<PAGE>


================================================================================

                                  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 SEPTEMBER 30, 2006

                        COMMISSION FILE NUMBER 000-21129


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


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


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

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


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

Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):

   Large Accelerated Filer    Accelerated Filer X   Non-Accelerated Filer
                          ---                  ----                      ---

Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). YES   NO  X
                                    ---   ---

Indicate the number of shares outstanding of the issuer's common stock as of
November 6, 2006:

            CLASS                                 NUMBER OF SHARES OUTSTANDING
            -----                                 ----------------------------
Common Stock, par value $0.01 per share                     23,569,937

================================================================================

<PAGE>

                                   AWARE, INC.
                                    FORM 10-Q
                    FOR THE QUARTER ENDED SEPTEMBER 30, 2006

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

Item 1.  Consolidated Financial Statements

         Consolidated Balance Sheets as of
         September 30, 2006 and December 31, 2005.......................... 3

         Consolidated Statements of Operations for the
         Three and Nine Months Ended September 30, 2006
         and September 30, 2005............................................ 4

         Consolidated Statements of Cash Flows for the
         Nine Months Ended September 30, 2006
         and September 30, 2005............................................ 5

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

Item 2.  Management's Discussion and Analysis of Financial
         Condition and Results of Operations............................... 13

Item 3.  Quantitative and Qualitative Disclosures about
         Market Risk....................................................... 18

Item 4.  Controls and Procedures........................................... 19

PART II  OTHER INFORMATION

Item 1.  Legal Proceedings................................................. 19

Item 1A. Risk Factors...................................................... 19

Item 6.  Exhibits ......................................................... 28

         Signatures........................................................ 28

                                       2

<PAGE>



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

                                                                           SEPTEMBER 30,  DECEMBER 31,
                                                                               2006          2005
                                                                             --------      --------
                                                 ASSETS
<S>                                                                          <C>           <C>
Current assets:
     Cash and cash equivalents .........................................     $ 12,679      $ 13,068
     Short-term investments ............................................       22,497        23,695
     Accounts receivable, net ..........................................        5,855         3,749
     Inventories .......................................................          752            86
     Prepaid expenses and other current assets .........................          748           764
                                                                             --------      --------
           Total current assets ........................................       42,531        41,362
                                                                             --------      --------

Property and equipment, net ............................................        7,934         8,075
Investments ............................................................        2,484             -
Other assets, net ......................................................          254           304
                                                                             --------      --------
           Total assets ................................................     $ 53,203      $ 49,741
                                                                             ========      ========

                      LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
     Accounts payable ..................................................     $    456      $    607
     Accrued expenses ..................................................          302           159
     Accrued compensation ..............................................        1,150           722
     Accrued professional ..............................................          209           212
     Deferred revenue ..................................................          758           538
                                                                             --------      --------
             Total current liabilities .................................        2,875         2,238
                                                                             --------      --------

Long-term deferred revenue .............................................          330             -

Stockholders' equity:
      Preferred stock, $1.00 par value; 1,000,000 shares authorized,
             none outstanding ..........................................            -             -
      Common stock, $.01 par value; 70,000,000 shares authorized; issued
             and outstanding, 23,569,937 in 2006 and 23,281,575 in 2005           236           233
      Additional paid-in capital .......................................       81,434        79,093
      Accumulated deficit ..............................................      (31,672)      (31,823)
                                                                             --------      --------
             Total stockholders' equity ................................       49,998        47,503
                                                                             --------      --------

             Total liabilities and stockholders' equity ................     $ 53,203      $ 49,741
                                                                             ========      ========


The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>

                                       3

<PAGE>


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

                                                     THREE MONTHS ENDED          NINE MONTHS ENDED
                                                        SEPTEMBER 30,              SEPTEMBER 30,
                                                    ---------------------     ----------------------
                                                      2006         2005         2006          2005
                                                    --------     --------     --------      --------
<S>                                                 <C>          <C>          <C>           <C>
Revenue:
    Product sales .............................     $  1,736     $  2,417     $  4,973      $  4,163
    Contract revenue ..........................        3,990        1,920        9,924         5,061
    Royalties .................................          956          750        2,710         2,770
                                                    --------     --------     --------      --------
     Total revenue ............................        6,682        5,087       17,607        11,994

Costs and expenses:
    Cost of product sales .....................          286          157          615           279
    Cost of contract revenue ..................        1,363          826        3,759         2,384
    Research and development ..................        2,726        2,487        8,646         7,400
    Selling and marketing .....................          784          721        2,518         2,064
    General and administrative ................          843          644        2,930         1,940
                                                    --------     --------     --------      --------
     Total costs and expenses .................        6,002        4,835       18,468        14,067

Income/(loss) from operations .................          680          252         (861)       (2,073)
Interest income ...............................          490          309        1,342           798
                                                    --------     --------     --------      --------

Income/(loss) before provision for income taxes        1,170          561          481        (1,275)
Provision for income taxes ....................          330            -          330             -
                                                    --------     --------     --------      --------

Net income/(loss) .............................     $    840     $    561     $    151      ($ 1,275)
                                                    ========     ========     ========      ========


Net income/(loss) per share - basic ...........     $   0.04     $   0.02     $   0.01      ($  0.06)
Net income/(loss) per share - diluted .........     $   0.03     $   0.02     $   0.01      ($  0.06)

Weighted average shares - basic ...............       23,552       23,116       23,433        23,027
Weighted average shares - diluted .............       24,987       25,168       24,976        23,027


         The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>

                                                  4

<PAGE>


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


<TABLE>
<CAPTION>

                                                                         NINE MONTHS ENDED
                                                                           SEPTEMBER 30,
                                                                      ----------------------
                                                                        2006          2005
                                                                      --------      --------
<S>                                                                   <C>           <C>
Cash flows from operating activities:
   Net income (loss) ............................................     $    151      ($ 1,275)
   Adjustments to reconcile net income (loss) to net cash
      provided by operating activities:
    Depreciation and amortization ...............................          491           460
    Stock-based compensation ....................................        1,694             -
      Increase (decrease) from changes in assets and liabilities:
         Accounts receivable ....................................       (2,106)         (536)
         Inventories ............................................         (666)           89
         Prepaid expenses .......................................           17          (239)
         Accounts payable .......................................         (151)           90
         Accrued expenses .......................................          567           389
         Deferred revenue .......................................          551           (10)
                                                                      --------      --------
            Net cash provided by (used in) operating activities .          548        (1,032)
                                                                      --------      --------

Cash flows from investing activities:
    Purchases of property and equipment .........................         (301)         (219)
    Other assets ................................................          -            (339)
    Sales of investments ........................................       14,031        20,028
    Purchases of investments ....................................      (15,316)      (13,388)
                                                                      --------      --------
            Net cash provided by (used in) investing activities .       (1,586)        6,082
                                                                      --------      --------

Cash flows from financing activities:
     Proceeds from issuance of common stock .....................          649           842
                                                                      --------      --------
            Net cash provided by financing activities ...........          649           842
                                                                      --------      --------

Increase (decrease) in cash and cash equivalents ................         (389)        5,892
Cash and cash equivalents, beginning of period ..................       13,068         7,482
                                                                      --------      --------

Cash and cash equivalents, end of period ........................     $ 12,679      $ 13,374
                                                                      ========      ========


    The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>

                                              5

<PAGE>




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


A)      BASIS OF PRESENTATION

        The accompanying unaudited consolidated balance sheet, statements of
        operations, and statements of cash flows reflect all adjustments
        (consisting only of normal recurring items) which are, in the opinion of
        management, necessary for a fair presentation of financial position at
        September 30, 2006, and of operations and cash flows for the interim
        periods ended September 30, 2006 and 2005.

        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, 2005 in conjunction with our 2005 Annual Report on Form
        10-K.

        The results of operations for the interim period ended September 30,
        2006 are not necessarily indicative of the results to be expected for
        the year.


B)      INVENTORY

        Inventory consists primarily of the following (in thousands):

                                                     SEPTEMBER 30,  DECEMBER 31,
                                                        2006            2005
                                                     -----------    ----------
          Raw materials.............................    $752            $86
                                                     ===========    ==========


C)      COMPUTATION OF EARNINGS PER SHARE

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

                                       6

<PAGE>


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

                                                   THREE MONTHS ENDED        NINE MONTHS ENDED
                                                      SEPTEMBER 30,            SEPTEMBER 30,
                                                 ---------------------     ---------------------
                                                   2006         2005         2006         2005
                                                 --------     --------     --------     --------

<S>                                              <C>          <C>          <C>          <C>
Net income (loss) ..........................     $    840     $    561     $    151     ($ 1,275)

Weighted average common shares outstanding .       23,552       23,116       23,433       23,027
Additional dilutive common stock equivalents        1,435        2,052        1,543            -
                                                 --------     --------     --------     --------
Diluted shares outstanding .................       24,987       25,168       24,976       23,027
                                                 ========     ========     ========     ========

Net income (loss) per share - basic ........     $   0.04     $   0.02     $   0.01     ($  0.06)
Net income (loss) per share - diluted ......     $   0.03     $   0.02     $   0.01     ($  0.06)
</TABLE>


        For the nine month period ended September 30, 2005, potential common
        stock equivalents of 1,789,280 were not included in the per share
        calculation for diluted EPS, because we had net losses and the effect of
        their inclusion would be anti-dilutive. For the three month periods
        ended September 30, 2006 and 2005, options to purchase 2,441,742 and
        202,167 shares of common stock, respectively, were outstanding, but were
        not included in the computation of diluted EPS because the options'
        exercise prices were greater than the average market price of the common
        stock and thus would be anti-dilutive. For the nine month periods ended
        September 30, 2006 and 2005, options to purchase 2,415,492 and 1,876,167
        shares of common stock, respectively, were outstanding, but were not
        included in the computation of diluted EPS because the options' exercise
        prices were greater than the average market price of the common stock
        and thus would be anti-dilutive.


D)      STOCK-BASED COMPENSATION

        Effective January 1, 2006, the Company adopted the provisions of
        Statement of Financial Accounting Standards 123(R), "Share-Based
        Payment," ("SFAS 123(R)"), which establishes accounting for equity
        instruments exchanged for employee services. Under the provisions of
        SFAS 123(R), stock-based compensation cost is measured at the grant
        date, based on the fair value of the award, and is recognized as an
        expense over the employee's requisite service period (generally the
        vesting period of the equity award). Prior to January 1, 2006, the
        Company accounted for share-based compensation to employees in
        accordance with Accounting Principles Board Opinion No. 25, "Accounting
        for Stock Issued to Employees," ("APB 25") and related interpretations.
        The Company also followed the disclosure requirements of Statement of
        Financial Accounting Standards No. 123, "Accounting for Stock-Based
        Compensation" ("SFAS 123"). The Company elected to adopt the modified
        prospective transition method as provided by SFAS 123(R) and,
        accordingly, financial statement amounts for the prior periods presented
        in this Form 10-Q have not been restated to reflect the fair value
        method of expensing stock-based compensation.

        FIXED STOCK OPTION PLANS - We have three fixed option plans. Under the
        1990 Incentive and Nonstatutory Stock Option Plan ("1990 Plan"), we may
        grant incentive stock options or nonqualified stock options to our
        employees and directors for up to 2,873,002 shares of common stock.
        Under the 1996 Stock Option Plan ("1996 Plan"),

                                       7

<PAGE>


        we may grant incentive stock options or nonqualified stock options to
        our employees and directors for up to 6,100,000 shares of common stock.
        Under the 2001 Nonqualified Stock Plan ("2001 Plan"), we may grant
        nonqualified stock options or stock awards to our employees and
        directors for up to 8,000,000 shares of common stock. Under all three
        plans, options are granted at an exercise price as determined by the
        Board of Directors and have terms ranging from four to a maximum of ten
        years. Our options generally vest over three to five years, although we
        have granted options that are 50% or fully vested on the date of grant.
        As of September 30, 2006, there were 5,107,363 shares available for
        grant under the 2001 Plan, and no shares available under the 1990 and
        1996 Plans.

        During the three (3) months ended June 30, 2006, the Company awarded
        unrestricted stock to its employees under the 2001 Plan. Half of the
        award was distributed in the second quarter of 2006 and the remaining
        shares will be distributed in the fourth quarter of 2006 to eligible
        employees. In the second quarter of 2006, a total of 31,895 shares were
        distributed representing $189,000 of stock-based compensation expense.

        Employee Stock Purchase Plan - In June 1996, we adopted an Employee
        Stock Purchase Plan (the "ESPP Plan") under which eligible employees
        could purchase common stock at a price equal to 85% of the lower of the
        fair market value of the common stock at the beginning or end of each
        six-month offering period. On November 29, 2005 we amended the ESPP Plan
        to provide that eligible employees may purchase common stock at a price
        equal to 95% of the fair market value of the common stock as of the end
        of each six-month offering period. Participation in the ESPP Plan is
        limited to 6% of an employee's compensation, may be terminated at any
        time by the employee and automatically ends on termination of
        employment. A total of 350,000 shares of common stock have been reserved
        for issuance. As of September 30, 2006 there were 138,046 shares
        available for future issuance under the ESPP Plan. During the three
        months ended September 30, 2006, no common shares were issued under the
        ESPP Plan.

        The following table presents stock-based employee compensation expenses
        included in the Company's unaudited condensed consolidated statements of
        operations (in thousands):

                                          THREE MONTHS ENDED   NINE MONTHS ENDED
                                          SEPTEMBER 30, 2006  SEPTEMBER 30, 2006
                                          ------------------  ------------------

         Cost of product sales ..........         $    4             $   12
         Cost of contract revenue .......             13                 98
         Research and development .......            241                786
         Selling and marketing ..........             88                266
         General and administrative .....            106                532
                                          ------------------  ------------------
         Stock-based compensation expense         $  452             $1,694
                                          ==================  ==================


        As a result of adopting SFAS 123(R), the Company's net income for the
        three and nine months ended September 30, 2006 was lower by $452,000 and
        $1,694,000, respectively, than if it had continued to account for
        stock-based compensation under APB 25. Basic and diluted earnings per
        share for the three and nine months ended September 30, 2006 was also
        lower by $0.02 and $0.07, respectively, due to the adoption of SFAS
        123(R).

        The Company estimates the fair value of stock options using the
        Black-Scholes valuation model. This valuation model takes into account
        the exercise price of the award, as well

                                       8

<PAGE>


        as a variety of significant assumptions. These assumptions used to
        estimate the fair value of stock options include the expected term, the
        expected volatility of the Company's stock over the expected term, the
        risk-free interest rate over the expected term, and the Company's
        expected annual dividend yield. The Company believes that the valuation
        technique and the approach utilized to develop the underlying
        assumptions are appropriate in calculating the fair values of the
        Company's stock options granted in the three months ended September 30,
        2006. Estimates of fair value are not intended to predict actual future
        events or the value ultimately realized by persons who receive equity
        awards.

        Assumptions used to determine the fair value of options granted during
        the three and nine months ended September 30, 2006, using the
        Black-Scholes valuation model were:
<TABLE>
<CAPTION>

                                                     THREE MONTHS ENDED        NINE MONTHS ENDED
                                                     SEPTEMBER 30, 2006        SEPTEMBER 30, 2006
                                                   ----------------------   ----------------------

         <S>                                                  <C>                <C>
           Expected term(1)                                   4.75 years         3.25 - 6.25 years
           Expected volatility factor(2)                             64%                    64-67%
           Risk-free interest rate(3)                              4.84%                4.47-4.99%
           Expected annual dividend yield                             --                        --

</TABLE>


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

        (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.

        There is no stock-based compensation expense related to the Company's
        Employee Stock Purchase Plan because it is not considered a compensatory
        plan. The plan does not have a look-back feature, and has a minimal
        discount of 5% of the fair market value of the common stock as of the
        end of each six-month offering period.

        Prior to January 1, 2006, the Company accounted for stock-based
        compensation to employees in accordance with APB 25. The Company also
        had previously adopted the provisions of SFAS 123, which required
        disclosure only of stock-based compensation and its impact on net income
        (loss) and net income (loss) per share. The following table illustrates
        the effects on net income (loss) and net income (loss) per share for the
        three and nine months ended September 30, 2005 as if the Company had
        applied the fair value recognition provisions of SFAS 123 to stock-based
        employee awards (in thousands):

                                       9

<PAGE>

<TABLE>
<CAPTION>

                                                                THREE MONTHS ENDED      NINE MONTHS ENDED
                                                                SEPTEMBER 30, 2005     SEPTEMBER 30, 2005
                                                                ------------------     ------------------

<S>                                                                     <C>                   <C>
Net income (loss) as reported                                           $    561              $ (1,275)
Add: Stock-based employee compensation expense included in net
income (loss)
Less: Total stock-based employee compensation expense
determined under the fair value method                                      (593)               (9,042)
                                                                ------------------     ------------------
Pro forma net loss                                                      ($    32)             ($10,317)
                                                                ==================     ==================
Net income (loss) per share:
Basic and diluted -- as reported                                        $   0.02              ($  0.06)
Basic and diluted -- pro-forma                                          $   0.00              ($  0.45)
</TABLE>


        In determining the stock-based compensation expense to be disclosed
        under SFAS 123, the Company was required to estimate the fair value of
        stock awards granted to employees using the Black-Scholes valuation
        model. However, differences between the requirements of SFAS 123(R) and
        SFAS 123 resulted in a different set of assumptions determined by the
        Company to be used in its valuation model. Assumptions used to determine
        the fair value of options granted under SFAS 123 during the three and
        nine months ended September 30, 2005 were:

                                       THREE MONTHS ENDED      NINE MONTHS ENDED
                                       SEPTEMBER 30, 2005     SEPTEMBER 30, 2005
                                       ------------------     ------------------

          Expected term                           5 years               5 years
          Volatility                                  82%                82-87%
          Risk-free interest rate                   4.04%            3.87-4.04%
          Dividend yield                               --                    --


        The Company issues common stock from previously authorized but unissued
        shares to satisfy option exercises and purchases under the Company's
        Employee Stock Purchase Plan.

        A summary of the Company's stock option activity for the nine months
        ended September 30, 2006 is as follows:
<TABLE>
<CAPTION>

                                                                                              WEIGHTED
                                                                                              AVERAGE
                                                                                             REMAINING
                                                                             WEIGHTED       CONTRACTUAL
                                                           NUMBER OF          AVERAGE         TERM (IN
                                                            OPTIONS        EXERCISE PRICE      YEARS)
                                                      -------------------  --------------  --------------

      <S>                                                       <C>                <C>
       Outstanding, December 31, 2005                           6,284,606          $ 4.73
       Granted                                                    236,500            5.55
       Exercised                                                 (254,706)           3.01
       Cancelled                                                 (159,087)           6.77
                                                      -------------------  --------------
       Outstanding, September 30, 2006                          6,107,313           $4.78           7.22
                                                      ===================  ==============

       Exercisable at September 30, 2006                        5,670,567           $4.71           7.28
</TABLE>

        All options granted during the nine months ended September 30, 2006 and
        2005 were granted with exercise prices equal to the fair market value of
        the Company's common stock

                                       10

<PAGE>


        on the grant date and had weighted average grant date fair values of
        $3.02 and $4.22, respectively.

        At September 30, 2006, the aggregate intrinsic value of options
        outstanding and options exercisable was $29,200,000 and $26,695,000,
        respectively. The intrinsic value of a stock option is the amount by
        which the market value of the underlying stock exceeds the exercise
        price of the option.

        The aggregate intrinsic value of options exercised during the nine
        months ended September 30, 2006 was $710,000.

        The following table summarizes the stock options outstanding at
        September 30, 2006:

<TABLE>
<CAPTION>

                                            OPTIONS OUTSTANDING                     OPTIONS EXERCISABLE
                             -------------------------------------------------  --------------------------
                                                 WEIGHTED     WEIGHTED AVERAGE                   WEIGHTED
                                                  AVERAGE       REMAINING                        AVERAGE
          EXERCISE PRICE                         EXERCISE      CONTRACTUAL                       EXERCISE
          RANGE                NUMBER             PRICE       TERM (IN YEARS)    NUMBER            PRICE

          <S>    <C>          <C>               <C>                 <C>          <C>               <C>
          $0 to $5           3,628,146         $    3.18           7.21         3,595,300         $    3.17
          $5 to $10          2,390,500              6.10           7.39         1,986,600              6.13
          $10 to $20             2,417             12.75           0.64             2,417             12.75
          $20 to $30            16,750             20.38           4.05            16,750             20.38
          $30 to $40            45,000             33.56           2.71            45,000             33.56
          $40 to $50            14,500             44.02           3.46            14,500             44.02
          $50 to $70            10,000             58.06           3.01            10,000             58.06
                             ---------                                          ---------
                             6,107,313         $    4.78           7.22         5,670,567         $    4.71
                             =========                                          =========

</TABLE>

        At September 30, 2006, unrecognized compensation expense related to
        non-vested stock options was $1,117,000, which is expected to be
        recognized over a weighted average period of 2 years.



E)      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):
<TABLE>
<CAPTION>

                                                       THREE MONTHS ENDED             NINE MONTHS ENDED
                                                          SEPTEMBER 30,                 SEPTEMBER 30,
                                                   ----------------------------  ----------------------------
                                                       2006           2005           2006          2005
                                                   -------------  -------------  ------------- --------------

<S>                                                     <C>            <C>           <C>            <C>
  North America....................................     $3,396         $3,470        $10,604        $8,092
  Europe...........................................      1,223          1,598          4,892         3,621
  Rest of World....................................      2,063             19          2,111           281
                                                   -------------  -------------  ------------- --------------
                                                        $6,682         $5,087        $17,607       $11,994
                                                   =============  =============  ============= ==============
</TABLE>

F)      RECENT ACCOUNTING PRONOUNCEMENTS

        In July 2006, the Financial Accounting Standards Board ("FASB") issued
        Financial Accounting Standards Interpretation No. 48 ("FIN 48"),
        "Accounting for Uncertainty in

                                       11

<PAGE>


        Income Taxes." FIN 48 clarifies the accounting for uncertainty in income
        tax positions taken or expected to be taken in tax returns that effect
        amounts reported in a company's financial statements in accordance with
        FASB Statement No. 109, "Accounting for Income Taxes." FIN 48
        establishes a threshold condition that a tax position must meet for any
        part of the benefit of that position to be recognized in the financial
        statements. FIN 48 also provides guidance concerning derecognition,
        measurement, classification, interest and penalties and disclosure of
        tax positions. FIN 48 is effective for fiscal years beginning after
        December 15, 2006. The Company is currently analyzing the effects of FIN
        48.

        In May 2005, the FASB issued FASB Statement No. 154, "Accounting Changes
        and Error Corrections, a replacement of APB Opinion No. 20, Accounting
        Changes and FASB Statement No. 3, Reporting Accounting Changes in
        Interim Financial Statements" ("FAS 154"). FAS 154 provides guidance on
        the accounting for and reporting of accounting changes and error
        corrections. It establishes, unless impracticable, retrospective
        application as the required method for reporting a change in accounting
        principle in the absence of explicit transition requirements specific to
        the newly adopted accounting principle. FAS 154 also provides guidance
        for determining whether retrospective application of a change in
        accounting principle is impracticable and for reporting a change when
        retrospective application is impracticable. The provisions of this
        Statement are effective for accounting changes and corrections of errors
        made in fiscal periods beginning after December 15, 2005. The adoption
        of the provisions of FAS 154 is not expected to have a material impact
        on the Company's financial position or results of operations.

        In September 2006 the FASB issued Statement No. 157, FAIR VALUE
        MEASUREMENTS. The Statement provides guidance for using fair value to
        measure assets and liabilities. This Statement references fair value as
        the price that would be received to sell an asset or paid to transfer a
        liability in an orderly transaction between market participants in the
        market in which the reporting entity transacts. The Statement applies
        whenever other standards require (or permit) assets or liabilities to be
        measured at fair value. The Statement does not expand the use of fair
        value in any new circumstances. It is effective for financial statements
        issued for fiscal years beginning after November 15, 2007, and interim
        periods within those fiscal years. The adoption of SFAS No. 157 is not
        expected to have a material impact on our financial position, results of
        operations or cash flows.

        In September 2006, the Securities and Exchange Commission, or SEC, Staff
        issued Staff Accounting Bulletin No. 108 (SAB 108) addressing how the
        effects of prior-year uncorrected financial statement misstatements
        should be considered in current-year financial statements. SAB 108
        requires registrants to quantify misstatements using both balance-sheet
        and income-statement approaches and to evaluate whether either approach
        results in quantifying an error that is material in light of relative
        quantitative and qualitative factors. SAB 108 does not change the SEC
        staff's previous guidance in Staff Accounting Bulletin No. 99 on
        evaluating the materiality of misstatements.

        SAB 108 addresses the mechanics of correcting misstatements that include
        the effects from prior years. Additionally, SAB 108 requires registrants
        to apply the new guidance for the first time that it identifies material
        errors in existence at the beginning of the first fiscal year ending
        after November 15, 2006 by correcting those errors through a one-time
        cumulative effect adjustment to beginning-of-year retained earnings. We
        do not anticipate the adoption of SAB 108 to have a material effect on
        our financial position, results of operations or cash flows.

                                       12

<PAGE>


                                     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 include ADSL test and
development systems, modules, and modems. Software products consist of standard
off-the-shelf software products for biometric, medical imaging and digital
imaging applications, as well as DSL test and diagnostics software.

Product sales decreased 28% from $2.4 million in the third quarter of 2005 to
$1.7 million in the current year quarter. As a percentage of total revenue,
product sales decreased from 48% in the third quarter of 2005 to 26% in the
current year quarter. For the nine months ended September 30, product sales
increased 19% from $4.2 million in 2005 to $5.0 million in 2006. As a percentage
of total revenue, product sales decreased from 35% in the first nine months of
2005 to 28% in the corresponding period of 2006.

For the three month period, the dollar decrease was due to a $0.9 million
decrease in revenue from the sale of software products, offset by a $0.2 million
increase from the sale of hardware products. For the nine month period, the
dollar increase was due to a $0.3 million increase in revenue from the sale of
software products and a $0.5 million increase from the sale of hardware
products.

        CONTRACT REVENUE. Contract revenue consists of patent, license and
engineering service fees that we receive under customer agreements relating to
Aware's patents, Aware's DSL technology and Aware's DSL test and diagnostics
technology.

Contract revenue increased 108% from $1.9 million in the third quarter of 2005
to $4.0 million in the current year quarter. As a percentage of total revenue,
contract revenue increased from 38% in the third quarter of 2005 to 60% in the
current year quarter. The increase of $2.1 million was primarily due to patent
and license fees that we received under agreements with our customers including
a patent license agreement with a new customer.

                                       13

<PAGE>


For the nine months ended September 30, contract revenue increased 96% from $5.1
million in 2005 to $9.9 million in the current year. As a percentage of total
revenue, contract revenue increased from 42% in the first nine months of 2005 to
56% in the corresponding period of 2006. The dollar increase was due to $2.5
million recognized from the transfer of certain technology licenses as a result
of the acquisition of a customer's business, plus an increase of $2.3 million
due to patent and license fees that we received under agreements with our
customers, including a patent licensing agreement with a new customer.

While we believe that the transition to ADSL2plus and VDSL2 technology increases
the value proposition of our technology, some existing and prospective DSL
chipset licensees have continued to be reluctant to begin new development
projects given a difficult and uncertain environment in the semiconductor and
telecommunications industries, and intense ADSL chipset competition and falling
chipset prices. During the last several years, customers and potential customers
cautiously evaluated new chipset projects or delayed or cancelled projects in
the face of such conditions.

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

Royalties increased 27% from $0.8 million in the third quarter of 2005 to $1.0
million in the current year quarter. As a percentage of total revenue, royalties
decreased from 15% in the third quarter of 2005 to 14% in the current year
quarter. The dollar increase in royalty revenues was a result of increased
chipset sales by our customers. For the nine months ended September 30,
royalties decreased 2% from $2.8 million in 2005 to $2.7 million in the current
year. As a percentage of total revenue, royalties decreased from 23% in the
first nine months of 2005 to 15% in the corresponding period of 2006. The dollar
decrease in royalty revenues was due to lower royalties from DSL chipset
customers. The decrease in royalty as a percentage of total revenue is due to
the increase in both product sales and contract revenue.

Our royalty revenue comes predominantly from ADSL chipset sales by Ikanos
Communications, Inc. ("Ikanos"), and Infineon Technologies AG ("Infineon"). On
February 17, 2006, Analog Devices, Inc. ("ADI") sold its ADSL business relating
to Aware technology to Ikanos and Ikanos has replaced ADI as an Aware licensee.
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 ADSL2plus and VDSL2 will impact our
customers in the near term, how quickly sales of our customers' chipsets will
increase and whether such increases will continue to contribute meaningful
royalties to us.

        COST OF PRODUCT SALES. Since the cost of software product sales is
minimal, cost of product sales consists primarily of the cost of hardware
product sales. Cost of product sales increased 82% from $157,000 in the third
quarter of 2005 to $286,000 in the current year quarter. As a percentage of
product sales, cost of product sales increased from 7% in the third quarter of
2005 to 16% in the current year quarter. For the nine months ended September 30,
cost of product sales increased 120% from $279,000 in 2005 to $615,000 in 2006.
As a percentage of product sales, cost of product sales increased from 7% in the
first nine months of 2005 to 12% in the corresponding period of 2006.

The percentage and dollar increases were primarily due to an increase in
hardware manufacturing and period costs related to new hardware products. In
addition, $4,000 and $12,000 of the

                                       14

<PAGE>


current quarter and nine month period increases, respectively, were from
stock-based compensation expense. The resulting decrease in product margin was
primarily due to a larger proportion of new hardware sales in the product sales
revenue mix.

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

Cost of contract revenue increased 65% from $0.8 million in the third quarter of
2005 to $1.4 million in the current year quarter. As a percentage of contract
revenue, cost of contract revenue decreased from 43% in the third quarter of
2005 to 34% in the current year quarter. For the nine months ended September 30,
cost of contract revenue increased 58% from $2.4 million in 2005 to $3.8 million
in 2006. As a percentage of contract revenue, cost of contract revenue decreased
from 47% in the first nine months of 2005 to 38% in the corresponding period of
2006.

The dollar increase in cost of contract revenue was primarily due to more
customer projects in the three month and nine month periods of 2006 as compared
with 2005. Our cost of contract revenue is based on the level of effort we
expend on customer projects. Since the number of customer projects increased,
the cost of contract revenue increased as well. In addition, $13,000 and $98,000
of the current quarter and nine month period increases, respectively, were from
stock-based compensation expense.

        RESEARCH AND DEVELOPMENT EXPENSE. Research and development expense
consists primarily of compensation costs for engineers and expenses for
consultants, recruiting, supplies, equipment, depreciation and facilities
related to engineering projects to improve our broadband intellectual property
offerings, as well as our software and hardware product technology.

Research and development expense increased 10% from $2.5 million in the third
quarter of 2005 to $2.7 million in the current year quarter. As a percentage of
total revenue, research and development expense decreased from 49% in the third
quarter of 2005 to 41% in the current year quarter. For the nine months ended
September 30, research and development expense increased 17% from $7.4 million
in 2005 to $8.6 million in 2006. As a percentage of total revenue, research and
development expense decreased from 62% in the first nine months of 2005 to 48%
in the corresponding period of 2006.

For the three month and nine month periods, the dollar increase was $241,000 and
$786,000, respectively, of stock-based compensation expense, increased
compensation and fringe benefit cost, and increased patent legal fees. These
increases were partially offset by a shift of engineers to customer projects,
where spending is classified as cost of contract revenue. This shift occurred
because we had more customer projects in 2006 than in 2005.

Our research and development spending was principally focused on improving our
ADSL, ADSL2 and ADSL2plus StratiPHY2+(TM) technology and chips, developing and
improving our VDSL2 StratiPHY3 technology and chips, developing analog front-end
technology for DSL solutions, developing test and diagnostics hardware and
software and developing imaging and biometrics software.

        SELLING AND MARKETING EXPENSE. Selling and marketing expense consists
primarily of compensation costs for sales and marketing personnel, travel,
advertising and promotion,

                                       15

<PAGE>


recruiting, and facilities expense. Sales and marketing expense of $0.8 million
in the third quarter of 2006 increased 9% compared to $0.7 million in the
corresponding quarter of 2005. As a percentage of total revenue, sales and
marketing expense decreased from 14% in the third quarter of 2005 to 12% in the
current year quarter due to higher revenues. For the three month period, the
dollar increase was mainly attributable to stock-based compensation expense of
$88,000.

For the nine months ended September 30, selling and marketing expense of $2.5
million increased 22% from $2.1 million in 2005. As a percentage of total
revenue, selling and marketing expense decreased from 17% in the first nine
months of 2005 to 14% in the corresponding period of 2006. For the nine month
period, the dollar increase was mainly attributable to stock-based compensation
expense of $266,000 and other compensation expenses of $130,000.

        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 31% from $0.6 million in the third quarter
of 2005 to $0.8 million in the current year quarter. As a percentage of total
revenue, general and administrative expense decreased slightly and was
approximately 13% in both the third quarter of 2005 and in the current year
quarter. For the three month period, the dollar increase was mainly attributable
to stock-based compensation expense of $106,000 and other compensation expenses
of $54,000.

For the nine months ended September 30, general and administrative expense
increased 51% from $1.9 million in 2005 to $2.9 million in 2006. As a percentage
of total revenue, general and administrative expense remained relatively flat at
approximately 16% in the first nine months of 2005 and 2006. For the nine month
period, the dollar increase was mainly attributable to stock-based compensation
expense of $532,000, other compensation expenses of $266,000 and professional
fees of $53,000.

        INTEREST INCOME. Interest income increased 59% from $309,000 in the
third quarter of 2005 to $490,000 in the current year quarter. For the nine
months ended September 30, interest income increased 68% from $798,000 in 2005
to $1,342,000 in 2006. For the three and nine month periods, the dollar increase
was due to higher interest rates earned on our cash and investment balances.

        INCOME TAXES. We made no provision for income taxes in the first nine
months of 2005 and 2006 due to net losses incurred and the uncertainty of the
timing of profitability in future periods, except for taxes paid in non-U.S.
jurisdictions that assess a source withholding tax. 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 September 30, 2006, 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.

LIQUIDITY AND CAPITAL RESOURCES

At September 30, 2006, we had cash, cash equivalents, and short and long-term
investments of $37.7 million, which represents an increase of $0.9 million from
December 31, 2005. The increase was primarily due to $0.6 million of cash
provided by operations and $0.6 million of

                                       16

<PAGE>


proceeds from the exercise of employee stock options. These increases were
partially offset by capital expenditures of $0.3 million.

Cash provided by operations in the first nine months of 2006 was from the net
income of $0.2 million adjusted for non-cash items related to depreciation and
amortization of $0.5 million, stock-based compensation expense of $1.7 million
and working capital requirements of $1.8 million. Capital spending was primarily
related to the purchase of computer hardware and software, and laboratory
equipment used principally in engineering activities.

Cash used in operations in the first nine months of 2005 was primarily from
operating losses. Capital spending was primarily related to the purchase of
computer hardware and software, and laboratory equipment used principally in
engineering activities, as well as expenditures related to the purchase of
certain technology assets.

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 July 2006, the Financial Accounting Standards Board ("FASB") issued Financial
Accounting Standards Interpretation No. 48 ("FIN 48"), "Accounting for
Uncertainty in Income Taxes." FIN 48 clarifies the accounting for uncertainty in
income tax positions taken or expected to be taken in tax returns that effect
amounts reported in a company's financial statements in accordance with FASB
Statement No. 109, "Accounting for Income Taxes." FIN 48 establishes a threshold
condition that a tax position must meet for any part of the benefit of that
position to be recognized in the financial statements. FIN 48 also provides
guidance concerning derecognition, measurement, classification, interest and
penalties and disclosure of tax positions. FIN 48 is effective for fiscal years
beginning after December 15, 2006. The Company is currently analyzing the
effects of FIN 48.

In May 2005, the FASB issued FASB Statement No. 154, "Accounting Changes and
Error Corrections, a replacement of APB Opinion No. 20, Accounting Changes and
FASB Statement No. 3, Reporting Accounting Changes in Interim Financial
Statements" ("FAS 154"). FAS 154 provides guidance on the accounting for and
reporting of accounting changes and error corrections. It establishes, unless
impracticable, retrospective application as the required method for reporting a
change in accounting principle in the absence of explicit transition
requirements specific to the newly adopted accounting principle. FAS 154 also
provides guidance for determining whether retrospective application of a change
in accounting principle is impracticable and for reporting a change when
retrospective application is impracticable. The provisions of this Statement are
effective for accounting changes and corrections of errors made in fiscal
periods beginning after December 15, 2005. The adoption of the provisions of FAS
154 is not expected to have a material impact on the Company's financial
position or results of operations.

In September 2006 the FASB issued Statement No. 157, FAIR VALUE MEASUREMENTS.
The Statement provides guidance for using fair value to measure assets and
liabilities. This Statement references fair value as the price that would be
received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants in the market in which the reporting
entity transacts. The Statement applies whenever other standards require (or
permit) assets or liabilities to be measured at fair value. The Statement does
not expand the use of fair value in any new circumstances. It is effective for
financial statements issued for fiscal years

                                       17

<PAGE>


beginning after November 15, 2007, and interim periods within those fiscal
years. The adoption of SFAS No. 157 is not expected to have a material impact on
our financial position, results of operations or cash flows.

In September 2006, the Securities and Exchange Commission, or SEC, Staff issued
Staff Accounting Bulletin No. 108 (SAB 108) addressing how the effects of
prior-year uncorrected financial statement misstatements should be considered in
current-year financial statements. SAB 108 requires registrants to quantify
misstatements using both balance-sheet and income-statement approaches and to
evaluate whether either approach results in quantifying an error that is
material in light of relative quantitative and qualitative factors. SAB 108 does
not change the SEC staff's previous guidance in Staff Accounting Bulletin No. 99
on evaluating the materiality of misstatements.

SAB 108 addresses the mechanics of correcting misstatements that include the
effects from prior years. Additionally, SAB 108 requires registrants to apply
the new guidance for the first time that it identifies material errors in
existence at the beginning of the first fiscal year ending after November 15,
2006 by correcting those errors through a one-time cumulative effect adjustment
to beginning-of-year retained earnings. We do not anticipate the adoption of SAB
108 to have a material effect on our financial position, results of operations
or cash flows.


                                     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:

        o       Cash and cash equivalents, which consist of financial
                instruments with original maturities of three months or less;
                and
        o       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 September 30, 2006, we had $35.2 million in cash, cash
equivalents and short-term investments that matured in twelve months or less.
Due to the short duration of these financial instruments, we do not expect that
an increase in interest rates would result in any material loss to our
investment portfolio.

As of September 30, 2006, we had invested $2.5 million in long-term investments
that matured in one to three years. These long-term securities are invested in
high quality U.S. government securities. Despite the high quality of these
securities, they may be subject to interest rate risk. This means that if
interest rates increase, the principal amount of our investment would probably
decline. A large increase in interest rates may cause a material loss to our
long-term investments. The following table (dollars in thousands) presents
hypothetical changes in the fair value of our long-term investments at September
30, 2006. The modeling technique measures the change in fair value arising from
selected potential changes in interest rates. Movements in interest rates of
plus or minus 50 basis points (BP) and 100 BP reflect immediate hypothetical
shifts in the fair value of these investments.

                                       18

<PAGE>

<TABLE>
<CAPTION>

                                        VALUATION OF SECURITIES                        VALUATION OF SECURITIES
                                         GIVEN AN INTEREST RATE                        GIVER AN INTEREST RATE
                                              DECREASE OF             NO CHANGE               INCREASE OF
                                       -------------------------     IN INTEREST      -------------------------
Type of security                         (100BP)      (50 BP)           RATES             100 BP        50 BP
---------------------------------------------------------------------------------------------------------------
<S>                                      <C>         <C>               <C>                <C>          <C>
Long-term investments with
  maturities of one to three years...    $2,519      $2,501            $2,484             $2,448       $2,466

</TABLE>


                                     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.


                           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. Because our revenue components
fluctuate and are difficult to predict, and our expenses are largely independent
of revenues in any particular period, it is difficult for us to accurately
forecast revenues and profitability. When appropriate, we recognize contract
revenues ratably over the period during which we expect to deliver technology
and provide engineering services. While this means that contract revenues from
certain current agreements are generally predictable, changes can be introduced
by a reevaluation of the length of the development period, or by the termination
of a contract. The initial estimate of this period is subject to revision as the
product being developed under a contract nears completion, and a revision may
result in an increase or decrease to the quarterly revenue for that contract. In
addition, accurate prediction of revenues from new contracts or licensees is
difficult

                                       19

<PAGE>


because contract negotiation is a lengthy process, frequently spanning a year or
more, and the fiscal period in which a new license agreement will be entered
into, if at all, and the financial terms of such an agreement are difficult to
predict. Contract revenues also include fees for engineering services, which are
dependent upon the varying level of assistance desired by licensees and,
therefore, the revenue from these services is also difficult to predict.

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

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

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

As a result of these factors, we believe that period-to-period comparisons of
our revenue levels and operating results are not necessarily meaningful. You
should not rely on our quarterly revenue and operating results to predict our
future performance.

                                       20

<PAGE>


WE EXPERIENCED NET LOSSES

We had a net annual loss during 2001, 2002, 2003, 2004 and 2005, but have net
income for the first nine months of 2006. We may experience losses in the future
if:

        o       the semiconductor and telecommunications markets do not improve;
        o       our existing customers do not increase their revenues from sales
                of chipsets with our technology;
        o       new or existing customers do not choose to license our
                intellectual property for new chipset products; or
        o       new or existing customers do not choose to use our software or
                hardware products.



WE HAVE A UNIQUE BUSINESS MODEL

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

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

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

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

Our business could be seriously harmed if:

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


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

The royalties we receive are influenced by many of the risks faced by the ADSL
market in general, including reduced average selling prices ("ASPs") for ADSL
chipsets during periods of surplus. In 2000, 2001, and 2002, the ADSL industry
had experienced an oversupply of ADSL

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<PAGE>


chipsets and central office equipment. Excessive inventory levels led to soft
chipset demand, which in turn led to declining ASPs. ASPs have also been under
pressure because of intense competition in the ADSL chipset marketplace. As a
result of the soft demand and declining ASPs for ADSL chipsets, our royalty
revenue has decreased substantially from the levels we achieved in 2000. Price
decreases for ADSL or VDSL chipsets, and the corresponding decreases in per unit
royalties received by us, can be sudden and dramatic. Pricing pressures may
continue during the fourth quarter of 2006 and beyond. Our royalty revenue may
decline over the long term.


WE DEPEND SUBSTANTIALLY UPON A LIMITED NUMBER OF LICENSEES

There are a relatively limited number of semiconductor and equipment companies
to which we can license our broadband technology in a manner consistent with our
business model. If we fail to maintain relationships with our current licensees
or fail to establish a sufficient number of new licensing relationships, our
business could be seriously harmed. In addition, our prospective customers may
use their superior size and bargaining power to demand license terms that are
unfavorable to us and prospective customers may not elect to license from us.


WE DERIVE A SIGNIFICANT AMOUNT OF REVENUE FROM A SMALL NUMBER OF CUSTOMERS

In 2003, 2004 and 2005, we derived 27%, 28% and 20%, respectively, of our total
revenue from ADI and 20%, 28%, and 30% respectively, of our total revenue from
Infineon. ADI and Infineon have developed many generations of ADSL chipsets
based upon our technology. On February 17, 2006 ADI sold its ADSL business
relating to Aware technology to Ikanos Communications, Inc. ("Ikanos") and
Ikanos replaced ADI as an Aware licensee.

Our royalty revenue in the near term is highly dependent upon the respective
market share and pricing of Ikanos' and Infineon's ADSL chipsets. The ADSL
market has experienced significant price erosion, which has adversely affected
ADSL chipset revenues, which in turn has adversely affected our royalty revenue.
To the extent that Ikanos or Infineon lose market share or are unable to gain
market share, or experience further price erosion in their DSL chipsets, our
royalty revenue could decline.


OUR SUCCESS REQUIRES ACCEPTANCE OF OUR TECHNOLOGY BY EQUIPMENT COMPANIES

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

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

        o       competition from other businesses in the same industry;

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<PAGE>


        o       market acceptance of its products;
        o       its engineering, sales and marketing, and management
                capabilities;
        o       technical challenges of developing its products unrelated to our
                technology; and
        o       its financial and other resources.

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


OUR SUCCESS REQUIRES TELEPHONE COMPANIES TO INSTALL DSL SERVICE IN VOLUME

The success of our DSL licensing business depends upon telephone companies
installing DSL service in significant volumes. Factors that affect the volume
deployment of DSL service include:
        o       the desire of telephone companies to install ADSL or VDSL
                service, which is dependent on the development of a viable
                business model for ADSL or VDSL service, including the
                capability to market, sell, install and maintain the service;
        o       the pricing of ADSL or VDSL services by telephone companies;
        o       the success of internet protocol TV ("IPTV") and video over DSL
                as viable consumer service offerings;
        o       the transition by telephone companies to new ADSL technologies,
                such as ADSL2, ADSL2plus and VDSL2;
        o       the quality of telephone companies' networks;
        o       deployment by phone companies of fiber-to-the home or broadband
                wireless services;
        o       government regulations; and
        o       the willingness of residential telephone customers to demand DSL
                service in the face of competitive service offerings, such as
                cable modems, fiber-based service or broadband wireless access.

If telephone companies do not install DSL service in significant volumes, or if
telephone companies install broadband service based on other technology such as
cable or fiber-to-the-home, our business will be seriously harmed.


OUR INTELLECTUAL PROPERTY IS SUBJECT TO LIMITED PROTECTION

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

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

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<PAGE>


intellectual property as necessary, the steps we have taken may be inadequate to
prevent misappropriation.

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

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


OUR BUSINESS IS SUBJECT TO RAPID TECHNOLOGICAL CHANGE

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

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

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

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<PAGE>


WE FACE INTENSE COMPETITION FROM A WIDE RANGE OF COMPETITORS

Our success as an intellectual property supplier depends on the willingness and
ability of semiconductor manufacturers to design, build and sell integrated
circuits based on our intellectual property. The semiconductor industry is
intensely competitive and has been characterized by price erosion, rapid
technological change, short product life cycles, cyclical market patterns and
increasing foreign and domestic competition.

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

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

ADSL and VDSL services offered over copper telephone networks also compete with
alternative broadband transmission technologies that use the telephone network
as well as other network architectures. Alternative technologies for the
telephone network include several types of symmetric high speed DSL, including
HDSL, SDSL and G.SHDSL. Alternative technologies that use other network
architectures to provide high-speed data service include cable modems using
cable networks, wireless solutions using wireless networks, and optical
solutions using fiber optics technology. These alternative broadband
transmission technologies may be more successful than ADSL or VDSL and we may
not be able to participate in the markets involving these alternative
technologies.

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


BIOMETRICS BUSINESS RISKS

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

        o       market acceptance of our biometric technologies and products;
        o       changes in contracting practices of government or law
                enforcement agencies;
        o       the failure of the biometrics market to experience continued
                growth;
        o       announcements or introductions of new technologies or products
                or our competitors;

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<PAGE>


        o       delays or problems in the introduction or performance of
                enhancements or of future generations of our technology;
        o       failures or problems in our biometric software products;
        o       delays in the adoption of new industry biometric standards or
                changes in market perception of the value of new or existing
                standards;
        o       growth of proprietary biometric systems which do not conform to
                industry standards;
        o       competitive pressures resulting in lower software product
                revenues;
        o       personnel changes, particularly those involving engineering,
                technical and sales and marketing personnel;
        o       costs associated with protecting our intellectual property;
        o       litigation by third parties for alleged infringement of their
                proprietary rights;
        o       the potential that licensees could fail to make payments under
                their current contracts;
        o       regulatory developments; and
        o       general economic trends and other factors.

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

We prepare our financial statements in accordance with generally accepted
accounting principles and certain critical accounting polices that are relevant
to our business. The application of these principles and policies requires us to
make significant judgments and estimates. In the event that judgments and
estimates we make are incorrect, we may have to change them, which could
materially affect our financial position and results of operations. Moreover,
accounting standards have been subject to rapid change and evolving
interpretations by accounting standards setting organizations over the past few
years. The implementation of new standards requires us to interpret and apply
them appropriately. If our current interpretations or applications are later
found to be incorrect, our financial position and results of operations could be
materially affected.


OUR STOCK PRICE MAY BE EXTREMELY VOLATILE

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

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

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<PAGE>


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


OUR BUSINESS MAY BE AFFECTED BY GOVERNMENT REGULATIONS

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

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<PAGE>


                                     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: November 8, 2006            By: /s/ Michael A. Tzannes
                                               ----------------------
                                               Michael A. Tzannes, Chief
                                               Executive Officer


         Date: November 8, 2006            By: /s/ Keith E. Farris
                                               -------------------
                                               Keith E. Farris, Chief Financial
                                               Officer (Principal Financial and
                                               Accounting Officer)

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