UNITED
STATES
 SECURITIES
AND EXCHANGE COMMISSION
 Washington,
D.C. 20549
 
 FORM
10-Q
 
 Quarterly
Report Pursuant To Section 13 Or 15(d) Of The
 Securities
Exchange Act of 1934
 
 For
the quarter ended March 31, 2008
 
 Commission
file number 000-21129
 
 
 AWARE,
INC.
 (Exact
Name of Registrant as Specified in Its Charter)
 Massachusetts
              04-2911026(State
      or Other Jurisdiction of
              (I.R.S.
      Employer Identification No.)Incorporation
      or Organization)
 
 
 40 Middlesex Turnpike,
Bedford, Massachusetts, 01730
 (Address
of Principal Executive Offices)
 (Zip
Code)
 
 (781)
276-4000
 (Registrant’s
Telephone Number, Including Area Code)
 
 
 Indicate
by check whether the registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.  YES x NO o
 
 Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company.  See definition of "large accelerated filer”, “accelerated filer",
and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check
one):
  Large
Accelerated Filer o   
Accelerated Filer x  
Non-Accelerated Filer o Smaller Reporting
Company o
 
 Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).  YES o   NO x
 
 Indicate
the number of shares outstanding of the issuer’s common stock as of May 5,
2008:
 
 Class
              Number of Shares
      OutstandingCommon
      Stock, par value $0.01 per share
              23,914,966
      shares
 
 AWARE,
INC.
 FORM
10-Q
 FOR
THE QUARTER ENDED MARCH 31, 2008
 
 TABLE
OF CONTENTS
 
 PagePART
      I
              FINANCIAL
      INFORMATIONItem
      1.
              Unaudited
      Consolidated Financial StatementsConsolidated
      Balance Sheets as of March 31, 2008 and December 31, 2007
              3Consolidated
      Statements of Operations for the Three Months Ended March 31, 2008 and
      March 31, 2007
              4Consolidated
      Statements of Cash Flows for the Three Months Ended March 31, 2008 and
      March 31, 2007
              5Notes
      to Consolidated Financial Statements
              6Item
      2.
              Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
              10Item
      3.
              Quantitative
      and Qualitative Disclosures about Market Risk
              14Item
      4.
              Controls
      and Procedures
              14PART
      II
              OTHER
      INFORMATIONItem
      1.
              Legal
      Proceedings
              15Item
      1A.
              Risk
      Factors
              15Item
      2.
              Unregistered
      Sales of Equity Securities and Use of Proceeds
              25Item
      6.
              Exhibits
              26Signatures
              26
  2
 PART
I. FINANCIAL INFORMATION
 ITEM
1: CONSOLIDATED FINANCIAL STATEMENTS
 AWARE,
INC.
 CONSOLIDATED
BALANCE SHEETS
 (in
thousands, except share data)
 (unaudited)
 
 March
      31,
                2008
              
              
              December
      31,
                2007ASSETSCurrent
      assets:Cash
      and cash equivalents
              
              $
              27,031
              
              
              $
              1,806Short-term
      investments
              
              
              13,273
              
              
              
              36,249Accounts
      receivable, net
              
              
              5,043
              
              
              
              7,661Inventories
              
              
              1,513
              
              
              
              1,424Prepaid
      expenses and other current assets
              
              
              698
              
              
              
              708Total
      current assets
              
              
              47,558
              
              
              
              47,848Property
      and equipment, net
              
              
              7,879
              
              
              
              7,872Investments
              
              
              -
              
              
              
              494Other
      assets, net
              
              
              153
              
              
              
              169Total
      assets
              
              $
              55,590
              
              
              $
              56,383LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      liabilities:Accounts
      payable
              
              $
              872
              
              
              $
              939Accrued
      expenses
              
              
              151
              
              
              
              174Accrued
      compensation
              
              
              1,315
              
              
              
              1,135Accrued
      professional
              
              
              226
              
              
              
              156Deferred
      revenue
              
              
              259
              
              
              
              413Total
      current liabilities
              
              
              2,823
              
              
              
              2,817Long-term
      deferred revenue
              
              
              330
              
              
              
              330Stockholders’
      equity:Preferred
      stock, $1.00 par value; 1,000,000 shares authorized,none
      outstanding
              
              
              -
              
              
              
              -Common
      stock, $.01 par value; 70,000,000 shares authorized; issuedand
      outstanding, 23,914,966 as of March 31, 2008 and 23,854,708 asof
      December 31, 2007
              
              
              239
              
              
              
              239Additional
      paid-in capital
              
              
              84,109
              
              
              
              83,626Accumulated
      deficit
              
              
              (31,911
              )
              
              
              (30,629
              )Total
      stockholders’ equity
              
              
              52,437
              
              
              
              53,236Total
      liabilities and stockholders’ equity
              
              $
              55,590
              
              
              $
              56,383
   The
accompanying notes are an integral part of the consolidated financial
statements.
 3
  AWARE,
INC.
 CONSOLIDATED
STATEMENTS OF OPERATIONS
 (in
thousands, except per share data)
 (unaudited)
 
 Three
      Months EndedMarch
      31,2008
              
              
              2007Revenue:Product
      sales
              
              $
              3,924
              
              
              $
              3,465Contract
      revenue
              
              
              1,521
              
              
              
              1,834Royalties
              
              
              431
              
              
              
              501Total
      revenue
              
              
              5,876
              
              
              
              5,800Costs
      and expenses:Cost
      of product sales
              
              
              824
              
              
              
              496Cost
      of contract revenue
              
              
              1,018
              
              
              
              1,352Research
      and development
              
              
              3,528
              
              
              
              2,557Selling
      and marketing
              
              
              969
              
              
              
              872General
      and administrative
              
              
              1,193
              
              
              
              1,116Total
      costs and expenses
              
              
              7,532
              
              
              
              6,393Loss
      from operations
              
              
              (1,656
              )
              
              
              (593
              )Interest
      income
              
              
              383
              
              
              
              505Loss
      before provision for income taxes
              
              
              (1,273
              )
              
              
              (88
              )Provision
      for income taxes
              
              
              9
              
              
              
              10Net
      loss
              
              $
              (1,282
              )
              
              $
              (98
              )Net
      loss per share – basic
              
              $
              (0.05
              )
              
              $
              0.00Net
      loss per share – diluted
              
              $
              (0.05
              )
              
              $
              0.00Weighted
      average shares – basic
              
              
              23,880
              
              
              
              23,657Weighted
      average shares – diluted
              
              
              23,880
              
              
              
              23,657
 
  The
accompanying notes are an integral part of the consolidated financial
statements.
 4
  AWARE,
INC.
 CONSOLIDATED
STATEMENTS OF CASH FLOWS
 (in
thousands)
 (unaudited)
 
 
 
 Three
      Months EndedMarch
      31,2008
              
              
              2007Cash
      flows from operating activities:Net
      loss
              
              $
              (1,282
              )
              
              $
              (98
              )Adjustments
      to reconcile net loss to net cashprovided
      by (used in) operating activities:Depreciation
      and amortization
              
              
              224
              
              
              
              210Stock
      based compensation
              
              
              325
              
              
              
              235Provision
      for doubtful accounts
              
              
              (15
              )
              
              
              -Increase
      (decrease) from changes in assets and liabilities:Accounts
      receivable
              
              
              2,633
              
              
              
              (603
              )Inventories
              
              
              (89
              )
              
              
              (318
              )Prepaid
      expenses
              
              
              10
              
              
              
              (111
              )Accounts
      payable
              
              
              (67
              )
              
              
              259Accrued
      expenses
              
              
              227
              
              
              
              173Deferred
      revenue
              
              
              (154
              )
              
              
              8Net
      cash provided by (used in) operating activities
              
              
              1,812
              
              
              
              (245
              )Cash
      flows from investing activities:Purchases
      of property and equipment
              
              
              (215
              )
              
              
              (251
              )Sales
      of investments
              
              
              25,470
              
              
              
              6,800Purchases
      of investments
              
              
              (2,000
              )
              
              
              (5,958
              )Net
      cash provided by investing activities
              
              
              23,255
              
              
              
              591Cash
      flows from financing activities:Proceeds
      from issuance of common stock
              
              
              158
              
              
              
              177Net
      cash provided by financing activities
              
              
              158
              
              
              
              177Increase
      in cash and cash equivalents
              
              
              25,225
              
              
              
              523Cash
      and cash equivalents, beginning of period
              
              
              1,806
              
              
              
              8,571Cash
      and cash equivalents, end of period
              
              $
              27,031
              
              
              $
              9,094
 
 The accompanying notes are an integral
part of the consolidated financial statements.
 5
  AWARE,
INC.
 NOTES
TO CONSOLIDATEDFINANCIAL
STATEMENTS
 (unaudited)
 
 
 A)           Basis of
Presentation
 
 The
accompanying unaudited consolidated balance sheet, statements of operations, and
statements of cash flows reflect all adjustments (consisting only of normal
recurring items) which are, in the opinion of management, necessary for a fair
presentation of financial position at March 31, 2008, and of operations and cash
flows for the interim periods ended March 31, 2008 and 2007.  Certain
reclassifications have been made to the prior year financial statements to
conform to the current year presentation.
 
 The
accompanying unaudited consolidated financial statements have been prepared in
accordance with the instructions for Form 10-Q and therefore do not include all
information and footnotes necessary for a complete presentation of our financial
position, results of operations and cash flows, in conformity with generally
accepted accounting principles.  We filed audited financial statements
which included all information and footnotes necessary for such presentation for
the three years ended December 31, 2007 in conjunction with our 2007 Annual
Report on Form 10-K.
 
 The
results of operations for the interim period ended March 31, 2008 are not
necessarily indicative of the results to be expected for the year.
 
 B)           Fair Value
Measurements
 
 In
September 2006, the FASB issued SFAS No. 157 ("SFAS 157"), "Fair Value
Measurements".  SFAS 157 defines fair value, establishes a framework
for measuring fair value in accordance with accounting principles generally
accepted in the United States, and expands disclosures about fair value
measurements. We adopted the provisions of SFAS 157 as of January 1, 2008, for
our financial instruments. Although the adoption of SFAS 157 did not materially
impact our financial condition, results of operations, or cash flow, we are now
required to provide additional disclosures as part of our financial
statements.
  SFAS 157
establishes a three-tier fair value hierarchy, which prioritizes the inputs used
in measuring fair value.  These tiers include: Level 1, defined as
observable inputs such as quoted prices in active markets; Level 2, defined as
inputs other than quoted prices in active markets that are either directly or
indirectly observable; and Level 3, defined as unobservable inputs in which
little or no market data exists, therefore requiring an entity to develop its
own assumptions.
 
 For
recognition purposes, on a recurring basis we are required to measure available
for sale investments at fair value. These investments had a fair value of $13.3
million as of March 31, 2008 and $36.7 million as of December 31, 2007 and are
included in short-term investments and investments on our consolidated balance
sheets. The fair value of these investments is determined using quoted prices in
active markets and is considered a Level 1 input.  Changes in the fair
value of these investments have historically been insignificant.
  6
  Our cash
and cash equivalents, including money market securities, are also classified
within Level 1 of the fair value hierarchy because they are valued using quoted
market prices.
 
 C)           Inventory
 
 Inventories
are stated at the lower of cost or net realizable value with cost being
determined by the first-in, first-out (“FIFO”) method.  Inventory
reserves are established for estimated excess and obsolete inventory. Inventory
consists primarily of the following (in thousands):
 
 March
      31,
                2008
              
              
              December
      31,
                2007Raw
      materials
              
              $
              1,506
              
              
              $
              1,424Finished
      goods
              
              
              7
              
              
              
              -Total
              
              $
              1,513
              
              
              $
              1,424
 
 D)           Computation of
Earnings per Share
 
 Basic earnings per share is computed by
dividing net income or loss by the weighted average number of common shares
outstanding.  Diluted earnings per share is computed by dividing net
income or loss by the weighted average number of common shares outstanding plus
additional common shares that would have been outstanding if dilutive potential
common shares had been issued.  For the purposes of this calculation,
stock options are considered common stock equivalents in periods in which they
have a dilutive effect.  Stock options that are anti-dilutive are
excluded from the calculation.
 
 Net loss
per share is calculated as follows (in thousands, except per share
data):
 
 Three
      Months Ended
                March
      31,2008
              
              
              2007Net
      loss
              
              $
              (1,282
              )
              
              $
              (98
              )Weighted
      average common shares outstanding
              
              
              23,880
              
              
              
              23,657Additional
      dilutive common stock equivalents
              
              
              -
              
              
              
              -Diluted
      shares outstanding
              
              
              23,880
              
              
              
              23,657Net
      loss per share – basic
              
              $
              (0.05
              )
              
              $
              0.00Net
      loss per share – diluted
              
              $
              (0.05
              )
              
              $
              0.00
 
 
 For the
three month periods ended March 31, 2008 and 2007 potential common stock
equivalents of 646,887 and 1,484,561, respectively, were not included in the per
share calculation for diluted EPS, because we had a net loss and the effect of
their inclusion would be anti-dilutive. For the three month periods ended March
31, 2008 and 2007, options to purchase 3,471,768 and 2,425,242 shares of common
stock, respectively, were outstanding, but were not included in the computation
of diluted EPS because the options’ exercise prices were greater than the
average market price of the common stock and thus would be
anti-dilutive.
  7
  E)           Stock-Based
Compensation
  The
following table presents stock-based employee compensation expenses included in
the Company’s unaudited consolidated statements of operations (in
thousands):
  Three
      Months Ended
                March
      31, 2008
              
              
              Three
      Months Ended
                March
      31, 2007Cost
      of product sales
              
              $
              3
              
              
              $
              2Cost
      of contract revenue
              
              
              34
              
              
              
              36Research
      and development
              
              
              167
              
              
              
              85Selling
      and marketing
              
              
              31
              
              
              
              21General
      and administrative
              
              
              90
              
              
              
              91Stock-based
      compensation expense
              
              $
              325
              
              
              $
              235
 
 The
Company estimates the fair value of stock options using the Black-Scholes
valuation model. This valuation model takes into account the exercise price of
the award, as well as a variety of significant assumptions. These assumptions
used to estimate the fair value of stock options include the expected term, the
expected volatility of the Company’s stock over the expected term, the risk-free
interest rate over the expected term, and the Company’s expected annual dividend
yield. The Company believes that the valuation technique and the approach
utilized to develop the underlying assumptions areappropriate in calculating
the fair values of the Company’s stock options granted in the three months ended
March 31, 2008 and March 31, 2007. For stock options issued prior to
December 31, 2007, we used the simplified method as promulgated by SAB 107 for
estimating the expected option term. For stock options issued subsequent to
December 31, 2007, we used the calculated historical term of stock options in
computing the expected option term. Estimates of fair value are not intended to
predict actual future events or the value ultimately realized by persons who
receive equity awards.
 
 F)           Business
Segments
 
 The
Company organizes itself as one segment and conducts its operations in the
United States.
 
 The
Company sells its products and technology to domestic and international
customers.  Revenues were generated from the following geographic
regions (in thousands):
 
 Three
      Months EndedMarch
      31,2008
              
              
              2007United
      States
              
              $
              4,001
              
              
              $
              3,997Germany
              
              
              1,514
              
              
              
              1,005Rest
      of World
              
              
              361
              
              
              
              798$
              5,876
              
              
              $
              5,800
 
 G)           Income
Taxes
 
 As of
December 31, 2007, we had federal net operating loss and research and
experimentation credit carryforwards of approximately $46.1 million and $12.2
million respectively, which may be available to offset future federal income tax
liabilities and expire at various dates from 2008 through 2027.  In
addition, at December 31, 2007, we had approximately $11.2 million and $6.2
million of state net operating losses and state research and development and
investment tax carryforwards, respectively, which expire at various dates from
2008 through 2022.
  8
  Based on an analysis that we performed
under Internal Revenue Code Section 382 on our NOLs generated for the period
1997 through 2007, we have not experienced a change in ownership as defined by
Section 382, and, therefore, the NOLs are not currently under any Section 382
limitation.
 
 H)           Recent Accounting
Pronouncements
 
 In
September 2006, the FASB issued SFAS No. 157 ("SFAS 157"), "Fair
Value Measurements," which defines fair value, establishes guidelines for
measuring fair value and expands disclosures regarding fair value measurements.
SFAS 157 does not require any new fair value measurements but rather
eliminates inconsistencies in guidance found in various prior accounting
pronouncements. SFAS 157 is effective for fiscal years beginning after
November 15, 2007. However, on February 6, 2008, the FASB issued FSP
FAS 157-b which defers the effective date of SFAS 157 for one year for
nonfinancial assets and nonfinancial liabilities that are recognized or
disclosed at fair value in the financial statements on a recurring basis. We
adopted SFAS 157 on January 1, 2008, except as it applies to those
nonfinancial assets and nonfinancial liabilities as noted in FSP FAS 157-b.
The partial adoption of SFAS 157 did not have a material impact on our
consolidated financial position, results of operations or cash flows, nor do we
believe that the adoption of FSP FAS 157-b will have a material impact on our
consolidated financial position, results of operations or cash
flows.
 
 In
February 2007, the FASB issued SFAS No. 159 ("SFAS 159"), “The Fair Value
Option for Financial Assets and Financial Liabilities”. SFAS 159 allows entities
to voluntarily choose to measure certain financial assets and liabilities at
fair value (“fair value option”). The fair value option may be elected on an
instrument-by-instrument basis and is irrevocable, unless a new election date
occurs. If the fair value option is elected for an instrument, SFAS 159
specifies that unrealized gains and losses for that instrument be reported in
earnings at each subsequent reporting date. SFAS 159 was effective on
January 1, 2008. We did not apply the fair value option to any of our
outstanding instruments and therefore, SFAS 159 did not have an impact on our
consolidated financial statements.
 
 I)            
Share
Repurchase Program
 
 On August
28, 2007, we announced a stock repurchase program to purchase up to $5 million
of our common stock, subject to market conditions and other factors. Any
purchases under our stock repurchase program may be made from time to time
without prior notice. The authorization to repurchase our stock expires on
December 31, 2008. Repurchases of common stock under this program included 9,107
shares in 2007 and no shares during the three months ended March 31,
2008.
  9
  ITEM
2:
 Management’s
Discussion and Analysis of
 Financial
Condition and Results of Operations
 
 
 Cautionary
Statement for Purposes of the “Safe Harbor” Provisions of the Private Securities
Litigation Reform Act of 1995
 
 Some
of the information in this Form 10-Q contains forward-looking statements that
involve substantial risks and uncertainties.  You can identify these
statements by forward-looking words such as “may,” “will,” “expect,”
“anticipate,” “believe,” “estimate,” “continue” and similar
words.  You should read statements that contain these words carefully
because they: (1) discuss our future expectations; (2) contain projections of
our future operating results or financial condition; or (3) state other
“forward-looking” information.  However, we may not be able to predict
future events accurately.  The risk factors listed in this Form 10-Q,
as well as any cautionary language in this Form 10-Q, provide examples of risks,
uncertainties and events that may cause our actual results to differ materially
from the expectations we describe in our forward-looking
statements.  You should be aware that the occurrence of any of the
events described in these risk factors and elsewhere in this Form 10-Q could
materially and adversely affect our business.
 
 Results
of Operations
 
 Product
Sales.  Product sales
consist primarily of revenue from the sale of hardware and software
products.  Hardware products consist of DSL test and diagnostics
hardware, including systems, modules, and modems. Software products consist of
software products for biometric, medical imaging and digital imaging
applications, as well as DSL test and diagnostics software.
 
 Product
sales increased 13% from $3.5 million in the first quarter of 2007 to $3.9
million in the current year quarter.  As a percentage of total
revenue, product sales increased from 60% in the first quarter of 2007 to 67% in
the current year quarter.  The dollar increase was primarily due to
increases in the sale of biometric and test and diagnostic software, and to a
lesser extent, hardware sales.
 
 Contract
Revenue. Contract revenueconsists of patent,
license and engineering service fees that we receive under agreements relating
to Aware’s patents, DSL technology, DSL test and diagnostic technology, and
biometrics technology.
 
 Contract
revenue decreased 17% from $1.8 million in the first quarter of 2007 to $1.5
million in the current year quarter.  As a percentage of total
revenue, contract revenue decreased from 32% in the first quarter of 2007 to 26%
in the current year quarter. The dollar decrease was primarily due to lower
contract revenue from DSL technology contracts, which was partially offset by
increased contract revenue from biometrics technology contracts. DSL contract
revenue was lower this quarter primarily because we were unable to sign new
contracts during the quarter. Lower contract revenue was also due to an
unannounced customer who notified us that it wished to terminate an ongoing
development project with us as a result of its sale of certain DSL assets to
another company.
 
 While we
believe that the transition to ADSL2+ and VDSL2 technology increases the value
proposition of our technology, some existing and prospective DSL chipset
licensees have continued to be reluctant to begin new development projects given
a difficult and uncertain environment in the semiconductor and
telecommunications industries, and intense ADSL chipset competition and falling
chipset prices.  During the last several years, customers and
potential customers cautiously evaluated new chipset projects or delayed or
cancelled projects in the face of such conditions.
  10
 Royalties.  Royalties
consist of royalty payments that we receive under licensing
agreements.  We receive royalties from customers for the right to use
our patents and technology in their chipsets or solutions.
 
 Royalties
decreased 14% from $0.5 million in the first quarter of 2007 to $0.4 million in
the current year quarter. As a percentage of total revenue, royalties decreased
from 9% in the first quarter of 2007 to 7% in the current year
quarter.  The dollar decrease in royalties was due to a $0.1 million
decrease in ADSL royalties.
 
 Our
royalty revenue comes predominantly from ADSL chipset sales by Ikanos
Communications, Inc. (“Ikanos”), and Infineon Technologies AG
(“Infineon”).  Despite steady growth of worldwide ADSL subscribers
over the last several years, the availability of ADSL chipsets from a number of
suppliers and intense competition among those suppliers has caused chipset
prices to steadily decline.  We are uncertain how the transition to
ADSL2+ and VDSL2 will impact our customers in the near term, how quickly sales
of our customers’ chipsets will increase and whether such increases will
contribute meaningful royalties to us.
 
 Cost of Product
Sales.  Since the cost of software product sales is minimal,
cost of product sales consists primarily of the cost of hardware product
sales.  Cost of product sales increased 66% from $496,000 in the first
quarter of 2007 to $824,000 in the current year quarter.  As a
percentage of product sales, cost of product sales increased from 14% in the
first quarter of 2007 to 21% in the current year quarter, which means that
product gross margins decreased from 86% to 79%. The cost of product sales
dollar increase and gross margin decline were primarily due to lower gross
margins on hardware products. The year over year decline in hardware gross
margins was primarily due to the margin characteristics of the products in the
sales mix and higher manufacturing overhead costs.
 
 Cost of Contract
Revenue.  Cost of contract
revenue consists primarily of compensation costs for engineers and expenses for
consultants, technology licensing fees, recruiting, supplies, equipment,
depreciation and facilities associated with customer development
projects.  Our total engineering costs are allocated between cost of
contract revenue and research and development expense.  In a given
period, the allocation of engineering costs between cost of contract revenue and
research and development is a function of the level of effort expended on
each.
 
 Cost of
contract revenue decreased 25% from $1.4 million in the first quarter of 2007 to
$1.0 million in the current year quarter.  Cost of contract revenue as
a percentage of contract revenue, was 74% in the first quarter of 2007 and 67%
in the current quarter. The dollar decrease in cost of contract revenue was
primarily a function of lower DSL contract revenue in the current quarter, which
decreased the amount we charged to cost of contract revenue. Lower cost of
contract revenue from DSL contracts was partially offset by increased cost of
contract revenue from biometrics contracts.
 
 Research and
Development Expense.  Research and development expense consists
primarily of compensation costs for engineers and expenses for consultants,
recruiting, supplies, equipment, depreciation and facilities related to
engineering projects to improve our broadband intellectual property offerings,
as well as our software and hardware product technology.
  11
 Research
and development expenses increased 38% from $2.6 million in the first quarter of
2007 to $3.5 million in the current year quarter. As a percentage of total
revenue, research and development expense increased from 44% in the first
quarter of 2007 to 60% in the current year quarter.  The dollar
increase in research and development expense was primarily due to a shift of
engineering resources from customer contracts (i.e., cost of contract revenue)
to internal development projects (i.e., research and development expense). To
the extent our engineering resources are not required for customer projects for
which we receive contract revenue, we redeploy those resources to work on
internal development projects, which is what we did in the current year
quarter.  The dollar increase in research and development expense was
also driven by higher engineering compensation expense, which was the result of
headcount growth and salary increases.
 
 Our
research and development spending was principally focused on improving our ADSL,
ADSL2 and ADSL2plus StratiPHY2+TM technology and chips, developing and improving
our VDSL2 StratiPHY3TM technology and chips, developing bonded ADSL and VDSL
technology and chips, developing analog front-end technology for DSL solutions,
developing test and diagnostics hardware and software and developing imaging and
biometrics software.
 
 Selling and
Marketing Expense.  Selling and marketing expense consists
primarily of compensation costs for sales and marketing personnel, travel,
advertising and promotion, recruiting, and facilities expense.  Sales
and marketing expense increased 11% from $0.9 million in the first quarter of
2007 to $1.0 million in the current year quarter.  As a percentage of
total revenue, sales and marketing expense increased from 15% in the first
quarter of 2007 to 16% in the current year quarter.  The dollar
increase was mainly attributable to headcount growth in the sales organization,
which increased compensation, travel and facilities expenses.
 
 General and
Administrative Expense.  General and administrative expense
consists primarily of compensation costs for administrative personnel, facility
costs, bad debt, audit, legal, stock exchange and insurance
expenses.  General and administrative expenses increased 7% from $1.1
million in the first quarter of 2007 to $1.2 million in the current year
quarter. As a percentage of total revenue, general and administrative expense
increased from 19% in the first quarter of 2007 to 20% in the current year
quarter. The dollar increase was mainly attributable to expenses related to a
CFO transition that occurred in the current year quarter, and salary increases
for administrative staff.
 
 Interest
Income.  Interest income decreased 24% from $505,000 in the
first quarter of 2007 to $383,000 in the current year quarter.  The
dollar decrease was primarily due to a significant fall in money market interest
rates during the first three months of 2008 and a decision we made to liquidate
our portfolio of auction rate securities in January 2008 and invest the proceeds
into a lower yielding money market fund.
 
 Income
Taxes. We made no provision for income taxes in the first three months of
2007 and 2008 due to net losses incurred and the uncertainty of the timing of
profitability in future periods, except for $9,000 and $10,000 of state excise
tax paid in the first quarter of 2008 and 2007, respectively.  In
2002, we determined that due to our continuing operating losses as well as the
uncertainty of the timing of profitability in future periods, we should fully
reserve our deferred tax assets.  As of March 31, 2008, our deferred
tax assets continue to be fully reserved.  We will continue to
evaluate, on a quarterly basis, the positive and negative evidence affecting the
realizability of our deferred tax assets.
 
 As of
December 31, 2007, we had federal net operating loss and research and
experimentation credit carryforwards of approximately $46.1 million and $12.2
million respectively, which may be available to offset future federal income tax
liabilities and expire at various dates from 2008 through 2027.  In
addition, at December 31, 2007, we had approximately $11.2 million and $6.2
million of state net operating losses and state research and development and
investment tax carryforwards, respectively, which expire at various dates from
2008 through 2022.
  12
 Based on an analysis that we performed
under Internal Revenue Code Section 382 on our NOLs generated for the period
1997 through 2007, we have not experienced a change in ownership as defined by
Section 382, and, therefore, the NOLs are not currently under any Section 382
limitation.
 
 Liquidity
and Capital Resources
 
 At March
31, 2008, we had cash, cash equivalents, short-term investments, and investments
of $40.3 million, which represents an increase of $1.8 million from December 31,
2007.  The increase was primarily due to $1.8 million of cash provided
by operations and $0.2 million of proceeds from the exercise of employee stock
options. The increase was partially offset by $0.2 million of capital
spending.
 
 Cash
provided by operations in the first three months of 2008 was primarily due to a
reduction of working capital of $2.5 million, which was partially offset by a
net loss of $1.3 million, adjusted for non-cash items related to depreciation
and amortization of $0.2 million, and stock based compensation expense of $0.3
million. Capital spending was primarily related to the purchase of computer
hardware, and laboratory equipment used principally in engineering
activities.
 
 While we
can not assure you that we will not require additional financing, or that such
financing will be available to us, we believe that our cash, cash equivalents
and short-term investments will be sufficient to fund our operations for at
least the next twelve months.
 
 Recent
Accounting Pronouncements
 
 In
September 2006, the FASB issued SFAS No. 157 ("SFAS 157"), "Fair
Value Measurements," which defines fair value, establishes guidelines for
measuring fair value and expands disclosures regarding fair value measurements.
SFAS 157 does not require any new fair value measurements but rather
eliminates inconsistencies in guidance found in various prior accounting
pronouncements. SFAS 157 is effective for fiscal years beginning after
November 15, 2007. However, on February 6, 2008, the FASB issued FSP
FAS 157-b which defers the effective date of SFAS 157 for one year for
nonfinancial assets and nonfinancial liabilities that are recognized or
disclosed at fair value in the financial statements on a recurring basis. We
adopted SFAS 157 on January 1, 2008, except as it applies to those
nonfinancial assets and nonfinancial liabilities as noted in FSP FAS 157-b.
The partial adoption of SFAS 157 did not have a material impact on our
consolidated financial position, results of operations or cash flows, nor do we
believe that the adoption of FSP FAS 157-b will have a material impact on our
consolidated financial position, results of operations or cash
flows.
 
 In
February 2007, the FASB issued SFAS No. 159 ("SFAS 159"), “The Fair Value
Option for Financial Assets and Financial Liabilities”. SFAS 159 allows entities
to voluntarily choose to measure certain financial assets and liabilities at
fair value (“fair value option”). The fair value option may be elected on an
instrument-by-instrument basis and is irrevocable, unless a new election date
occurs. If the fair value option is elected for an instrument, SFAS 159
specifies that unrealized gains and losses for that instrument be reported in
earnings at each subsequent reporting date. SFAS 159 was effective on
January 1, 2008. We did not apply the fair value option to any of our
outstanding instruments and therefore, SFAS 159 did not have an impact on our
consolidated financial statements.
 
 13
  ITEM
3:
 Quantitative
and Qualitative Disclosures about Market Risk
 
 
 Our
exposure to market risk relates primarily to our investment portfolio, and the
effect that changes in interest rates would have on that
portfolio.  Our investment portfolio has included:
 
 ●
              Cash
      and cash equivalents, which consist of financial instruments with original
      maturities of three months or less; and●
              Investments,
      which consist of financial instruments that meet the high quality
      standards specified in our investment policy.  This policy
      dictates that all instruments mature in three years or less, and limits
      the amount of credit exposure to any one issue, issuer, and type of
      instrument.
 
 We do not
use derivative financial instruments for speculative or trading
purposes.  As of March 31, 2008, we had $40.3 million in cash, cash
equivalents and short-term investments that matured in twelve months or
less.  Due to the short duration of these financial instruments, we do
not expect that an increase in interest rates would result in any material loss
to our investment portfolio. In January 2008, we liquidated all of our auction
rate securities and invested the proceeds in a money market
account.
 
 
 ITEM
4:
 Controls
and Procedures
 
 Our
management, including our chief executive officer and chief financial officer,
has evaluated our disclosure controls and procedures as of the end of the
quarterly period covered by this Form 10-Q and has concluded that our disclosure
controls and procedures are effective.  They also concluded that there
were no changes in our internal control over financial reporting that occurred
during the quarterly period covered by this Form 10-Q that have materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting.
  14
  PART
II.  OTHER INFORMATION
 
 ITEM
1:
 Legal
Proceedings
 
 From time
to time we are involved in litigation incidental to the conduct of our
business.  We are not party to any lawsuit or proceeding that, in our
opinion, is likely to seriously harm our business.
 
 ITEM
1A:
 Risk
Factors
 
 Risk
Factors
 
 
 Our
Quarterly Results are Unpredictable and May Fluctuate Significantly
 
 Our
quarterly revenue and operating results are difficult to predict and may
fluctuate significantly from quarter-to-quarter due to the unpredictably of our
revenue components.
 
 It is
difficult for us to make accurate forecasts of product
revenues.  Product revenues consist of sales of test and diagnostics
hardware as well as biometrics, medical imaging and test and diagnostics
software. Sales of hardware and software products fluctuate based upon demand by
our customers which is difficult to predict.  Since our product
revenues include the sales of hardware products which typically have lower gross
margins than our other sources of revenue, profitability is also difficult to
predict.
 
 Contract
revenues are also unpredictable. Making accurate predictions of contract
revenues from new customers is difficult because the contract negotiation
process is lengthy, frequently spanning a year or more, and the fiscal period in
which a new agreement will be entered into, if at all, and the financial terms
of such an agreement are difficult to predict.  Making accurate
predictions of contract revenues from existing customers is also difficult,
because such revenues are affected by the level of cooperation we receive from
customers; the level of engineering services desired by customers; the potential
of contract termination once a project starts, or customers may not pay us as
anticipated under our contracts.
 
 It is
also difficult for us to make accurate forecasts of royalty
revenues.  Royalties are recognized in the quarter in which we receive
a report from a customer regarding the shipment of integrated circuits in the
prior quarter, and are dependent upon fluctuating sales volumes and/or prices of
chips containing our technology, all of which are beyond our ability to control
or assess in advance.
 
 Our
business is subject to a variety of additional risks, which could materially
adversely affect quarterly and annual operating results, including:
 
 ●
              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;
  15
  ●
              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 our technology;●
              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 existing standards;●
              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 market surpluses;●
              VDSL
      market-related issues, including lower VDSL chipset unit demand brought on
      by excess channel inventory and lower average selling prices for VDSL
      chipsets as a result of market surpluses;●
              hardware
      manufacturing issues, including yield problems in our hardware platforms,
      and inventory buildup and obsolescence;●
              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.
 
 As a
result of these factors, we believe that period-to-period comparisons of our
revenue levels and operating results are not necessarily
meaningful.  You should not rely on our quarterly revenue and
operating results to predict our future performance.
 
 We
Experienced Net Losses
 
 We had a
net annual loss during 2001, 2002, 2003, 2004 and 2005, and a quarterly loss in
the first quarter of 2008.  We may experience losses in the future
if:
 ●
              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.
 
 16
 
 Our
DSL Licensing and DSL Test and Diagnostic Businesses Depend Upon a Limited
Number of Customers, Therefore We Derive a Significant Amount of Revenue from a
Small Number of Customers
 
 There are
a relatively limited number of companies to which we can sell our DSL technology
and OEM equipment companies to which we can sell our DSL test and diagnostic
products in a manner consistent with our business model. If we fail to maintain
relationships with our current customers or fail to establish a sufficient
number of new customer relationships, our business could be seriously
harmed.  In addition, our current and prospective customers may use
their superior size and bargaining power to demand terms that are unfavorable to
us.
 
 Due to
the limited number of customers to which we can license or sell our DSL
technology and DSL hardware and software products, we derive a significant
amount of revenue from a small number of customers.  In 2007, we
derived approximately 19%, 16%, and 10% of our total revenue from Infineon,
Spirent, and Alcatel, respectively. In 2006, we derived approximately 26% and
20% of our total revenue from Infineon and ADI/Ikanos,
respectively.  On February 17, 2006 ADI sold its ADSL business
relating to Aware technology to Ikanos and Ikanos replaced ADI as an Aware
customer.  In 2005, we derived approximately 30% and 20% of our total
revenue from Infineon and ADI, respectively.
 
 Our
Business is Subject to Rapid Technological Change
 
 The
semiconductor and telecommunications industries for high-speed network access
technologies are characterized by rapid technological change, with new
generations of products being introduced regularly and with ongoing evolutionary
improvements.  We expect to depend on our DSL technology and products
for a substantial portion of our revenue for the foreseeable
future.  Therefore, we face risks that others could introduce
competing technology that renders our DSL technology and products less desirable
or obsolete.  Also, the announcement of new technologies could cause
our customers or their customers to delay or defer entering into arrangements
for the use of our existing technology.  Either of these events could
seriously harm our business.  The biometrics industry is also subject
to rapid technological change and uncertainty.
 
 We expect
that our business will depend to a significant extent on our ability to
introduce enhancements and new generations of our DSL and biometrics technology
and products as well as new technologies and products that keep pace with
changes in the telecommunications and broadband industries and that achieve
rapid market acceptance. We must continually devote significant engineering
resources to achieving technical innovations and product
developments.  These developments are complex and require long
development cycles.  Moreover, we may have to make substantial
investments in technological innovations and product developments before we can
determine their commercial viability.  We may lack sufficient
financial resources to fund future development.  Also, our customers
may decide not to share certain research and development costs with
us.  Revenue from technological innovations, even if successfully
developed, may not be sufficient to recoup the costs of
development.
 
 One
element of our business strategy is to assume the risks of technology
development failure while reducing such risks for our customers.  In
the past, we have spent significant amounts on development projects that did not
produce any marketable technologies or products, and we cannot assure you that
it will not occur again.
 
 17
 
 We
Face Intense Competition from a Wide Range of Competitors
 
 The
success of our DSL licensing business depends on the willingness and ability of
semiconductor manufacturers to design, build and sell integrated circuits based
on our intellectual property.  The semiconductor industry is intensely
competitive and has been characterized by price erosion, rapid technological
change, short product life cycles, cyclical market patterns and increasing
foreign and domestic competition.
 
 As an
intellectual property supplier to the semiconductor industry, we face intense
competition from internal development teams within potential semiconductor
customers.  We must convince potential customers to buy from us rather
than develop technology internally.  Furthermore, our semiconductor
customers may choose to abandon joint development projects with us and develop
chipsets themselves without using our technology.   In addition
to competition from internal development teams, we compete against other
independent suppliers of intellectual property.  We anticipate intense
competition from suppliers of intellectual property for ADSL.
 
 The
market for DSL chipsets is also intensely competitive.  Our success
within the DSL industry requires that DSL equipment manufacturers buy chipsets
from our semiconductor customers, and that telephone companies buy DSL equipment
from those equipment manufacturers.  Our customers’ chipsets compete
with products from other vendors of standards-based and DSL chipsets, including
Broadcom, Centillium, Conexant, Ikanos, and ST Microelectronics.
 
 The
markets for our DSL test and diagnostics hardware and software products are also
competitive and uncertain.  We cannot assure you that phone companies
will purchase significant quantities of products to test and diagnose their DSL
networks, nor that if they do they will purchase products incorporating our
hardware and software.  Our success as a supplier of hardware and
software products for DSL test and diagnostics depends on the willingness and
ability of OEM customers to design, build and sell automated test heads,
hand-held testers, and DSLAMs that incorporate or work with our
products.
 
 Our DSL
licensing and DSL test and diagnostic revenues are dependent upon the success of
ADSL and VDSL services. ADSL and VDSL services offered over copper telephone
networks also compete with alternative broadband transmission technologies that
use other network architectures.  Alternative technologies that use
other network architectures to provide high-speed data service include cable
modems using cable networks, wireless solutions using wireless networks, and
optics technology using fiber optic networks. These alternative broadband
transmission technologies may be more successful than ADSL or VDSL and we may
not be able to participate in the markets involving these alternative
technologies.
 
 Many of
our DSL competitors, including our customers’ competitors, have significantly
greater financial, technological, manufacturing, marketing and personnel
resources than we do. Some of these competitors include Broadcom, Conexant, and
ST Microelectronics in our DSL licensing business; and JDS Uniphase and Sunrise
Communications in our DSL test and diagnostic business.
 
 Also, the
markets for our biometrics, medical and digital imaging software products are
competitive and uncertain. Many of our biometric software competitors have
significantly greater financial, technological, marketing and personnel
resources than we do. Also, we face intense competition from internal
development teams within potential customers.  We must convince
potential customers to purchase from us rather than develop software
internally.  Furthermore, customers, who have already purchased from
us, may choose to stop purchasing our software and develop their own
software.
  18
 We may be
unable to compete successfully in our DSL licensing, DSL test and diagnostics,
and biometrics and  imaging businesses, and our competitive position
may be adversely affected in the future by one or more of the factors described
in this section.
 
 Our
Intellectual Property is Subject to Limited Protection
 
 Because
we are a technology provider, our ability to protect our intellectual property
and to operate without infringing the intellectual property rights of others is
critical to our success.  We regard our technology as proprietary, and
we have approximately 51 U.S. patents and 117 foreign patents and a number of
pending patent applications.  We also rely on a combination of trade
secrets, copyright and trademark law and non-disclosure agreements to protect
our unpatented intellectual property.  Despite these precautions, it
may be possible for a third party to copy or otherwise obtain and use our
technology without authorization.
 
 As part
of our agreements, we typically work closely with our customers, many of whom
are also our potential competitors, and provide them with proprietary know-how
necessary for their development of customized chipsets based on our DSL
technology.  Although our agreements contain non-disclosure provisions
and other terms protecting our proprietary know-how and technology rights, it is
possible that, despite these precautions, some of our customers might obtain
from us proprietary information that they could use to compete with us in the
marketplace.  Although we intend to defend our intellectual property
as necessary, the steps we have taken may be inadequate to prevent
misappropriation.
 
 In the
future, we may choose to bring legal action to enforce our intellectual property
rights.  Any such litigation could be costly and time-consuming for
us, even if we were to prevail.  Moreover, even if we are successful
in protecting our proprietary information, our competitors may independently
develop technologies substantially equivalent or superior to our
technology.  The misappropriation of our technology or the development
of competitive technology could seriously harm our business.
 
 Our
technology, software or hardware may infringe the intellectual property rights
of others.  A large and increasing number of participants in the
telecommunications and compression industries have applied for or obtained
patents.  Some of these patent holders have demonstrated a readiness
to commence litigation based on allegations of patent and other intellectual
property infringement.  Third parties may assert patent, copyright and
other intellectual property rights to technologies that are important to our
business.  In the past, we have received claims from other companies
that our technology infringes their patent rights.  Intellectual
property rights can be uncertain and can involve complex legal and factual
questions.  We may infringe the proprietary rights of others, which
could result in significant liability for us.  If we were found to
have infringed any third party’s patents, we could be subject to substantial
damages or an injunction preventing us from conducting our
business.
 
 We
Have a Unique DSL Licensing Business Model
 
 The
success of our DSL licensing products depends upon our ability to license our
technology to semiconductor and equipment companies, and our customers’
willingness and ability to sell products that incorporate our technology so that
we may receive meaningful royalties that are consistent with our plans and
expectations.
  19
 We face
numerous risks in successfully obtaining suitable customers on terms consistent
with our business model, including, among others:
 
 ●
              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.
 
 Moreover,
the success of our business model also depends on the receipt of royalties from
customers. Royalties from our customers are often based on the selling prices of
their chipsets and products, over which we have little or no
control.  We also have little or no control over our customers’
promotional and marketing efforts.  They are not prohibited from
competing against us.
 
 Our DSL
licensing business could be seriously harmed if we cannot obtain suitable
customers, if our current customers cancel or put on hold DSL programs utilizing
our technology, or if our customers do not successfully market and sell chipsets
or products incorporating our technology.
 
 There
Has Been and May Continue to be a Cyclical Demand for DSL Chipsets, and There is
Intense Competition for DSL Chipsets, Which Has Caused Our Royalty Revenue to
Decline
 
 The
royalties we receive are influenced by many of the risks faced by the DSL market
in general, including cyclical demand which may result in reduced average
selling prices (“ASPs”) for DSL chipsets during periods of surplus.  In the
past, the DSL industry has experienced an oversupply of DSL chipsets, central
office or customer premises equipment.  Excessive inventory levels led
to soft chipset demand, which in turn led to declining ASPs.  ASPs have
also been under pressure because of intense competition in the DSL chipset
marketplace. As a result of the soft demand and declining ASPs for ADSL
chipsets, our royalty revenue has decreased substantially from the levels we
achieved in 2000. Price decreases for ADSL or VDSL chipsets, and the
corresponding decreases in per unit royalties received by us, can be sudden and
dramatic.  Pricing pressures may continue during 2008 and beyond.  Our
royalty revenue may decline over the long term.
 
 The
Success of Our DSL Licensing Business Requires Acceptance of Our Technology by
Equipment Companies
 
 The
success of our DSL licensing business is dependent on our ability to generate
meaningful royalties from our licensing arrangements with semiconductor
manufacturers.  Our ability to generate such royalties is materially
affected by the willingness of equipment companies to purchase integrated
circuits that incorporate our technology from our customers.  There
are other competitive solutions available for equipment companies seeking to
offer broadband communications products.  We face the risk that
equipment manufacturers will choose those alternative solutions. Generally, our
ability to influence equipment companies’ decisions whether to purchase
integrated circuits that incorporate our technology is limited.
  20
 We also
face the risk that equipment companies that elect to use integrated circuits
that incorporate our technology into their products will not compete
successfully against other equipment companies.  Many factors beyond
our control could influence the success or failure of a particular equipment
company that uses integrated circuits based on our technology. Even if equipment
companies incorporate chipsets based on our intellectual property into their
products, their products may not achieve commercial acceptance or result in
meaningful royalties to us.
 
 The
Success of Our DSL Licensing Business Requires Telephone Companies to Install
DSL Service in Volume
 
 The
success of our DSL licensing business depends upon telephone companies
installing DSL service in significant volumes.  If telephone companies
do not install DSL service in significant volumes, or if telephone companies
install broadband service based on other technologies such as cable or
fiber-to-the-home, our DSL licensing business will be seriously
harmed.
 
 The
Success of Our DSL Test and Diagnostic Products Depends On a Number of
Factors
 
 Our
success in developing, introducing, selling, and supporting new and enhanced
test and diagnostic products depends upon a variety of factors, including timely
and efficient completion of hardware and software design and development,
implementation of manufacturing processes, and effective sales, marketing, and
customer service.  Because of the complexity of our test and
diagnostic products, significant delays may occur between a hardware product's
initial introduction and commencement of volume production. If we are
unsuccessful in developing, introducing, selling and supporting new and enhanced
test and diagnostic products, our DSL test and diagnostic business could be
seriously harmed.
 
 If
Our Test and Diagnostic Hardware and Software Products Have Quality Problems,
Our Business Could Be Harmed
 
 If our
test and diagnostic products have actual or perceived reliability, quality,
functionality or other problems, we may suffer reduced orders, higher
manufacturing costs, inability to recognize revenue, delays in collecting
accounts receivable and higher service, support and warranty expenses or
inventory write-offs, among other effects. We believe that the acceptance,
volume production, timely delivery and customer satisfaction of our test and
diagnostic products is important to our future financial results. As a result,
any inability to correct any technical, reliability, parts shortages or other
difficulties or to manufacture and ship our test and diagnostic products on a
timely basis meeting customer requirements could damage our relationships and
reputation with current and prospective customers, which would harm our revenues
and operating results.
  21
 We
are Dependent On a Single Source Contract Manufacturer for the Manufacture of
Our DSL Hardware Products, the Loss of Which Would Harm Our
Business
 
 We
currently depend on one contract manufacturer to manufacture our DSL hardware
products. If this company was to terminate its arrangement with us or fail to
provide the required capacity and quality on a timely basis, we would be unable
to manufacture our products until replacement contract manufacturing services
could be obtained. To qualify a new contract manufacturer, familiarize it with
our products, quality standards and other requirements, and commence production
is a costly and time-consuming process. We cannot assure you that we would be
able to establish alternative manufacturing relationships on acceptable
terms.  Although we make reasonable efforts to ensure that our
contract manufacturer performs to our standards, our reliance on a single source
limits our control over quality assurance and delivery schedules. Defects in
workmanship, unacceptable yields, and manufacturing disruptions and difficulties
may impair our ability to manage inventory and cause delays in shipments and
cancellation of orders that may adversely affect our relationships with current
and prospective customers.  As a result, our revenues and operating results
may be harmed.
 
 Our
Manufacturing Systems May Not Be Adequate For Our DSL Test and Diagnostics
Hardware Product Offerings
 
 Our
current manufacturing systems adequately address hardware products we are
currently manufacturing in limited volumes.  Our manufacturing systems have
not been extensively tested under anticipated, more complex hardware products or
in volumes higher than that of our current hardware products.  If our
manufacturing systems are inadequate or have other problems, our revenues and
operating results may be harmed.
 
 We
are Dependent on Single Source Suppliers for Components in Our DSL Hardware
Products
 
 We rely
on single source suppliers for components and materials used in our DSL hardware
products. Our dependence on single source suppliers involves several risks,
including limited control over pricing, availability, quality and delivery
schedules. Any delays in delivery of such components or shortages of such
components could cause delays in the shipment of our products, which could
significantly harm our business. Because of our reliance on these vendors, we
may also be subject to increases in component costs. These increases could
significantly harm our business. If any one or more of our single source
suppliers cease to provide us with sufficient quantities of our components in a
timely manner or on terms acceptable to us, we would have to seek alternative
sources of supply. We could incur delays while we locate and engage alternative
qualified suppliers and we might be unable to engage alternative suppliers on
favorable terms. We could incur substantial hardware and software redesign costs
if we are required to replace the components.  Any such disruption or
increased expenses could harm our commercialization efforts and adversely affect
our ability to generate revenues.
 
 Biometrics
Business Risks
 
 Our
biometrics business is subject to a variety of additional risks, which could
materially adversely affect quarterly and annual revenue and operating results,
including:
 
 ●
              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 our
technology;
  22
  ●
              failures
      or problems in our biometric software products;●
              the
      risk that current or potential customers might decide to develop their own
      software rather than buy it from us;●
              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.
 
 We
Must Make Judgments in the Process of Preparing Our Financial
Statements
 
 We
prepare our financial statements in accordance with generally accepted
accounting principles and certain critical accounting polices that are relevant
to our business.  The application of these principles and policies
requires us to make significant judgments and estimates.  In the event
that judgments and estimates we make are incorrect, we may have to change them,
which could materially affect our financial position and results of
operations.
 
 Moreover,
accounting standards have been subject to rapid change and evolving
interpretations by accounting standards setting organizations over the past few
years.  The implementation of new standards requires us to interpret
and apply them appropriately.  If our current interpretations or
applications are later found to be incorrect, our financial position and results
of operations could be materially affected.
 
 If
We are Unable to Maintain Effective Internal Controls Over Financial Reporting,
Investors Could Lose Confidence In The Reliability of Our Financial Statements,
Which Could Result In a Decline in the Price of Our Common Stock
 
 As a
public company, we are required to enhance and test our financial, internal and
management control systems to meet obligations imposed by the Sarbanes-Oxley Act
of 2002. Consistent with the Sarbanes-Oxley Act and the rules and
regulations of the SEC, management's assessment of our internal controls over
financial reporting and the audit opinion of our independent registered
accounting firm as to the effectiveness of our controls is required in
connection with our filing of our Annual Report on Form 10-K. If we are unable
to timely identify, implement and conclude that we have effective internal
controls over financial reporting or if our independent auditors are unable to
conclude 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. Our
assessment of our internal controls over financial reporting may also uncover
weaknesses or other issues with these controls that could also result in adverse
investor reaction.
 
 23
 
 Our
Stock Price May Be Extremely Volatile
 
 Volatility
in our stock price may negatively affect the price you may receive for your
shares of common stock and increases the risk that we could be the subject of
costly securities litigation.  The market price of our common stock
has fluctuated substantially and could continue to fluctuate based on a variety
of factors, including:
 
 ●
              quarterly
      fluctuations in our operating results;●
              changes
      in future financial guidance that we may provide to investors and public
      market analysts;●
              changes
      in our relationships with our customers;●
              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 afford them;●
              changes
      in earnings estimates by public market analysts;●
              key
      personnel losses;●
              sales
      of our common stock; and●
              developments
      or announcements with respect to industry standards, patents or
      proprietary rights.
 
 In
addition, the equity markets have experienced volatility that has particularly
affected the market prices of equity securities of many high technology
companies and that often has been unrelated or disproportionate to the operating
performance of such companies. These broad market fluctuations may adversely
affect the market price of our common stock.
 
 Our
Business May Be Affected by Government Regulations
 
 The
extensive regulation of the telecommunications industry by federal, state and
foreign regulatory agencies, including the Federal Communications Commission,
and various state public utility and service commissions, could affect us
through the effects of such regulation on our customers and their
customers.  In addition, our business may also be affected by the
imposition of certain tariffs, duties and other import restrictions on
components that our customers obtain from non-domestic suppliers or by the
imposition of export restrictions on products sold internationally and
incorporating our technology.  Changes in current or future laws or
regulations, in the United States or elsewhere, could seriously harm our
business.
 
 24
 
 ITEM
2:
 Unregistered
Sales of Equity Securities and Use of Proceeds
 
 Issuer
Purchases of Equity Securities
 
 Period
              
              (a)
                Total
      Number of
                Shares
      Purchased
              
              (b)
                Average
      Price
                Paid
      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 BePurchased
                Under
      the Plans
                or
      ProgramsJanuary
      1, 2008, to March 31, 2008
              
              -
              
              -
              
              -
              
              $4,961,830
 
 (1) On
August 28, 2007, we issued a press release announcing that our board of
directors had approved the repurchase from time to time through December 31,
2008 of up to $5,000,000 of our common stock. During 2007, we purchased 9,107
shares authorized under this plan.  During the first quarter of 2008,
we made no repurchases under this plan.
  25
  ITEM
6:
 Exhibits
 
 
 (a)  Exhibits
 
 
 Exhibit
      31.1
              Certification
      of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002.Exhibit
      31.2
              Certification
      of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002.Exhibit
      32.1
              Certification
      of Chief Executive Officer and Chief Financial Officer pursuant to Section
      906 of the Sarbanes-Oxley Act of
2002.
 
 ____________________
 
  
 SIGNATURES
 
 
 Pursuant to the requirements of the
Securities Exchange Act of 1934, the Registrant has duly caused this report to
be signed on its behalf by the undersigned thereunto duly
authorized.
 
 
 AWARE,
      INC.Date:
      May 9, 2008
              
              By:
              /s/ Michael A. TzannesMichael
      A. Tzannes, Chief Executive OfficerDate:
      May 9, 2008
              
              By:
              /s/ Richard P. MobergRichard
      P. Moberg,   Chief FinancialOfficer  (Principal
      Financial andAccounting
      Officer)








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