                                                                                       |   |            |   |   |            |   |   |           |   |   |            |   |   |           |   |   |   |   |   |   |
|                                                                                                                                                                                                       |   |            |   |   |            |   |   |           |   |   |            |   |   |           |   |   |   |   |   |   |
| Inventory      reserves:                                                                                                                                                                                   |   |            |   |   |            |   |   |           |   |   |            |   |   |           |   |   |   |   |   |   |
|    2007                               |   | $               | 313    |   |            | $      | 102    |           |   |   | -               |   |   | $              | 6      |   |   | $ | 409 |   |
|    2006                               |   | $               | 284    |   |            |   | 29     |           |   |   | -               |   |   |           | -      |   |   | $ | 313 |   |
|    2005                               |   | $               | 284    |   |            |   | -      |           |   |   | -               |   |   |           | -      |   |   | $ | 284 |   |

----

----

----

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          | Page     |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|----------|
| (1)      Report of Independent Registered Public Accounting      Firm                                                                                                                                                                                 | 34       |
| Consolidated      Balance Sheets as of December 31, 2007 and 2006                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             | 35       |
| Consolidated      Statements of Operations for each of the three    years      in the period ended December 31,      2007                                                                                                         |  36 |
| Consolidated      Statements of Cash Flows for each of the    three      years in the period ended December 31, 2007                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |  37 |
| Consolidated      Statements of Stockholders’ Equity for each of     the      three years in the period ended December 31, 2007                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |  38 |
| Notes      to Consolidated Financial Statements                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          | 39       |
| (2)      Schedule II - Valuation and Qualifying      Accounts                                                                                                                                                                                         | 51       |

| 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 3.1 to the Company’s Form 8-K filed      with the Securities and Exchange Commission on December 10, 2007 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).                                                                                                                                                                                                                    |
| 4.4         | Amendment      No. 1 to Rights Agreement dated September 6, 2007 between Aware, Inc. and      Computershare Trust Company, N.A., as Rights Agent (filed as Exhibit 4.1      to the Company’s Form 8-K filed with the Securities and Exchange      Commission on September 7, 2007 and incorporated herein by      reference). |
| 10.1*       | 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).                                                                                  |
| 10.2*       | 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 29, 2005 and incorporated herein by      reference).                                                               |
| 10.3*       | 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).                                                                                                                           |

----

| 10.4* | 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).                                                             |
|-------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.5* | Form      of Nonqualified Stock Option Agreement under the 2001 Nonqualified Stock      Plan (filed as Exhibit 10.6 to Company’s Form 10-K for the year ended      December 31, 2006 and incorporated herein byreference).                                                |
| 10.6* | Offer      letter dated December 17, 2007 by and between Richard Moberg and Aware,      Inc. (filed as Exhibit 99.2 to Company’s Form 8-K filed with the      Securities and Exchange Commission on December 18, 2007 and incorporated      herein by reference).         |
| 10.7* | Consultant      Agreement dated December 17, 2007 by and between Richard Moberg and Aware,      Inc. (filed as Exhibit 99.3 to Company’s Form 8-K filed with the      Securities and Exchange Commission on December 18, 2007 and incorporated      herein by reference). |
| 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 of2002.                                                                                                                                        |

----

| Signature                             |   | Title                                             |
|---------------------------------------|--------|---------------------------------------------------|
|                                  |   |                                              |
| /s/      Michael A. Tzannes           |   | Chief      Executive Officer and Director         |
| Michael      A. Tzannes               |   | (Principal      Executive Officer)                |
|                                  |   |                                              |
|                                  |   |                                              |
| /s/      Edmund C. Reiter             |   | President      and Director                       |
| Edmund      C. Reiter                 |   |                                              |
|                                  |   |                                              |
|                                  |   |                                              |
| /s/      Keith E. Farris              |   | Chief      Financial Officer                      |
| Keith      E. Farris                  |   | (Principal      Financial and Accounting Officer) |
|                                  |   |                                              |
|                                  |   |                                              |
| /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                  |   |                                              |