<PAGE>   1



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

                                    FORM 10-K

              ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                         SECURITIES EXCHANGE ACT OF 1934

                   FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996

                        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)


                   ONE OAK PARK, BEDFORD, MASSACHUSETTS, 01730
                   -------------------------------------------
                    (Address of Principal Executive Offices)
                                   (Zip Code)

                                 (617) 276-4000
                                 --------------
              (Registrant's Telephone Number, Including Area Code)

        Securities registered pursuant to Section 12(b) of the Act: NONE
           Securities registered pursuant to Section 12(g) of the Act:
                     COMMON STOCK, PAR VALUE $.01 PER SHARE
                                (Title of class)


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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]

The aggregate market value of the voting stock held by non-affiliates of the
registrant as of February 28, 1997, based on the closing price of the Common
Stock on February 28, 1997 as reported on the Nasdaq National Market, was
approximately $134,917,832.

The number of shares outstanding of the registrant's common stock as of February
28, 1997 was 19,116,561.

                     DOCUMENTS INCORPORATED BY REFERENCE
  Portions of the registrant's definitive Proxy Statement to be delivered to
      shareholders in connection with the registrant's Annual Meeting of
         Shareholders to be held on May 21, 1997 are incorporated by
         reference into Part III of this Annual Report on Form 10-K.
================================================================================



<PAGE>   2


                                   AWARE, INC.
                                    FORM 10-K
                      FOR THE YEAR ENDED DECEMBER 31, 1996


                                TABLE OF CONTENTS


<TABLE>
<CAPTION>


                                                  PART I

<S>           <C>                                                                                   <C>

Item 1.       Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .   3

Item 2.       Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  15

Item 3.       Legal Proceedings  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  15

Item 4.       Submission of Matters to a Vote of Security Holders  . . . . . . . . . . . . . . . .  15


                                                  PART II


Item 5.       Market for Registrant's Common Equity and Related Stockholder Matters     . . . . . . 16

Item 6.       Selected Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

Item 7.       Management's Discussion and Analysis of Financial Condition and Results
              of Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

Item 8.       Financial Statements and Supplementary Data . . . . . . . . . . . . . . . . . . . . . 23

Item 9.       Changes in and Disagreements with Accountants on Accounting and Financial
              Disclosure  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37


                                                 PART III


Item 10.      Directors and Executive Officers of the Registrant . . . . . . . . . . . . . . . . .  38

Item 11.      Executive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  39

Item 12.      Security Ownership of Certain Beneficial Owners and Management . . . . . . . . . . .  39

Item 13.      Certain Relationships and Related Transactions . . . . . . . . . . . . . . . . . . .  39


                                                  PART IV


Item 14.      Exhibits, Financial Statement Schedule, and Reports on Form 8-K . . . . . . . . . . . 40

Signatures  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43

</TABLE>



                                       2



<PAGE>   3



                                     PART I



ITEM 1.  BUSINESS


                                     GENERAL

     Aware, Inc. (the "Company" or "Aware") was incorporated in Massachusetts in
1986. During its first seven years, the Company was engaged primarily in
research, specializing in wavelet mathematics applications, digital compression,
and telecommunications and channel modulation and coding. The Company holds
thirteen patents in areas related to wavelet mathematics, digital compression
and similar technologies. The Company's revenue during this period consisted
largely of research grants from agencies of the U.S. government and certain
commercial companies. In 1993, the Company began to shift its business from
contract research toward development of: (i) Asymmetric Digital Subscriber Line
("ADSL") and other broadband technologies, and (ii) image compression products.
Two principal lines of business emerged as a result of the decision to
commercialize the Company's core technology: telecommunications and image
compression.

     The Company's telecommunications products include software and hardware
interfaces that integrate ADSL and Hybrid Fiber Coaxial ("HFC") chipsets into
modems and other communications devices, and high speed ADSL Internet Access
Modems that incorporate the Company's proprietary technology and software. The
Company has co-developed chipsets incorporating the Company's technology with
Analog Devices, Inc. ("ADI"), a leading supplier of integrated circuits. ADI has
an exclusive license to manufacture and sell such chipsets for which the Company
receives royalty payments. The Company's broadband products are designed to
increase the speed of data communications over conventional copper telephone and
cable television networks. The Company believes that its products will enable
telephone companies ("telcos") and cable companies to utilize their installed
bases of dedicated copper lines and coaxial cable to provide both residential
and business customers with interactive data transmission at speeds much higher
than currently available.

     The Company's image compression products include WSQ by Aware, AccuPress
for Radiology, AccuPress for Remote Sensing, AccuPress for Multimedia, and
SeisPact. In addition, the Company's image compression organization continues to
perform some contract research for the U.S. government.

     The Company's executive offices are located at One Oak Park, Bedford,
Massachusetts, 01730, and its telephone number is (617) 276-4000.


                                       3



<PAGE>   4



                              PRODUCTS AND MARKETS

TELECOMMUNICATIONS
- ------------------

TELECOMMUNICATIONS MARKET

     With the rise of the Internet and World Wide Web, network service providers
are experiencing a fundamental shift in the type of communications traffic
transmitted over their networks. The existing network infrastructure of
twisted-pair copper wiring, which was originally designed to provide analog
voice service ("Plain Old Telephone Service" or "POTS" ), and coaxial cable,
which was designed to provide cable television service, are increasingly
required to carry large amounts of data produced by computers. Service providers
are faced with the challenge of providing high-speed data communications at
reasonable costs, while preserving their investment in copper wire and coaxial
cable networks.

     Copper wire telephone networks are estimated to include over 150 million
lines in the United States and over 600 million lines worldwide, according to
industry sources. These networks represent an undepreciated capital investment
of approximately $100 billion. Cable television service is currently available
to ninety percent of the homes in the U.S. and sixty-five percent of the homes
in the U.S. subscribe to the service.

     To date, telcos' copper wire and cable companies' HFC infrastructures have
not proven adequate for the increasing volume of traffic generated by computers
remotely connected to each other and the Internet. Digital information requires
more bandwidth than traditional analog voice communications if it is to be
transmitted at a speed that is satisfactory to the computer user. Currently, the
fastest transmission rate readily available to typical home or remote office
computer users over existing copper wire is achieved through the use of a 33.6
kilobits per second ("Kbps") modem, although many users still employ modems that
are slower than this. For the over 30 million and growing Internet users, these
transmission rates are one of the chief frustrations of using the World Wide
Web, which is the fastest growing and most data intensive segment of the
Internet.

     Service providers, recognizing the need for higher speed data
communications, are increasingly seeking to upgrade their networks. The telcos
are replacing copper wire with fiber optic cable, which permits high speed data
transmissions, particularly through the backbone of the network that links their
central offices to one another. However, installing fiber optic cable all the
way into customers' homes or businesses is prohibitively expensive and would
take decades. Similarly, cable companies are testing cable modems, which permit
two-way data transmissions over their existing HFC networks.

     Telcos are seeking cost-effective technologies to accommodate high speed
data transmission over copper wires. Some of these technologies are described
below:

          ISDN. In the early 1980's, telcos introduced Integrated Service
          Digital Network ("ISDN") technology, which provides digital
          transmission over copper wire typically at basic rates up to 144 Kbps.
          Although this technology is several times faster than a voiceband
          modem, the market penetration of existing ISDN technology is limited
          because its equipment and installation costs are relatively high, and
          it does not allow simultaneous POTS and data transmission on those
          wires.

          T-1. T-1 (E-1 in countries outside the U.S.) is a multiplexing format
          that allows digital conversion of an analog line. Once converted, a
          T-1 digital line can deliver data at speeds up to 1.544 megabits per
          second ("Mbps"). However, T-1 service cannot use the existing copper


                                       4

<PAGE>   5



          wire networks without expensive and time-consuming modifications,
          including installation of repeaters every 3,000 to 5,000 feet to
          regenerate the signal as it passes along the line. T-1 also requires
          two sets of twisted-pair copper wires and does not allow simultaneous
          POTS and data transmission on those wires.

          HDSL. In 1992, telcos introduced High bit-rate Digital Subscriber Line
          ("HDSL") technology, which reduces the cost of installing T-1 service.
          HDSL increases the distance of T-1 transmission over copper wires to
          approximately 12,000 feet, which reduces the need for repeaters. As a
          result, some telcos are deploying HDSL technology in their local
          access networks. However, HDSL still requires two sets of twisted-pair
          copper wires and does not allow simultaneous POTS and data
          transmission on those wires.

          ADSL. Telcos are currently considering deployment of ADSL technology,
          which uses digital signal processing technology to expand the useable
          bandwidth of copper telephone wire. ADSL was initially created in the
          late 1980s by Bellcore, the research entity jointly created and funded
          by the Regional Bell Operating Companies ("RBOCs"). ADSL technology
          allows non-repeated transmissions of data at a distance of up to
          18,000 feet over telcos' existing copper networks at a rate of up to 8
          Mbps downstream to the customer and at a rate of up to 640 Kbps
          upstream from the customer, with the speed of transmission decreasing
          as distance increases. ADSL allows simultaneous POTS and high speed
          digital data transmission on a single set of twisted-pair copper
          wires.

     In addition to these telco technologies, cable company suppliers are
working to improve HFC technology, which would permit two-way broadband digital
communications over typical cable networks. HFC technology uses digital signal
processing to allow efficient sharing of upstream bandwidth so that a cable line
can be used for two-way transmissions. New HFC networks are also being installed
by telcos so that they can offer television service as well as telephone and
data dial-tone services.

     Telcos typically put new products through a rigorous approval process
before deploying them on a broad basis. The approval process usually involves a
number of different phases, including (i) laboratory evaluations, in which the
product is tested against relevant industry standards; (ii) technical trials, in
which the product is tested in the field with a small number of users; (iii)
marketing trials, in which the product is tested in the field with a larger
number of users and telcos begin to train their personnel to install and
maintain the product; (iv) initial commercial deployment, in which telcos make
the product available to selected customers for selected applications; and (v)
commercial deployment, in which telcos make the product available to a
substantial number of customers.

     During 1996, a number of telcos performed laboratory and technical trials,
in which they evaluated and tested the Company's, as well as competitors', ADSL
products. The Company believes the telcos' trial experience provided them with
evidence that ADSL technology is capable of delivering high-speed data
transmissions rates. This knowledge coupled with rapidly dropping equipment
prices may have obviated the need for many of the marketing trials the Company
and others had anticipated. The Company now believes the telcos will commence
commercial ADSL deployment in late 1997 and that such deployment will continue
into 1998.

TELECOMMUNICATIONS PRODUCTS

     The Company designs and develops products utilizing its proprietary
software to implement ADSL that it believes have advantages over its
competitors' ADSL products. The ASDL products developed by Aware incorporate
proprietary software and algorithms based on digital signal processing
technology as


                                       5



<PAGE>   6


well as application specific integrated circuits (ASICs). In contrast to the
approach taken by some competing developers of ADSL technology, Aware's approach
is to maintain a high level of functionality in the software component of the
product as opposed to the ASIC. The Company believes that this approach allows
it to engineer improvements in its technology quickly and efficiently, rather
than having to design and produce a new ASIC each time an improvement is made.
The Company's ADSL technology enables data communications protocols, such as
Frame Relay, TCP/IP, and ATM, to operate at higher transmission rates over
copper wire. The Company has chosen to use the multi-carrier Discrete Multi-Tone
("DMT") modulation for ADSL, rather than the single-carrier Carrierless
Amplitude Phase ("CAP") modulation technique. The Company believes that ADSL/DMT
technology has greater potential for deployment than CAP, because (i) DMT is
more flexible, (ii) the standardization process for DMT is more advanced, and
(iii) there are multiple vendors who supply DMT as opposed to CAP which is
offered by one vendor. (See Item 1. Business - TECHNOLOGY)

     Existing Telecommunications Products
     ------------------------------------

     Chipsets. The Company and ADI developed a first generation ADSL chipset,
which began shipping in November 1995. The chipset uses a combination of ASICs,
digital signal processors, and proprietary software developed by the Company to
provide all the functions necessary in a modem. The ADSL chipset meets the
performance objectives of the DMT multi-carrier modulation chosen by the
American National Standards Institute ("ANSI") as the standard for ADSL.

     In 1993 ADI and the Company entered into an agreement, under which ADI
produces and markets broadband chipsets incorporating the Company's DMT-based
ADSL technology, and for which the Company receives royalties and development
funding. The relationship between ADI and the Company is an exclusive
arrangement, under which neither party may enter into competing agreements with
third parties. The Company's ability to achieve its business objectives will
depend on ADI's ability and desire to deliver chipsets to the market place. (See

I
tem 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations - FACTORS THAT MAY AFFECT FUTURE RESULTS.)

     In 1994 and 1995, the Company and ADI entered into additional agreements to
expand their relationship to include the development and marketing of chipsets
incorporating the Company's Discrete Wavelet Multi-Tone ("DWMT") technology for
HFC and VDSL data communications. The Company also agreed that, if it develops
and sells ADSL technology that implements DWMT technology, it would license such
technology to ADI on substantially the same terms as those for the Company's
ADSL technology.

     Software and Hardware Interfaces. The Company develops software and
hardware interfaces for its ADSL chipset which can be used to connect the
chipset with PCs, network and central office equipment, and other telephony and
data communications devices. The interfaces are custom developed by the Company
for OEMs, who seek to incorporate the Company's ADSL technology into their
systems.

     Modems. The Company developed and markets an ADSL Internet Access Modem,
which contains the Company's ADSL chipset and software and hardware interfaces
developed by the Company. In a typical configuration, the Company's ADSL modem
is designed to receive data at speeds up to 4.4 Mbps and send it at speeds of up
to 440 Kbps at a distance of up to 12,000 feet over standard copper wire. This
modem was designed to demonstrate technical feasibility and will not be suitable
for mass production without additional redesign to reduce the power
requirements, size and costs of the modem.


                                       6



<PAGE>   7


Products Under Development
- --------------------------

     The Company is currently engaged in the following product development and
enhancement activities:

     Chipsets. The Company and ADI have announced a second generation ADSL
chipset, which the Company anticipates will begin shipping in production
quantities in the third quarter of 1997. While maintaining the same data
transmission speed, the second generation chipset contains the following
enhancements as compared to the first generation chipset: (i) the number of
chips in the core transceiver has been reduced from twelve to five; (ii) the
power requirement has been reduced from twelve to five watts, and (iii) the
dimensions of the core transceiver, DSP circuitry, and line driver circuitry
have been reduced from 7" by 9" to 3" by 5".

     The Company and ADI have announced that ADI expects to begin shipping an
HFC chipset, which is based upon the Company's DWMT technology, in June 1997.
This chipset is the first implementation of the Company's DWMT technology.

     Board-Level Products. The Company plans to design, manufacture and market
board-level products for installation into ADSL systems offered by OEMs. The
first such board-level product that the Company has announced is an ADSL module.
This module is a 3" by 5" transceiver card which will contain a second
generation ADSL chipset. The Company anticipates that its module will be
available in limited production quantities in the third quarter of 1997.

     Modems. The Company has announced and intends to begin shipping a rate
adaptive ADSL modem in the first quarter of 1997. In addition to rate
adaptability, this modem will contain a single board first generation chipset
design, an improved user interface, and improved diagnostic capabilities.

     Advanced ADSL, SDSL, VDSL, and HFC. The Company also intends to offer new
generations of advanced ADSL products, as well as chipsets, interfaces, modems,
boards and systems incorporating SDSL, VDSL, and HFC technology. (See Item 1.
Business - TECHNOLOGY.) The Company has not announced any such products other
than those described herein.


IMAGE COMPRESSION
- -----------------

     In 1993, the Company began an effort to produce commercially marketable
wavelet image compression software products. The Company currently offers five
software-based compression products and has an agreement with ADI to produce a
wavelet video compression ASIC. The Company's compression products include the
following: WSQ by Aware (which compresses digital fingerprint data for use by
law enforcement agencies, such as the FBI); AccuPress for Radiology (which is
used to compress digital radiographs and other types of medical imagery);
AccuPress for Multimedia (which is a general purpose compression product);
AccuPress for Remote Sensing (which is designed for compression of
satellite-based remote sensing imagery); and SeisPact (which companies in the
oil and gas industry can use to store and transmit large amounts of seismic
data).


                                       7



<PAGE>   8


                                   TECHNOLOGY

     The Company's core technology is based on its research into wavelet
mathematics and digital compression. From that core technology, three principal
technologies have emerged, including: (i) DMT-based ADSL technology, (ii) DWMT
technology, and (iii) image compression technology.

     ADSL Technology

     ADSL is a method for expanding the useable bandwidth of copper wire.
Typically, ADSL systems divide a one megahertz (MHz) bandwidth on copper wire
into three segments: (i) the 0 to 4 kilohertz (KHz) range is used for POTS, (ii)
the 25 KHz to 100 KHz range is used to transmit data upstream and (iii) the 100
KHz to 1 MHz range is used to transmit information downstream. The ANSI
specification for ADSL calls for operation rates of 1.5 to 8 Mbps downstream and
64 to 640 Kbps upstream when operating over existing copper wires at a distance
of up to 18,000 feet.

     There are two primary ADSL modulation techniques for transmitting data
signals: (i) DMT, which the Company uses, and (ii) CAP. DMT is a multi-carrier
modulation technique that was chosen by ANSI as the telecommunications industry
standard for ADSL. CAP is a single-carrier modulation technique originally
developed by AT&T Paradyne Corporation (now Globespan Technologies, Inc.). The
fundamental difference between CAP and DMT is that CAP treats each of the
upstream and downstream frequency ranges as a single element over which as many
information bits as possible are transmitted. In contrast, DMT divides the
upstream and downstream bands into groups of different smaller subchannel
frequency ranges (approximately 4 KHz each) into which a much smaller number of
bits are coded and transmitted simultaneously.

     The Company believes that DMT technology is better able than CAP technology
to address the inherent problems of the telcos' copper wire networks. Because of
its multiple small frequency bands, DMT is able to adjust and adapt the movement
of information to both extract more throughput from a wire and to avoid sending
information into frequency ranges that are not useable. Since CAP treats the
entire frequency range as a single element, it does not have the ability to
balance as easily the use of the frequency spectrum to match efficiently the
performance of a given wire. DMT-based systems have greater flexibility than
CAP-based systems, because DMT-based modems are better able to adapt and operate
to within 32 Kbps of the highest speed achievable on the link.


     DWMT Technology

     The Company has invented a proprietary technology based on wavelet
mathematics called DWMT. The Company believes that, as a result of its research
and development of DWMT technology, it is a leader in commercialization of
wavelets for telecommunications.

     Multi-carrier systems divide a frequency range into the desired number of
subchannels by using a digital filter bank, which is a mathematical process.
Because of basic limits of the form of mathematics and the limits of time and
computerization speeds, the process of creating isolated subchannels is
imperfect. These imperfections inhibit modems from achieving theoretical
performance limits. The subchannelization method used in creating DMT modems
utilized a technique called a Fourier transform. This technique has been used in
the telecommunications industry since the 1960s, but has become more practical
for high speed, high volume use as digital signal processors have improved. The
wavelet transform yields significantly better subchannelization than the Fourier
transform. Because this technique more closely approximates ideal
subchannelization, the performance of a wavelet-based


                                       8



<PAGE>   9



DWMT system can produce performance superior to a non-wavelet DMT system
operating in a noisy environment.

     The Company intends to apply DWMT technology to new products using SDSL,
VDSL and HFC applications. The Company is seeking to incorporate DWMT techniques
into industry standards body recommendations. The following is a brief
description of possible applications using SDSL, VDSL and HFC:

     SDSL. Symmetric Digital Subscriber Line technology is similar to ADSL, but
allows two-way data transmission at the same rates. The Company is developing an
SDSL application using its DWMT technology. SDSL provides up to 2 Mbps of data
in both directions on single twisted-pair copper wire at distances up to 18,000
feet while allowing simultaneous POTS. The Company expects that this SDSL
application can be used for LAN interconnecting and enhanced telephony
applications.

     VDSL. The Company believes that Very high-speed Digital Subscriber Line
technology will be the next generation of high-speed user access, critical to
the implementation of fiber-to-the-neighborhood and fiber-to-the-curb
architectures. These architectures involve the deployment of an access node that
utilizes fiber optic cable from a telco's central office to the access node,
thus bringing fiber closer to the user. The final connection to the user is new
or existing copper wire or new coaxial cable. VDSL is being designed with the
objective of providing performance up to six times faster than ADSL, but over a
shorter distance. The goal of VDSL is to enable telcos to provide a combination
of digital TV, data dial-tone and regular telephony service on a single
twisted-pair of copper wire. The Company is using DWMT to develop the upstream
portion of a VDSL system.

     HFC. By using the frequency band from 5 to 40 MHz for upstream transmission
and the frequency band from 450 to 750 MHz for downstream transmission, it is
possible to provide two-way services, such as telephony and data communications,
on existing HFC networks. Each of these frequency bands is typically divided
into smaller bands, 1 to 2 MHz wide. The Company's HFC technology, called
WaveTel HFC, is based upon DWMT and will provide up to 8 Mbps transmission over
a 2 MHz band. HFC telephony and cable modem technology enables cable companies
to re-use their existing network to provide two-way services.


     Image Compression Technology

     Since 1988, the Company has developed expertise, trade secrets, and
intellectual property in the field of wavelet transform-based data compression
and has obtained several patents in this area. The Company's wavelet compression
technology enables digital image, video and certain types of data to be
compressed to between 1% and 10% of their original size. Using wavelet
compression, the decompressed data are not bit for bit identical to the original
data. A risk with this technique is that, as the original data get smaller, a
larger amount of error is introduced into the decompressed data. However,
compressed data can be transmitted across networks faster and storage costs are
reduced.


                                       9



<PAGE>   10


                            RESEARCH AND DEVELOPMENT

     The Company believes that its future success depends on its ability to
adapt to the rapidly changing telecommunications environment and to meet its
customers' needs. The timely development and introduction of new products is
essential to maintain the Company's competitive position. The Company's product
development activities are focused on delivering products to its service
provider customers that will enable them to make maximum use of the capabilities
of their existing copper wire and coaxial cable networks. Key development
objectives include enhancements to the Company's ADSL technology as well as on
products incorporating DWMT technology for VDSL, SDSL, and HFC applications.

     Most of the Company's products are developed internally. As of December 31,
1996, the Company had a research and development staff of 35 employees,
including ten employees holding doctorate degrees related to digital signal
processing and digital communications theory. The Company anticipates that its
research and development organization will grow significantly in the future as
the Company attempts to strengthen its technology and product position in the
telecommunications marketplace.

     During the years ended December 31, 1996, 1995 and 1994, research and
development costs charged to operations were $3,234,799, $2,333,200, and
$3,492,249, respectively. Such costs are net of software development costs
capitalized in accordance with Statement of Financial Accounting Standards
("SFAS") No. 86. There were no SFAS 86 costs capitalized in 1996, 1995 or 1994.

     New product development schedules are difficult to predict, because
telecommunications product development, quality assurance testing and debugging
are complex processes that often take longer than expected. Accordingly,
although the Company estimates the shipment dates of proposed new products for
internal purposes, such estimates are subject to frequent adjustment based on
the Company's own periodic assessment of its progress in the development
process. No assurance can be given that any of the development projects referred
to in the "Products and Markets" section will be successful or that any
announced shipping dates for new products will be met.



                               SALES AND MARKETING

     To date, the Company's principal telecommunications sales and marketing
strategy has been to partner with OEM equipment suppliers. These OEM customers
manufacture and sell telephone network equipment, cable plant equipment, data
communications equipment, and end user customer premises equipment. The
Company's objective is to incorporate its technology and components into
products offered by its OEM customers. Examples of companies with whom the
Company has announced partnership agreements as of December 31, 1996, include
DSC Communications Corporation, Teltrend, Inc., Hayes Microcomputer Products,
Inc., PairGain Technologies, Inc., and RELTEC Corporation.

     Due to the complexity of the Company's telecommunications technology, the
Company's sales people must have a high degree of technical sophistication in
order to market its products effectively. The Company believes that technology
selections involving the Company's products are frequently made at senior levels
within a prospective customer's organization. Consequently, the Company relies
primarily on presentations by senior management to key employees of OEMs.

     This type of OEM selling does not require a large sales force, therefore as
of December 31, 1996, the Company had four people in its telecommunications
sales and marketing organization. As ADSL technologies are more broadly adopted,
the Company expects to hire additional sales and marketing


                                       10



<PAGE>   11


employees to support the efforts of senior management. Additional sales and
marketing employees will also be required to develop new channels of
distribution so that the Company may sell its products to non-OEM customers,
such as telcos, cable operators, Internet service providers, and competitive
access providers.

     The Company sells its software-based compression products through
distributors and directly to end user customers. As of December 31, 1996, there
were two people in the Company's compression software sales organization.

     The Company has in the past and expects in the future to derive a
substantial portion of its revenues from a limited number of customers. There
are relatively few OEM equipment suppliers, telcos and cable operators to whom
the Company can sell its products. Consequently, the Company's future success
will depend to a large extent upon: (i) the timing and size of future purchase
orders for the Company's products from these customers, (ii) the financial and
operating success of these customers, and (iii) the success of services offered
by these customers that use the Company's products. Any attempt by such
customers to seek out additional or alternative suppliers or to undertake the
internal development and sale of products comparable to those of the Company
could have a material adverse effect on the Company's business, financial
condition and results of operations. (See Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations - FACTORS THAT MAY
AFFECT FUTURE RESULTS.)

     The Company derived approximately 22%, 17%, 12%, and 10% of its total
revenue in 1996 from DSC Communications Corporation, ADI, the United States
government, and Teltrend, Inc., respectively. The Company derived approximately
23%, 18%, 12%, and 10% of its total revenue in 1995 from ADI, General Instrument
Corporation, the United States government, and GSS/Array Technology,
respectively. The Company derived approximately 38% and 10% of its total revenue
in 1994 from the United States government and ADI, respectively. Substantially
all revenue in 1996, 1995, and 1994 was sold to unaffiliated customers in North
America.


                                  MANUFACTURING

     The Company does its own final assembly and testing of its ADSL products at
its Bedford, Massachusetts facility. The Company believes that its manufacturing
capacity is relatively limited. A modest number of ADSL modems have been
manufactured to date. As demand for ADSL and other products increases, the
Company intends to rely on third party manufacturers as well as its internal
manufacturing capacity to assemble and test its products. The Company obtains
ADSL chipsets directly from ADI and other components needed for its ADSL
products from a variety of suppliers. The Company expects that third party
manufacturers will obtain product parts directly from the Company, and from
suppliers chosen by the Company or the third party manufacturer. Other than the
ADSL chipset, which is available through ADI, the Company believes that other
components for its ADSL products are available from a large number of suppliers
and that there exist many qualified manufacturers to assemble and test the
Company's products. (See Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations - FACTORS THAT MAY AFFECT FUTURE
RESULTS.)


                                       11



<PAGE>   12


                                   COMPETITION

     The markets for the Company's products are intensely competitive and the
Company expects competition to increase in the immediate future, especially in
the emerging ADSL market. The Company intends to compete on the basis of
technology, price, the timing of product delivery, product features, quality,
reliability, and customer satisfaction. The Company currently competes, or
expects to compete in the future, with the following categories of companies:
(i) other vendors of DMT-based ADSL technology, such as Amati Communications
Corporation ("Amati"), Orckit Communications Limited ("Orckit") and Alcatel
Network Systems, Inc. ("Alcatel"); (ii) vendors of alternative ADSL
technologies, such as Globespan Technologies, Inc. ("Globespan"), which is
currently marketing its CAP-based ADSL technology, (iii) Regional Bell Operating
Companies ("RBOCs") and other telcos, who are no longer prohibited from
manufacturing telecommunications equipment as a result of deregulation, and (iv)
OEMs and other systems integrators, such as Pairgain Technologies, Inc., U.S.
Robotics Corporation, Ericsson, Inc., and Motorola, Inc.

     The Company's success will depend on telcos' willingness to invest in
broadband digital services based on ADSL technology. The Company expects that
its ADSL products will compete not only with other products that increase the
efficiency of digital transmission technologies over copper wire, such as ISDN
for Internet access, but also with other broadband transmission technologies,
such as HFC, coaxial cable, fiber optic cable, digital broadcast satellite and
other wireless technologies. The Company believes its current and future
broadband products will permit telcos to upgrade their networks in a flexible
and cost effective way, but telcos may choose to deploy products using better
established technologies to upgrade their networks including fiber optic cable,
which many telcos favor. To the extent that telcos choose to install fiber optic
cable or other transmission media between central offices and end users, the
Company's business, financial condition and results of operations will be
materially adversely affected.

     The Company believes that, in the ADSL market, its DMT-based products are
more flexible and will enjoy greater potential for deployment than products
using the CAP technique. However, CAP-based ADSL products were introduced prior
to the Company's products and are more readily available than the Company's
products.

     To date, there has been only limited commercial deployment of the Company's
competitors' DMT-based ADSL products. Therefore, the Company is uncertain how
its products will compare with products sold by Amati and Orckit, each of whom
manufacture DMT-based ADSL products. Amati and Orckit have each made claims in
their sales literature and elsewhere suggesting that their products provide data
transmission rates that are equal to or faster than that of the Company's
products. However, there is no independent means by which the Company can
corroborate these claims.

     In the HFC market, the Company is attempting to sell its products to system
integrators such as Tellabs, Inc., Northern Telecom Ltd., Scientific-Atlanta,
Inc. and General Instrument Corporation. The Company believes that these
companies have developed or are developing proprietary modulation schemes using
in-house technology that may be competitive with the Company's technology.
Although the Company believes that its DWMT technology will offer more robust
communications than these proprietary modulation schemes, the Company has not
manufactured any marketable products based on its DWMT technology, and there can
be no assurance that the Company will be able to do so or that a market or such
products will develop.

     The markets for the Company's wavelet image compression technology are
competitive, and are expected to become increasingly so in the near future. In
addition, the Company's WSQ product is an implementation of an open standard and
is therefore subject to competition.


                                       12



<PAGE>   13


     Many of the Company's competitors and potential competitors, including the
RBOCs and Alcatel, have significantly greater financial, technological,
manufacturing, marketing and personnel resources than the Company. There can be
no assurance that the Company will be able to compete successfully or that
competition will not have a material adverse effect on the Company's business,
financial condition and results of operations. (See Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations -
FACTORS THAT MAY AFFECT FUTURE RESULTS.)


                              INTELLECTUAL PROPERTY

     In the field of telecommunications technology, the Company holds three
patents for applying wavelet mathematics to communications systems. The Company
has five pending patent applications that pertain to the application of
multi-carrier technology to broadband communications. The Company also holds six
patents for image compression and processing, three patents for video
compression, two patents for audio compression and one patent for certain
optical applications.

     Although the Company has patented certain aspects of its technology, the
Company relies primarily on know-how and trade secrets to protect its
intellectual property. The Company attempts to protect its trade secrets and
other proprietary information through agreements with its customers, suppliers,
employees and consultants, and through security measures. Each of the Company's
employees is required to sign a nondisclosure and noncompetition agreement.
Although the Company intends to protect its rights vigorously, there can be no
assurance that these measures will be successful. In addition, the laws of
certain countries in which products incorporating the Company's technology may
be developed, manufactured or sold may not protect the Company's products and
intellectual property rights to the same extent as the laws of the United
States.

     While the Company's ability to compete may be affected by its ability to
protect its intellectual property, the Company believes that, because of the
rapid pace of technological change in the telecommunications industry, its
technical expertise and ability to introduce new products on a timely basis will
be more important in maintaining its competitive position than protection of its
existing intellectual property and that patent, trade secret and copyright
protections are important but must be supported by other factors such as the
expanding knowledge, ability and experience of the Company's personnel, new
technology and products, and product enhancements. Although the Company
continues to implement protective measures and intends to defend vigorously its
intellectual property rights, there can be no assurance that these measures will
be successful.

     Many participants in the telecommunications industry have an increasing
number of patents and have frequently demonstrated a readiness to commence
litigation based on allegations of patent and other intellectual property
infringement. Third parties may assert exclusive patent, copyright and other
intellectual property rights to technologies that are important to the Company.
The Company has received letters from two companies, Amati and Telebit
Corporation ("Telebit"), each asserting that it owns certain U.S. and foreign
patents that are necessary for products that comply with the ANSI standard for
ADSL, claiming that the Company's ADSL technology would infringe such patents,
and offering the Company the opportunity to enter into a license agreement with
respect to such patents. The Company has been informed that ADI has received
similar letters. The Company has reviewed the Amati and Telebit patents and has
received an opinion of its patent counsel, based upon the Company's oral
description of its technology, to the effect that the Company's ADSL modem does
not infringe any valid 


                                       13



<PAGE>   14


claim of any of the Amati and Telebit patents. Based upon this opinion, the
Company believes that it does not require a license under the Amati or Telebit
patents in order to conduct its business.

     Despite this opinion, there can be no assurance that a court to which the
issue is submitted would not find that the Company's products infringe the Amati
or Telebit patents, nor that Amati or Telebit will not continue to assert
infringement. If the Company is found to have infringed any of such patents, the
Company could be subject to substantial damages and/or an injunction preventing
it from conducting its proposed business, and the Company's business could be
materially and adversely affected. The Company has also received notice from
Amati of the pendency of various patent applications which Amati considers to be
pertinent to the design and operation of ADSL modems. Unless and until a patent
actually issues, there can be no infringement, and the Company has not examined
any such patent applications or received opinion of patent counsel with respect
thereto. Although Amati and Telebit have offered to license their patents and
their patent applications to the Company, there can be no assurance that any
license would be available on acceptable terms should the Company choose to
pursue such license or be found to infringe such patents. In addition, there can
be no assurance that other third parties will not assert infringement claims
against the Company in the future, that these assertions or those of Amati and
Telebit, will not result in protracted and costly litigation, or that the
Company would prevail in any such litigation or be able to license any valid
patents from third parties on commercially reasonable terms. Further, such
litigation, regardless of its outcome, could result in substantial costs to and
diversion of effort by the Company. Litigation may also be necessary to enforce
the Company's intellectual property rights. Any infringement claim or other
litigation against or by the Company could have a material adverse effect on the
Company's business, financial condition and results of operations. (See Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations - FACTORS THAT MAY AFFECT FUTURE RESULTS.)


                                    EMPLOYEES

     At December 31, 1996, the Company employed 53 people, including 35 in
research and development, 6 in sales and marketing, 3 in manufacturing, and 9 in
finance, information systems and administration. All of these employees were
based in Massachusetts. As necessary, the Company supplements its regular
employees with temporary and contract personnel. The Company believes that its
future success will depend in large part on the continued service of its
technical and senior management personnel and upon the Company's continuing
ability to attract and retain highly qualified technical, sales and marketing,
and managerial personnel. Competition for highly qualified personnel is intense,
and there can be no assurance that the Company will be able to retain its key
managerial and technical employees or that it will be able to attract and retain
additional highly qualified personnel in the future. None of the Company's
employees is represented by a labor union. The Company considers its employee
relations to be good.

                                      14


<PAGE>   15



I
TEM 2. PROPERTIES

     The Company has two office facilities located in Bedford and Billerica,
Massachusetts. The Bedford location consists of 11,000 square feet and serves as
the Company's headquarters. The Company's sales and marketing, finance and
administration, manufacturing and image compression organizations are housed at
this location. The Company has occupied this space since June 1995 under a lease
that expires in 1998 with an option to renew for two additional one-year
periods.

     The Company subleases approximately 16,000 square feet of space in
Billerica, which is located approximately 1.5 miles from the Bedford location.
This building is occupied by the Company's telecommunications research and
development organization. The Company has occupied this space since December
1996 under a lease that expires in 1997 with an option to renew for an
additional three months.

     The Company believes that its facilities are substantially utilized, well
maintained and suitable for the products and services offered by the Company,
and that suitable space will be available as needed.



ITEM 3.  LEGAL PROCEEDINGS

     There are no pending legal proceedings to which the Company is a party or
to which any of its properties are subject which, either individually or in the
aggregate, are expected by the Company to have a material adverse effect on its
business, financial position or results of operations.



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

     No matters were submitted to a vote of security holders during the fourth
quarter of 1996.


                                       15



<PAGE>   16



                                     PART II



ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

     The Company has one class of stock outstanding, its common stock, which has
a par value of $.01 per share. The Company's common stock is traded on the
Nasdaq National Market under the symbol AWRE. The following table sets forth the
high and the low sales prices as reported on the Nasdaq National Market from
August 9, 1996, the date of the Company's initial public offering, to December
31, 1996.


<TABLE>
<CAPTION>

1996                                  HIGH              LOW
- -------------------------------------------------------------
<S>                                    <C>             <C>  
Third Quarter                          19              10 1/2
Fourth Quarter                         17 1/2           8 1/2
</TABLE>



     As of February 21, 1997, the Company had approximately 134 shareholders of
record. This number does not include shareholders from whom shares were held in
a "nominee" or "street" name. The Company has never paid cash dividends on its
common stock and anticipates it will continue to reinvest earnings to finance
future operations.

     The Company did not sell any equity securities that were not registered
under the Securities Act during the three months ended December 31, 1996.



ITEM 6.  SELECTED FINANCIAL DATA

     The following selected historical financial data has been derived from the
Company's audited consolidated financial statements. The historical financial
data should be read in conjunction with the Company's consolidated financial
statements and notes thereto included in Item 8.


<TABLE>
<CAPTION>

(in 000's, except per share data)
Year Ended December 31,                       1996       1995        1994        1993        1992
- --------------------------------------------------------------------------------------------------

Statements of Operations Data
- -----------------------------
<S>                                        <C>         <C>        <C>         <C>         <C>    
Revenue                                    $ 5,301     $3,260     $ 3,827     $ 3,172     $ 1,908
Income (loss) from operations                 (538)      (454)    $(1,095)     (1,028)     (3,267)
Net income (loss)                              259       (343)    $(1,012)       (992)     (3,249)
Net income (loss) per share                $  0.01     $(0.17)

Balance Sheet Data
- ------------------
Cash and short-term investments            $36,719     $2,154     $ 2,566     $   186     $   813
Working capital                             38,280      2,516       2,877         281       1,114
Total assets                                40,123      3,228       3,930         978       1,902
Total liabilities                              676        309         684         493         405
Total stockholders' equity                  39,446      2,920       3,246         485       1,497
- --------------------------------------------------------------------------------------------------
</TABLE>



                                       16



<PAGE>   17



ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
         RESULTS OF OPERATIONS


RESULTS OF OPERATIONS

     The following table sets forth, for the periods indicated, certain line
items from the Company's consolidated statements of operations as a percentage
of total revenue:


<TABLE>
<CAPTION>

 Year ended December 31,              1996             1995              1994
- --------------------------------------------------------------------------------
<S>                                   <C>              <C>                <C>  
 Revenue:
    Product                           12.3 %           12.5 %             4.7 %
    License and royalty               56.0             31.8              26.4
    Research and development          31.7             55.7              68.9
- --------------------------------------------------------------------------------
      Total revenue                  100.0            100.0             100.0

 Costs and expenses:
    Cost of product revenue           15.7              7.5               3.0
    Research and development          61.0             71.6              91.3
    Sales and marketing               14.5             12.6               8.6
    General and administrative        18.9             22.3              25.8
- --------------------------------------------------------------------------------
       Total costs and expenses      110.2            113.9             128.6

 Income (loss) from operations       (10.2)           (13.9)            (28.6)
 Interest income                      15.0              3.4               2.2
- --------------------------------------------------------------------------------

 Net income (loss)                     4.9 %          (10.5)%           (26.5)%
================================================================================
</TABLE>



PRODUCT REVENUE
     Product revenue consists primarily of revenue from the sale of tangible
products, such as ADSL modems and video editing chipset products, which are
manufactured by the Company or third party suppliers. Product revenue increased
by 60% from $406,000 in 1995 to $649,000 in 1996. Product revenue as a
percentage of total revenue was 12.3% and 12.5% in 1996 and 1995, respectively.
A year to year comparison of product revenue is not meaningful due to
differences in the composition of product revenue. Product revenue in 1996
consists primarily of revenue from the sale of the Company's ADSL Internet
access modems, which were introduced in early 1996. Product revenue in 1995
consists primarily of revenue from the sale of video editing chipset products,
which the Company discontinued in 1995.

     Product revenue increased by 124% from $181,000 in 1994 to $406,000 in
1995. Product revenue in 1995 and 1994 was comprised of sales of video editing
chipset products. The increase in video editing chipset product revenue was
primarily due to significant orders from a customer purchasing large quantities
in 1995 before the Company discontinued that product line.

LICENSE AND ROYALTY REVENUE
     License and royalty revenue consists primarily of revenue from the sale of
intellectual property, such as hardware and software technology licenses,
compression software licenses, and royalties from the sale of chipsets by
customers who have licensed the Company's technology. As such revenue has only a


                                       17



<PAGE>   18


nominal cost of sale associated with it, the Company does not report a separate
cost of license and royalty revenue line in its Statements of Operations.

     License and royalty revenue increased by 187% from $1,037,000 in 1995 to
$2,971,000 in 1996. License and royalty revenue as a percentage of total revenue
was 56.0% and 31.8% in 1996 and 1995, respectively. The increase in 1996 is
primarily attributable to an increase in the sale of ADSL and other broadband
technology licenses to telephone company equipment suppliers. Revenue from the
sale of compression software licenses also contributed to the increase in
license and royalty revenue in 1996. Approximately 51% of license and royalty
revenue in 1996 was received from three customers.

     License and royalty revenue increased by 3% from $1,008,000 in 1994 to
$1,037,000 in 1995. The increase is primarily due to increased sales of
compression software licenses and royalty revenue in 1995, which was partially
offset by a decline in revenue from sales of technology licenses.

RESEARCH AND DEVELOPMENT REVENUE
    Research and development revenue consists primarily of revenue from
commercial contract engineering and development, and government research
contracts. In 1993, the Company made a decision to reduce its government
research activities and focus on the commercialization of its technology. This
decision has resulted in lower research and development revenue and higher
product and license and royalty revenue, which explains why research and
development revenue as a percentage of total revenue has declined from 68.9% in
1994 to 55.7% in 1995 to 31.7% in 1996.

     Research and development revenue decreased by 8% from $1,817,000 in 1995 to
$1,680,000 in 1996. The decrease is primarily due to lower revenue from
commercial research and development contracts and slightly lower revenue from
U.S. government research contracts. Research and development revenue decreased
by 31% from $2,637,000 in 1994 to $1,817,000 in 1995. The decrease is primarily
due to a significant decrease in U.S. government research revenue, which was
partially offset by an increase in commercial contract engineering revenue.

COST OF PRODUCT REVENUE
     Cost of product revenue consists primarily of direct material, direct labor
and overhead costs to produce the Company's products, and cost of goods for
purchases of finished goods inventory from third party suppliers. Cost of
product revenue as a percentage of product revenue was 128% in 1996 as compared
to 60% in 1995. Such percentages primarily reflect the cost of modem revenue in
1996 and the cost of video editing chipset revenue in 1995. The cost of product
revenue in 1996 also includes a $365,000 provision for excess and obsolete
inventory related to modems. Excluding this charge, cost of product revenue as a
percentage of product revenue was 72%. Accordingly, a comparison of cost of
product revenue on a year to year basis is not meaningful due to differences in
the composition of product revenue.

     Cost of product revenue increased by 115% from $113,000 in 1994 to $243,000
in 1995. As a percentage of product revenue, cost of product revenue decreased
from 62% in 1994 to 60% in 1995. The slight improvement in cost as a percentage
of product revenue is primarily due to marginally lower pricing from the third
party supplier of video editing chipset products as a result of higher volumes
in 1995.

RESEARCH AND DEVELOPMENT
     Research and development expense consists primarily of employee and
consultant costs, supplies and allocated facilities costs related to the
development of the Company's products and technology. Research and development
expense increased by 39% from $2,333,000 in 1995 to $3,235,000 in 1996. The
increase in research and development expense is primarily attributable to higher
spending on projects to 


                                       18



<PAGE>   19


develop, enhance, and commercialize the Company's ADSL, VDSL, SDSL and HFC
broadband technologies. Higher spending on these projects was partially offset
by lower spending as a result of the discontinuance of research involving audio
compression technology and lower facilities costs as a result of the relocation
of the Company's facilities in June 1995. The Company anticipates that research
and development spending will grow significantly in 1997.

     Research and development expense decreased by 33% from $3,492,000 in 1994
to $2,333,000 in 1995. The decrease is primarily due to the discontinuance, in
January 1995, of research and development efforts associated with audio
compression technology, lower facilities costs as a result of the relocation of
the Company's facilities in June 1995, and a reduction of U.S. government
research activity.

SELLING AND MARKETING
     Selling and marketing expense consists primarily of salaries for sales and
marketing personnel, travel, product advertising, and allocated facilities
expense. Selling and marketing expense increased 87% from $412,000 in 1995 to
$769,000 in 1996. The increase is primarily due to the addition of sales
personnel and increased product advertising related to the Company's ADSL
Internet access modem. Selling and marketing expense increased 25% from $329,000
in 1994 to $412,000 in 1995. The increase is primarily due to increases in the
Company's sales force and product advertising. The Company anticipates that
selling and marketing expenses will increase significantly in 1997.

GENERAL AND ADMINISTRATIVE
     General and administrative expense consists primarily of salaries for
administrative officers and support personnel, allocated facilities costs, and
professional services, such as legal and audit expenses. General and
administrative expense increased by 38% from $726,000 in 1995 to $1,004,000 in
1996. The increase is primarily attributable to additions to the Company's
management team and administrative infrastructure, and expenses associated with
becoming a public company. General and administrative expense decreased by 27%
from $988,000 in 1994 to $726,000 in 1995. The decrease is primarily due to
management and support staff reductions in January 1995.

INTEREST INCOME
     Interest income increased 621% from $111,000 in 1995 to $798,000 in 1996
primarily as a result of higher average cash balances due to the investment of
net proceeds from the Company's initial public offering. Interest income
increased 34% from $83,000 in 1994 to $111,000 in 1995 primarily due to higher
average cash balances in 1995 as compared to 1994.

INCOME TAXES
     The Company has made no provision for income taxes as it has a history of
net losses, which has resulted in tax loss carryforwards. As of December 31,
1996, the Company had net operating loss carryforwards of approximately
$9,773,000 and approximately $493,000 of research and development tax credit
carryforwards to offset future federal taxable income. To the extent not
utilized, the net operating loss and tax credit carryforwards expire between
2003 and 2011.


                                       19



<PAGE>   20


LIQUIDITY AND CAPITAL RESOURCES

     At December 31, 1996, the Company had cash, cash equivalents and short-term
investments of $36.7 million, an increase of $34.5 million from the prior year.
The Company has funded its operations primarily from sales of common stock,
including an initial public offering in August 1996, which generated net
proceeds of $35.2 million. The Company also received proceeds of $1.1 million
from the issuance of common stock in connection with its stock option plans in
1996.

     Cash used by operations was $586,000 in 1996. Accounts receivable and
unbilled accounts receivable increased $1.1 million from December 31, 1995. The
increase in total accounts receivable reflects increased revenue in 1996, as
well as the achievement of significant contract milestones and the closure of
several license agreements late in the year. Inventory balances increased
$408,000 from December 31, 1995, which reflects the purchase of raw materials to
manufacture ADSL modems in larger quantities.

     Investment activities in 1996 included capital expenditures of $1.1
million. Capital investments included the purchase of engineering development
equipment, manufacturing equipment, and engineering and administrative software.
The Company purchased $5.6 million of short-term investments, which were placed
in highly rated corporate debt and U.S. agency securities.

     While there can be no assurance that the Company will not require
additional financing, or that such financing will be available to the Company,
the Company believes that its financial resources are adequate to meet its
liquidity requirements over the next twelve months.


                                       20



<PAGE>   21


FACTORS THAT MAY AFFECT FUTURE RESULTS


     The statements contained in this Annual Report on Form 10-K which are not
historical are "forward looking statements" within the meaning of Section 27A of
the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. These forward-looking statements represent the
Company's present expectations or beliefs concerning future events, however the
Company cautions that such statements are qualified by important factors. Such
factors, which are identified under the heading "Risk Factors" below, could
cause actual results to differ materially from those indicated in Management's
Discussion and Analysis of Financial Condition and Results of Operations.

     The Company believes that the occurrence of any one or some combination of
the following risk factors could have a material adverse effect on the Company's
business, financial condition and results of operations.

History of Operating Losses
     The Company has incurred operating losses in every fiscal year since
inception. Substantial additional research and development expenses to enhance
the performance and reduce the manufacturing costs of the Company's products
will be required before market acceptance can be determined. Also, the Company
anticipates that substantial selling and marketing expenses will be required to
establish sales channels for the Company's products and technology. There can be
no assurance that the Company will achieve profitable operations in any future
period.

Dependence on Acceptance of ADSL Technology
     The Company's future success is substantially dependent upon whether ADSL
technology gains widespread commercial acceptance by the telcos ("telcos") and
end users of telco services. The Company has invested substantial resources in
the development of ADSL technology implemented through the Discrete Multi-Tone
("DMT") modulation technique. Telcos have only begun evaluating DMT-based ADSL
technology, and there can be no assurance that the telcos will pursue the
deployment of such ADSL technology.

Reliance on Telcos; Dependence on a Limited Number of Customers
     Even if telcos adopt policies favoring full-scale implementation of ADSL
technology, there can be no assurance that sales of the Company's ADSL products
will become significant. The Company's customers, including Regional Bell
Operating Companies ("RBOCs"), OEMs and other telcos, are relatively few in
number and have significantly greater resources than that of the Company. The
Company has limited ability to influence or control decisions made by these
customers. There can be no assurance that these customers will not use their
size and bargaining power to demand unfavorable terms and conditions (including
price), seek alternative suppliers, or undertake internal development of
products comparable to those of the Company's.

Substantial Dependence on Analog Devices, Inc.
     The Company and Analog Devices, Inc. ("ADI") have entered into a series of
agreements to develop integrated chipsets based on the Company's technology. The
inability or refusal of ADI to manufacture, market and sell such chipsets in
substantial quantities would prevent telcos from adopting the Company's
technology and would have a material adverse effect on the Company's business.
There can be no assurance that ADI will succeed or, in the event that ADI is not
successful, that the Company would be able to find a substitute chipset
manufacturer without significant delays.


                                       21



<PAGE>   22


Proprietary Technology; Risk of Third Party Claims of Infringement
     The Company's ability to compete effectively will depend to a significant
extent on its ability to protect it proprietary information and to operate
without infringing the intellectual property rights of others. Despite the
precautions the Company has taken to protect its intellectual property, there
can be no assurance that such steps will be adequate to prevent the
misappropriation of its technology. In addition, third parties may assert
exclusive patent, copyright and other intellectual property rights to
technologies that are important to the Company. There can be no assurance that
other third parties will not assert such claims against the Company in the
future.

Rapid Technological Change; Dependence on New Products
     The markets for the Company's products are characterized by rapid
technological advances, evolving industry standards, changes in end-user
requirements, frequent new product introductions, and evolving telco offerings.
The Company's business will be materially adversely affected if technologies or
standards on which Company's products are based become obsolete, or if the
Company is unable to develop and introduce new products in a timely manner in
response to changing market conditions.

Competition
     The markets for the Company's products are intensely competitive and the
Company expects competition to increase in the immediate future. Many of the
Company's competitors and potential competitors have significantly greater
financial, technological, manufacturing, marketing and personnel resources than
the Company. There can be no assurance that the Company will be able to compete
successfully or that competition will not adversely affect the Company's
business.

Manufacturing
     The Company has limited experience in manufacturing or in supervising the
manufacture of its products, including its ADSL modem. There can be no assurance
that the Company will not encounter significant difficulties in manufacturing or
controlling the quality of its products, or that its products will be reliable
in the field.


                                       22



<PAGE>   23



ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA



                        REPORT OF INDEPENDENT ACCOUNTANTS


     We have audited the accompanying consolidated balance sheets of Aware, Inc.
as of December 31, 1996 and 1995, and the related consolidated statements of
operations, stockholders' equity, and cash flows for each of the three years in
the period ended December 31, 1996. Our audits also included the financial
statement schedule listed in the Index at Item 14. These financial statements
and financial statement schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on the financial
statements and financial statement schedule based on our audits.

     We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

     In our opinion, the consolidated financial statements present fairly, in
all material respects, the financial position of Aware, Inc. at December 31,
1996 and 1995, and the results of its operations and its cash flows for each of
the three years in the period ended December 31, 1996, in conformity with
generally accepted accounting principles. Also, in our opinion, such financial
statement schedule, when considered in relation to the basic consolidated
financial statements taken as a whole, present fairly, in all material respects,
the information set forth therein.


/s/  Deloitte & Touche LLP


Boston, Massachusetts
January 30, 1997



                                       23



<PAGE>   24


<TABLE>
<CAPTION>

AWARE, INC.
CONSOLIDATED BALANCE SHEETS


December 31,                                                                              1996              1995
- -----------------------------------------------------------------------------------------------------------------

<S>                                                                                  <C>             <C>         
ASSETS
Current assets:
     Cash and cash equivalents                                                       $ 31,092,273    $  2,153,681
     Short-term investments                                                             5,626,725              --
     Accounts receivable (less allowance for doubtful
        accounts of $35,000 in 1996 and $5,300 in 1995)                                 1,654,980         500,828
     Unbilled accounts receivable                                                         110,722         116,261
     Inventories                                                                          447,534          39,713
     Prepaid expenses                                                                      23,426          14,471
- -----------------------------------------------------------------------------------------------------------------
           Total current assets                                                        38,955,660       2,824,954
- -----------------------------------------------------------------------------------------------------------------

Property and equipment, net of accumulated depreciation and
     amortization of $557,901 in 1996 and $1,480,614 in 1995                            1,166,928         403,405
- -----------------------------------------------------------------------------------------------------------------
           Total assets                                                              $ 40,122,588    $  3,228,359
=================================================================================================================



LIABILITIES AND STOCKHOLDERS' EQUITY 
Current liabilities:
     Accounts payable                                                                $    337,339    $    111,519
     Accrued expenses                                                                      60,091          65,404
     Accrued compensation                                                                 173,692          67,887
     Accrued professional                                                                  65,000          14,000
     Deferred revenue                                                                      40,000          50,000
- -----------------------------------------------------------------------------------------------------------------
             Total current liabilities                                                    676,122         308,810
- -----------------------------------------------------------------------------------------------------------------

Stockholders' equity:
     Preferred stock, $1.00 par value; 1,000,000 shares authorized,                            
          none outstanding                                                                     --              --
     Preferred stock, $1.00 par value:
         Series B convertible preferred stock, 15,875 shares authorized; issued                
             and outstanding, none in 1996 and 15,875 in 1995                                  --          15,875
         Series C convertible preferred stock, 13,525 shares authorized; issued                
             and outstanding, none in 1996 and 13,525 in 1995                                  --          13,525
         Series D convertible preferred stock, 74,800 shares authorized; issued                
             and outstanding, none in 1996 and 69,166 in 1995                                  --          69,166
         Series E convertible preferred stock, 45,000 shares authorized; issued                
             and outstanding, none in 1996 and 29,432 in 1995                                  --          29,432
      Common stock, $.01 par value; 30,000,000 shares authorized; issued
             and outstanding, 18,959,897 in 1996 and 1,166,960 in 1995                    189,600          11,670
      Additional paid-in capital                                                       50,025,548      13,807,945
      Accumulated deficit                                                             (10,315,720)    (10,575,102)
      Treasury stock                                                                     (452,962)       (452,962)
- -----------------------------------------------------------------------------------------------------------------
             Total stockholders' equity                                                39,446,466       2,919,549
- -----------------------------------------------------------------------------------------------------------------
             Total liabilities and stockholders' equity                              $ 40,122,588    $  3,228,359
=================================================================================================================

</TABLE>


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


                                       24



<PAGE>   25


AWARE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS


<TABLE>
<CAPTION>


Year Ended December 31,                         1996            1995           1994
- --------------------------------------------------------------------------------------

<S>                                         <C>             <C>           <C>        
Revenue:
    Product                                 $   649,422     $  406,459    $   181,217
    License and royalty                       2,971,238      1,036,615      1,008,434
    Research and development                  1,680,449      1,816,820      2,637,199
- -------------------------------------------------------------------------------------
         Total revenue                        5,301,109      3,259,894      3,826,850
- -------------------------------------------------------------------------------------


Costs and expenses:
    Cost of  product revenue                    831,241        242,983        112,925
    Research and development                  3,234,799      2,333,200      3,492,249
    Selling and marketing                       769,395        411,777        329,068
    General and administrative                1,003,948        725,511        987,640
- -------------------------------------------------------------------------------------
         Total costs and expenses             5,839,383      3,713,471      4,921,882
- -------------------------------------------------------------------------------------

Income (loss) from operations                  (538,274)      (453,577)    (1,095,032)
Interest income                                 797,656        110,615         82,683
- -------------------------------------------------------------------------------------
Net income (loss) before provision for          259,382       (342,962)    (1,012,349)
income taxes
Provision for income taxes                           --             --             --
=====================================================================================

Net income (loss)                           $   259,382     $ (342,962)   $(1,012,349)
=====================================================================================


Net income (loss) per share                 $     0.01      $    (0.17)
======================================================================

Weighted average number of
    shares used in per share calculation     18,394,395      2,045,006
======================================================================

</TABLE>



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



                                       25



<PAGE>   26


AWARE, INC.

<TABLE>
CONSOLIDATED STATEMENTS OF CASH FLOWS


<CAPTION>
Year ended December 31,                                                  1996          1995          1994
- ---------------------------------------------------------------------------------------------------------
<S>                                                               <C>           <C>          <C>
Cash flows from operating activities:
 Net income (loss)                                                $   259,382   $  (342,962) $ (1,012,349)
 Adjustments to reconcile net income (loss) to net cash
   provided by (used in) operating activities:
   Depreciation and amortization                                      352,715       200,701       206,140
   Increase (decrease) from changes in assets and
liabilities:
   Accounts receivable                                             (1,154,152)       94,168      (326,756)
   Unbilled accounts receivable                                         5,539       187,840       (55,603)
   Inventories                                                       (407,821)      (18,044)       25,071
   Prepaid expenses                                                    (8,955)       59,071       (49,385)
   Accounts payable                                                   225,820        14,757      (115,045)
   Accrued expenses                                                   151,492      (350,150)      314,595
   Deferred revenue                                                   (10,000)      (39,720)       (8,408)
- ----------------------------------------------------------------------------------------------------------
       Net cash used in operating activities                         (585,980)     (194,339)   (1,021,740)
- ----------------------------------------------------------------------------------------------------------

Cash flows from investing activities:
   Purchases of property and equipment                             (1,116,238)     (234,131)     (371,658)
   Net purchases of short-term investments                         (5,626,725)            -             -
- ---------------------------------------------------------------------------------------------------------
       Net cash used in investing activities                       (6,742,963)     (234,131)     (371,658)
- ---------------------------------------------------------------------------------------------------------

Cash flows from financing activities:
   Proceeds from issuance of common stock, net of
       issuance costs                                              36,267,535        16,023         9,500
   Proceeds from issuance of preferred stock, net of
       issuance costs                                                       -             -     3,764,058
   Proceeds from stockholders' loans                                        -             -       150,000
   Repayment of stockholders' loans                                         -             -      (150,000)
- ---------------------------------------------------------------------------------------------------------
       Net cash provided by financing activities                   36,267,535        16,023     3,773,558
- ---------------------------------------------------------------------------------------------------------

Increase (decrease) in cash and cash equivalents                   28,938,592      (412,447)    2,380,160
Cash and cash equivalents, beginning of period                      2,153,681     2,566,128       185,968
- ---------------------------------------------------------------------------------------------------------

Cash and cash equivalents, end of period                          $31,092,273    $2,153,681   $ 2,566,128
=========================================================================================================



- ---------------------------------------------------------------------------------------------------------
SUPPLEMENTAL CASH FLOW INFORMATION:
   Cash paid for interest                                         $       820    $      877   $     4,359
- ---------------------------------------------------------------------------------------------------------

- ---------------------------------------------------------------------------------------------------------
SUPPLEMENTAL NONCASH DISCLOSURES:
   Conversion of preferred stock to common stock                  $   127,998             -             -
   Increase in notes receivable for accrued interest                        -             -   $    25,413
   Repurchase of Series D preferred shares for
       cancellation of notes                                                -    $  457,062             -
- ---------------------------------------------------------------------------------------------------------
</TABLE>


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


                                       26



<PAGE>   27



AWARE, INC.

<TABLE>
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

<CAPTION>

                                                                                             
                                                                    
                                                         Convertible Preferred Stock                    Additional               
                                              ---------------------------------------------  Common      Paid-In       Accumulated
                                              Series B    Series C   Series D     Series E    Stock      Capital         Deficit   
- ------------------------------------------------------------------------------------------------------------------------------------
<S>                                           <C>         <C>         <C>         <C>       <C>        <C>           <C>           
Balance,  December 31, 1993                   $ 15,875    $ 13,525    $ 73,266    $         $ 11,401   $10,022,652   $ (9,219,791) 
- ------------------------------------------------------------------------------------------------------------------------------------
   Sale of 29,432 shares of Series E
     convertible preferred stock,                    
     net of issuance costs of $36,689                -           -           -      29,432         -     3,760,039              -   
   Exercise of common stock options, 10,000          
     shares                                          -           -           -           -       100         9,400              -   
   Accrued interest on notes receivable for
     stock issuances                                 -           -           -           -         -             -              -   
   Net loss                                          -           -           -           -         -             -     (1,012,349)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance,  December 31, 1994                     15,875      13,525      73,266      29,432    11,501    13,792,091    (10,232,140)
- ------------------------------------------------------------------------------------------------------------------------------------
   Exercise of common stock options, 16,867          
     shares                                          -           -           -           -       169        15,854              -   
   Repurchase of Series D preferred stock,
     4,100 shares                                    -           -      (4,100)          -         -             -              -   
   Net loss                                          -           -           -           -         -             -       (342,962)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance,  December 31, 1995                     15,875      13,525      69,166      29,432    11,670    13,807,945    (10,575,102)
- ------------------------------------------------------------------------------------------------------------------------------------
   Issuance of common stock in initial
     public offering, net of                         
     issuance costs, 3,910,000 shares                -           -           -           -    39,100    35,123,900              -   
   Exercise of common stock options,
     1,083,162 shares                                -           -           -           -    10,832     1,093,703              -   
   Conversion of preferred stock to common
     stock, 12,799,800 shares                  (15,875)    (13,525)    (69,166)    (29,432)  127,998             -              -   
   Net income                                        -           -           -           -         -             -        259,382
- ------------------------------------------------------------------------------------------------------------------------------------
Balance,  December 31, 1996                  $       -    $      -    $      -    $      -  $189,600   $50,025,548   $(10,315,720)
- ------------------------------------------------------------------------------------------------------------------------------------

</TABLE>




<TABLE>
<CAPTION>



                                                                 Notes                              
                                                              Receivable                        Total    
                                                                  For           Treasury     Stockholders'  
                                                             Issued Stock        Stock          Equity   
- ---------------------------------------------------------------------------------------------------------
<S>                                                            <C>                            <C>      
Balance,  December 31, 1993                                   $(431,649)       $       -      $   485,279
- ---------------------------------------------------------------------------------------------------------
   Sale of 29,432 shares of Series E convertible                      
    preferred stock, net of issuance costs of $36,689                 -                -        3,789,471
   Exercise of common stock options, 10,000 shares                    -                -            9,500
   Accrued interest on notes receivable for
    stock issuances                                             (25,413)               -          (25,413)
   Net loss                                                           -                -       (1,012,349)
- ---------------------------------------------------------------------------------------------------------
Balance,  December 31, 1994                                    (457,062)               -        3,246,488
- ---------------------------------------------------------------------------------------------------------
   Exercise of common stock options, 16,867 shares                    -                -           16,023
   Repurchase of Series D preferred stock,
    4,100 shares                                                457,062         (452,962)               -   
   Net loss                                                           -                -         (342,962)
- ---------------------------------------------------------------------------------------------------------
Balance,  December 31, 1995                                           -         (452,962)       2,919,549
- ---------------------------------------------------------------------------------------------------------
   Issuance of common stock in initial public                         
    offering, net of issuance costs,
    3,910,000 shares                                                  -                -       35,163,000
   Exercise of common stock options,
    1,083,162 shares                                                  -                -        1,104,535
   Conversion of preferred stock to common
    stock, 12,799,800 shares                                          -                -                -   

   Net income                                                         -                -          259,382
- ---------------------------------------------------------------------------------------------------------
Balance,  December 31, 1996                                   $       -        $(452,962)     $39,446,466
=========================================================================================================
                                                                                            

</TABLE>



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


                                       27



<PAGE>   28


AWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.   NATURE OF BUSINESS

     Aware, Inc. (the "Company") designs, develops and markets
     telecommunications software, chipsets and modems that incorporate
     Asymmetric Digital Subscriber Line (ADSL), Very High Speed Digital
     Subscriber Line (VDSL), Symmetric Digital Subscriber Line (SDSL), and
     Hybrid Fiber Coaxial (HFC) technologies. Such broadband technologies are
     designed to increase the speed of data communications over conventional
     copper telephone lines and coaxial cable. The Company's products are
     designed to allow telephone and cable companies to utilize their installed
     bases of dedicated copper lines and coaxial cable to provide both
     residential and business customers with interactive data transmission at
     speeds much higher than currently available. The Company also offers image
     compression software products.



2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     BASIS OF PRESENTATION - The consolidated financial statements include the
     accounts of Aware, Inc. and its subsidiary. All significant intercompany
     transactions have been eliminated.

     CASH AND CASH EQUIVALENTS - Cash and cash equivalents consist primarily of
     demand deposits, money market funds, commercial paper, and discount notes
     in highly liquid short-term instruments with original maturities of three
     months or less from the date of purchase and are stated at cost, which
     approximates market.

     SHORT-TERM INVESTMENTS - The Company follows Statement of Financial
     Accounting Standard ("SFAS") No. 115, "Accounting for Certain Investments
     in Debt and Equity Securities ("SFAS 115"). The Company has the intent and
     the ability to hold to maturity all securities that mature in less than one
     year. Accordingly, these "held-to-maturity" securities have been recorded
     at amortized cost. The Company has categorized all other securities as
     "available-for-sale," since the Company may liquidate these investments
     currently. SFAS 115 requires that unrealized gains and losses on
     available-for-sale securities be excluded from earnings and reported in a
     separate component of stockholders' equity. As of December 31, 1996, the
     unrealized gain was immaterial.


<TABLE>
     The amortized cost of securities, which approximates fair value, consists
     of the following at December 31, 1996:

<CAPTION>

  ----------------------------------------------------------------------------
                                             MATURITY

                                   LESS THAN          ONE TO
  TYPE OF SECURITY                 ONE YEAR         FIVE YEARS        TOTAL
  ----------------------------------------------------------------------------
  <S>                             <C>              <C>              <C>       
  Corporate debt securities       $3,040,072       $1,602,023       $4,642,095
  U.S. agency securities             984,630                -          984,630
  ----------------------------------------------------------------------------
      Total                       $4,024,702       $1,602,023       $5,626,725
  ----------------------------------------------------------------------------
</TABLE>



     ALLOWANCE FOR DOUBTFUL ACCOUNTS - Accounts are charged to the allowance for
     doubtful accounts as they are deemed uncollectible based on a periodic
     review of the accounts. Bad debt expense was approximately $20,000, $5,000,
     and $0 for 1996, 1995, and 1994, respectively.


                                       28



<PAGE>   29

AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


     INVENTORIES - Inventories are stated at the lower of cost or market with
     cost being determined by the first-in, first-out ("FIFO") method.

     PROPERTY AND EQUIPMENT - Property and equipment are stated at cost.
     Depreciation and amortization of property and equipment is provided using
     the straight-line method over the estimated useful lives of the assets (3
     to 5 years).

     REVENUE RECOGNITION - Product revenue consists primarily of revenue from
     the sale of tangible products, such as modems and compression chipsets.
     Revenue is recognized upon shipment.

     License and royalty revenue consists primarily of revenue from the sale of
     intellectual property, such as hardware and software technology licenses,
     compression software licenses, and royalties from the sale of chipsets by
     customers who have licensed the Company's technology. Revenue from the sale
     of technology licenses for the initial transfer of hardware and software
     designs is recognized when a definitive agreement is reached, the transfer
     has been effected, and no contingent factors are present. Revenue from the
     sale of compression software licenses is recognized upon shipment. Royalty
     revenue is recognized based upon billing schedules when no right to return
     exists or upon sales reports from customers.

     Research and development revenue is comprised of revenue from government
     and commercial research and development contracts. Revenue on government
     contracts is generally recognized when services are performed. Certain
     long-term contracts are accounted for using the percentage-of-completion
     method, whereby revenue and profit are recognized throughout the
     performance period of the contract based on the ratio that incurred costs
     bear to established total costs to complete. Losses, if any, on contracts
     are provided for in the period in which the losses are first identified.
     Revenue on commercial contracts is generally recognized as research is
     performed under the terms of the respective agreements.

     Unbilled accounts receivable are stated at estimated realizable value.
     These amounts will be billable to customers based on the terms of contracts
     which include achievement of milestones or completion of the contract.

     INCOME TAXES - The Company accounts for income taxes under SFAS No. 109,
     "Accounting for Income Taxes." This Statement requires the Company to
     compute deferred income taxes based on the differences between the
     financial statement and tax basis of assets and liabilities using enacted
     rates in effect in the years in which the differences are expected to
     reverse.

     CAPITALIZATION OF SOFTWARE COSTS - The Company capitalizes certain
     internally generated software development costs after technological
     feasibility of the product has been established. Capitalized software costs
     also include amounts paid for purchased software which has reached
     technological feasibility. Such costs are amortized, on a
     product-by-product basis, on a straight-line basis over their useful
     economic lives (generally two to four years), or the ratio of current gross
     revenues to total gross current and future revenues, whichever is greater.
     There were no capitalized software costs at December 31, 1995 and 1996,
     because such costs incurred subsequent to the establishment of
     technological feasibility, but prior to commercial availability, were
     immaterial.

     CONCENTRATION OF RISK - At December 31, 1996 and 1995, the Company had bank
     cash balances and money market investments, in excess of federally insured
     deposit limits of approximately $36,619,000 and $2,079,000, respectively.


                                       29



<PAGE>   30

AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


     Concentration of credit risk with respect to accounts receivable is limited
     to $549,000, $275,000, and $155,000 with three customers at December 31,
     1996 and to $250,000 with one customer at December 31, 1995.

     STOCK-BASED COMPENSATION - The Company grants stock options for a fixed
     number of shares to employees with an exercise price equal to the fair
     value of the shares at the date of grant. The Company adopted SFAS No. 123,
     "Accounting for Stock-Based Compensation" on January 1, 1996. As permitted
     by SFAS No. 123, the Company accounts for stock option grants in accordance
     with Accounting Principles Board ("APB") Opinion No. 25, "Accounting for
     Stock Issued to Employees." Accordingly, the Company recognized no
     compensation expense for stock option grants.

     NET INCOME (LOSS) PER SHARE - Net income (loss) per share (pro forma for
     1995) is based on the weighted average number of common and dilutive common
     equivalent shares (common stock options and convertible preferred stock)
     outstanding. Common equivalent shares are not included in the per share
     calculations for the year ended December 31, 1995, because the effect of
     their inclusion would be antidilutive, except in accordance with Securities
     and Exchange Commission Staff Accounting Bulletin No. 83. The Bulletin
     requires all common shares issued and options to purchase shares of common
     stock granted by the Company during the twelve-month period prior to the
     filing of a proposed initial public offering to be included in the
     calculation as if they were outstanding for all periods. Fully diluted net
     income (loss) per share is not presented as the dilutive effect is
     immaterial.

     USE OF ESTIMATES - The preparation of the Company's financial statements in
     conformity with generally accepted accounting principles necessarily
     requires management to make estimates and assumptions that effect the
     reported amounts of assets and liabilities and disclosure of contingent
     assets and liabilities at the balance sheet date. Significant estimates
     include reserves for doubtful accounts, reserves for excess and obsolete
     inventory, useful lives of fixed assets, valuation allowance for deferred
     income tax assets and accrued liabilities. Actual results may differ from
     these estimates.

     FAIR VALUE OF FINANCIAL INSTRUMENTS - SFAS No. 107, "Disclosures About Fair
     Value of Financial Instruments," requires disclosure of the fair value of
     certain financial instruments. The carrying amounts of cash and cash
     equivalents, short-term investments, accounts receivable, accounts payable
     and accrued expenses approximate fair value because of their short-term
     nature.

     ACCOUNTING FOR LONG-LIVED ASSETS - The Company adopted SFAS No. 121,
     "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
     Assets to be Disposed Of", in 1996. This Statement establishes accounting
     standards for the impairment of long-lived assets, certain identifiable
     intangibles, and goodwill related to those assets to be held and used and
     for long-lived assets and certain identifiable intangibles to be disposed
     of. Adoption did not have a material effect on the Company's financial
     position or results of operations.

     RECLASSIFICATIONS - Certain prior year amounts have been reclassified to be
     consistent with the current year presentation.


                                       30



<PAGE>   31

AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


3.   INVENTORY


<TABLE>
     Inventory consists primarily of the following at December 31:

<CAPTION>

                                      1996                   1995
        -----------------------------------------------------------
       <S>                          <C>                     <C>    
        Raw materials               $408,643                $39,713
        Work-in-process               38,891                      -
        Finished goods                     -                      -
        -----------------------------------------------------------
               Total                $447,534                $39,713
        ===========================================================
</TABLE>





4.   PROPERTY AND EQUIPMENT


<TABLE>
      Property and equipment consisted of the following at December 31:

<CAPTION>

                                                                    1996              1995
        -----------------------------------------------------------------------------------
         <S>                                                   <C>             <C>        
        Computer equipment                                      $ 983,819       $ 1,556,790
        Office equipment                                           83,917            88,390
        Furniture and fixtures                                    124,677           106,499
        Purchased software                                        375,467           117,638
        Manufacturing equipment                                   118,998                --
        Leasehold improvements                                     37,951            14,702
        -----------------------------------------------------------------------------------
        Total                                                   1,724,829         1,884,019
        Less accumulated depreciation and amortization           (557,901)       (1,480,614)
        -----------------------------------------------------------------------------------
        Net                                                    $1,166,928        $  403,405
        ===================================================================================
</TABLE>



     In 1996, the Company removed from the accounts approximately $1,275,000 of
fully depreciated assets, which were no longer in service.



5.   INCOME TAXES


<TABLE>
     Deferred income tax assets at December 31 are attributable to the
following:

<CAPTION>
                                                                           1996            1995
     ------------------------------------------------------------------------------------------------
     <S>                                                               <C>               <C>         
     Depreciation                                                      $     69,000      $     75,000
     Accrued expenses                                                       187,000            28,000
     Deferred revenue                                                        22,000            21,000
     Alternative minimum tax credit                                           6,000                 -
     Federal net operating loss carryforwards                             3,367,000         3,383,000
     State net operating loss carryforwards                                 518,000           587,000
     Research and development and other tax credit carryforwards            761,000           576,000
     ------------------------------------------------------------------------------------------------
     Total                                                                4,930,000         4,670,000
     Valuation allowance                                                 (4,930,000)       (4,670,000)
     ------------------------------------------------------------------------------------------------
     Net                                                               $          -      $          -
      =============================================================================================== 
</TABLE>



                                       31



<PAGE>   32

AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


     A valuation allowance is provided against temporary deductible differences,
     net operating loss carryforwards and tax credits which are not likely to be
     realized. During 1996 and 1995, the net valuation allowance was changed to
     fully reserve gross deferred tax assets.


<TABLE>
     A reconciliation of the U.S. federal statutory rate to the effective tax
     rate is as follows:
<CAPTION>

                                                          1996          1995          1994
         -----------------------------------------------------------------------------------
         <S>                                               <C>          <C>            <C>  
         Federal statutory rate                            34 %         (34)%          (34)%
         State rate, net of federal benefit                 6            (6)            (6)
         Operating losses with no current tax benefit       -            40             40
         Tax benefit from the utilization of net
            operating loss carryforwards                  (40)            -              -
         -----------------------------------------------------------------------------------
         Effective tax rate                                 - %           - %            - %
         ===================================================================================
</TABLE>


     At December 31, 1996, the Company had available federal net operating loss
     carryforwards of approximately $9,773,000 which expire in 2004 through
     2010, and federal research and development credit carryforwards of
     approximately $493,000 which expire in 2003 through 2011. The Company also
     had available state net operating loss carryforwards of approximately
     $5,448,000 which expire in 1997 through 2000 and state research and
     development and investment tax credit carryforwards of approximately
     $268,000 which expire in 2006 through 2011.



6.   STOCKHOLDERS' EQUITY

     COMMON STOCK - In 1996, the Company increased the number of shares of
     authorized common stock from 18,650,000 to 30,000,000.

     In August 1996, the Company completed an initial public offering of its
     common stock consisting of 3,910,000 shares at $10.00 per share. Proceeds
     to the Company, net of issuance costs, were approximately $35,163,000
     (issuance costs were approximately $3,937,000).

     In accordance with the terms of the underlying agreements, all outstanding
     shares of Series B, C, D, and E convertible preferred stock were
     automatically converted into common stock upon completion of the initial
     public offering.

     PREFERRED STOCK - In 1996, the Company authorized 1,000,000 shares of $1.00
     par value preferred stock.

     NOTES RECEIVABLE FOR STOCK ISSUANCES - In December 1992, the Company issued
     4,100 shares of Series D preferred stock to two officers of the Company in
     exchange for notes receivable totaling $410,000. Interest was payable
     quarterly at the applicable federal rate (approximately 5.3% at December
     31, 1994). At December 31, 1994, unpaid interest on the notes amounted to
     $47,062. The notes were secured by the related Series D preferred stock.
     Upon the resignation of the two officers from the Company in March 1995,
     the Company accepted the Series D preferred stock in payment of the notes
     and unpaid interest thereon.


                                       32


<PAGE>   33

AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


7.   STOCK COMPENSATION PLANS


<TABLE>
     At December 31, 1996, the Company has three stock-based compensation plans,
     which are described below. The Company applies APB Opinion 25 and related
     Interpretations in accounting for its plans. Accordingly, no compensation
     cost has been recognized for its fixed stock option plans and its employee
     stock purchase plan. The Company has no performance-based stock option
     plans. Had compensation cost for the Company's three stock-based
     compensation plans been determined based on the fair value at the grant
     dates for awards under those plans consistent with the method of SFAS 123,
     the Company's net income (loss) and per share amounts would have been
     adjusted to the pro forma amounts indicated below:
<CAPTION>

           Year ended December 31,                                           1996               1995
           ---------------------------------------------------------------------------------------------
            <S>                                         <C>              <C>                 <C>      
           Net income (loss)
                                                        As reported      $   259,382         $(342,962)
                                                        Pro forma        $(4,405,824)        $(580,611)

           Primary earnings (loss) per share
                                                        As reported      $      0.01         $   (0.17)
                                                        Pro forma        $    ($0.24)        $   (0.28)

           Fully diluted earnings (loss) per share
                                                        As reported      $      0.01         $   (0.17)
                                                        Pro forma        $     (0.24)        $   (0.28)
</TABLE>



     The fair value of each option grant in the pro forma presentation is
     estimated on the date of grant using the Black-Scholes option-pricing
     model. The following assumptions were used to determine the pro forma
     compensation cost of option grants in 1996 and 1995 for both stock option
     plans: dividend yield of 0%; expected volatility of 97%; risk-free interest
     rates of 6.25%; and expected lives of four years.

     FIXED STOCK OPTION PLANS - The Company has two fixed option plans. Under
     the 1990 Incentive and Nonstatutory Stock Option Plan, the Company may
     grant incentive stock options or nonqualified stock options to its
     employees and directors for up to 2,873,002 shares of common stock. Under
     the 1996 Stock Option Plan, the Company may grant incentive stock options
     or nonqualified stock options to its employees and directors for up to
     3,000,000 shares of common stock. Under both plans, options: are granted at
     an exercise price as determined by the Board of Directors; have a maximum
     term of ten years; and generally vest on a monthly basis over three years.



                                       33




<PAGE>   34


AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



<TABLE>
     A summary of the status of the Company's two fixed stock option plans as of
     December 31, 1996, 1995, and 1994, and changes during the years ending on
     those dates is presented below:

<CAPTION>

                                       1996                           1995                           1994
                             -----------------------------  ----------------------------  -----------------------------
                                            Wgtd. Avg.                     Wgtd. Avg.                    Wgtd. Avg.
                                 Shares     Exer. Price        Shares     Exer. Price        Shares      Exer. Price
                             -----------------------------  ----------------------------  -----------------------------
<S>                             <C>            <C>            <C>            <C>           <C>               <C> 
Outstanding at
  beginning of year             2,757,500     $ 1.21          2,481,948      1.45          1,533,448        $ .98
Granted                         1,818,250       9.10          1,139,750      1.30          1,138,000         1.45
Exercised                       1,083,162       1.02             16,867       .95             10,000          .95
Forfeited                          96,180      14.54            847,331      1.90            179,500         1.90
                               ----------                    ----------                    ---------         
Outstanding at                                                                         
   end of year                  3,396,408       7.71          2,757,500      1.21          2,481,948         1.45
                               ==========                    ==========                    =========        
                                                                                       
Options exercisable at year                                                            
end                             1,343,617                     1,447,474                    1,378,633
                                                                                       
Weighted-average fair value                                                            
of options granted during                                                              
the year                       $     6.07                    $     0.92                
                                                                                       
</TABLE>




<TABLE>
The following table summarizes information about stock options outstanding at
December 31, 1996:
<CAPTION>

                                     Options Outstanding                                   Options Exercisable
                     ----------------------------------------------------------  -----------------------------------------
                         Number         Weighted-Avg.                                  Number
 Range of             Outstanding        Remaining             Weighted-Avg.         Exercisable            Weighted-Avg.
Exercise Prices        at 2/31/96     Contractual Life        Exercise Price         at 12/31/96           Exercise Price
- ---------------      ----------------------------------------------------------  -----------------------------------------
 <S>                   <C>                  <C>                    <C>              <C>                       <C>   
 $  0 to 1                40,400            4.85 years             $  .95              40,400                 $  .95
    1 to 2             1,620,258            8.07                     1.30             910,173                   1.30
    8 to 9             1,456,000            9.39                     8.25             388,671                   8.25
  10 to 11               279,750            9.93                   $10.25               4,373                 $10.25
- -------------------------------------------------------------------------------   ----------------------------------------
                       3,396,408            8.83                   $ 7.71           1,343,617                 $ 6.37
===============================================================================   =========================================
</TABLE>

                                   

     EMPLOYEE STOCK PURCHASE PLAN - In June 1996, the Company adopted an
     Employee Stock Purchase Plan (the "ESPP Plan") under which eligible
     employees may 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. 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 with the
     Company. A total of 100,000 shares of common stock have been reserved for
     issuance. During 1996, no shares of common stock were issued under this
     plan, as the Company had not commenced implementation of the plan.


                                       34


<PAGE>   35

AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


8.   COMMITMENTS

     LEASE COMMITMENTS - During December 1994, management of the Company decided
     to relocate its office and research facilities and initiated negotiations
     to terminate its lease. In March 1995, the Company completed negotiations
     to terminate the lease effective May 31, 1995. The Company's cost to
     terminate the lease of approximately $180,000 was included in rent expense
     in 1994.

     The Company entered into a three year noncancelable operating lease for its
     office and research facilities commencing June 1, 1995. The lease provides
     that the Company pay a base monthly rental of $10,500, plus, as additional
     rent, a proportionate annual share of the building common expenses and real
     estate taxes in excess of a specified amount.

     In November 1996, the Company entered into a twelve month operating lease
     for additional space for its research facilities commencing December 1,
     1996. The lease provides that the Company pay a total monthly rental of
     $18,600, which includes the rental of furniture from the lessor.

     Rental expense approximated $143,000, $283,000, and $494,000 in 1996, 1995
     and 1994, respectively.


<TABLE>
     Future annual minimum lease payments under the leases are as follows:

<CAPTION>
                   Year
                   ------------------------------------
                   <S>                         <C>     
                   1997                        $330,000
                   1998                          52,000
                   ------------------------------------
                   Total                       $382,000
                   ====================================
</TABLE>



     LITIGATION - There are no material pending legal proceedings to which the
     Company is a party or to which any of its properties are subject which,
     either individually or in the aggregate, are expected by the Company to
     have a material adverse effect on its business, financial position or
     results of operations.



9.   TRANSACTIONS WITH RELATED PARTIES

     CONSULTING AGREEMENTS - The Company pays consulting fees for scientific
     research and development services provided by certain stockholders. The
     total charges from related parties approximated $8,000, $66,000, and
     $27,000 in 1996, 1995 and 1994, respectively. There were no amounts due to
     related parties at December 31, 1996 and 1995.


                                       35




<PAGE>   36

AWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


10.  MAJOR CUSTOMERS


<TABLE>
     The portion of total revenue that was derived from major customers was as
     follows:
<CAPTION>

                                          1996         1995         1994
         --------------------------------------------------------------   
         <S>                              <C>          <C>           <C>
         Customer A                       17%          23%           10%
         Customer B                       12%          12%           38%
         Customer C                       22%           -             - 
         Customer D                       10%           -             - 
         Customer E                        -           18%            - 
         Customer F                        -           10%            - 
</TABLE>





11.  EMPLOYEE BENEFIT PLAN

     In 1994, the Company established a qualified 401(k) Retirement Plan (the
     "Plan") under which employees are allowed to contribute certain percentages
     of their pay, up to the maximum allowed under Section 401(k) of the
     Internal Revenue Code. Company contributions to the Plan are at the
     discretion of the Board of Directors. There were no Company contributions
     in 1996, 1995 and 1994.



12.  QUARTERLY RESULTS OF OPERATIONS - UNAUDITED


<TABLE>
     The following table presents unaudited quarterly operating results for each
     of the Company's eight quarters in the two-year period ended December 31,
     1996:
<CAPTION>

                                                     1996
- ----------------------------------------------------------------------------------
 Quarters ended                  March 31,     June 30     Sept. 30       Dec. 31
                                 -------------------------------------------------
<S>                              <C>          <C>          <C>           <C>
 Revenue                         $962,003   $1,128,475   $1,505,820    $1,704,811
 Income (loss) from operations     17,651       18,300        4,250      (578,475)
 Net income (loss)                 41,151       48,668      261,683       (92,120)
- ----------------------------------------------------------------------------------

 Net income (loss) per share     $   0.00   $     0.00   $     0.01    $     0.00
==================================================================================
</TABLE>



<TABLE>
<CAPTION>

                                                      1995
- ----------------------------------------------------------------------------------
Quarters ended                   March 31,     June 30     Sept. 30       Dec. 31
                                 -------------------------------------------------
<S>                                <C>          <C>          <C>        <C>     
Revenue                         $ 950,376    $ 361,575     $963,498      $984,445
Income (loss) from operations    (115,837)    (562,514)     155,034        69,740
Net income (loss)                 (87,213)    (530,282)     179,965        94,568
- ----------------------------------------------------------------------------------
Net income (loss) per share     $  ( 0.04)   $   (0.26)    $   0.01      $   0.01
==================================================================================
</TABLE>



                                       36


<PAGE>   37




I
TEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

     None.











                                       37



<PAGE>   38



                                    PART III



ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

     Information with respect to Directors and Executive Officers and compliance
with Section 16(a) of the Exchange Act may be found in the sections captioned
"Directors and Executive Officers" and "Section 16(a) Beneficial Ownership
Reporting Compliance" appearing in the Company's definitive Proxy Statement to
be delivered to shareholders in connection with the Annual Meeting of
Shareholders to be held on Wednesday, May 21, 1997. Such information is
incorporated herein by reference.

EXECUTIVE OFFICERS OF THE REGISTRANT


<TABLE>
         The executive officers of the Company as of February 28, 1997 are:
<CAPTION>

                   NAME           AGE       POSITION
                   ----           ---       --------
<S>                               <C>       <C>                                                 
James C. Bender ..............    44        President, Chief Executive Officer, and Director
David C. Hunter ..............    41        Senior Vice President, Product Development
Richard P. Moberg ............    41        Chief Financial Officer and Treasurer
Edmund C. Reiter .............    33        Vice President, Advanced Products
Michael A. Tzannes ...........    35        Senior Vice President, Telecommunications
</TABLE>



James C. Bender has been President, Chief Executive Officer and a director of
the Company since October 1994. From April 1992 to February 1994, Mr. Bender
served as President and Chief Executive Officer of Logicraft, Inc., a network
service provider. From 1986 to April 1992, Mr. Bender serviced as Logicraft's
President and Chief Operating Officer. Mr. Bender received an M.B.A. from the
Harvard Graduate School of Business Administration and a B.S. from Lowell
Technological Institute.

David C. Hunter joined the Company in May 1996 as Senior Vice President, Product
Development. From 1982 to April 1996, Mr. Hunter served as Vice President,
Research and Development of I.D.E. Corporation ("IDEA"), a manufacturer of data
communications equipment. Mr. Hunter was a founder and director of IDEA. Mr.
Hunter received an M.B.A. with high distinction from the Harvard Graduate School
of Business Administration and a B.S. with distinction from Cornell University.

Richard P. Moberg joined the Company in June 1996 as Chief Financial Officer and
Treasurer. From December 1990 to June 1996, Mr. Moberg held a number of
positions at Lotus Development Corporation, a computer software developer,
including Corporate Controller from June 1995 to June 1996, Assistant Corporate
Controller from May 1993 to June 1995, and Director of Financial Services from
December 1990 to May 1993. Mr. Moberg received an M.B.A. from Bentley College
and a B.B.A. in accounting from the University of Massachusetts at Amherst.

Edmund C. Reiter has been the Company's Vice President, Advanced Products since
August 1995. Prior to that, he served as the Company's Manager of Product
Development for still image compression products from June 1994 to August 1995,
as a Senior Member of the Company's Technical Staff from November 1993 to June
1994, and as a Member of the Technical Staff from December 1992 to November
1993. Dr. Reiter served as Senior Scientist at New England Research, Inc. from
January 1991 to October 1992. Dr. Reiter received a B.S. from Boston College and
a Ph.D. from the Massachusetts Institute of Technology.


                                       38



<PAGE>   39



Michael A. Tzannes has been the Company's Senior Vice President,
Telecommunications since April 1996. Dr. Tzannes served as the Company's Vice
President, Telecommunications from December 1992 to April 1996, as a Senior
Member of the Company's Technical Staff from January 1991 to November 1992, and
as a consultant to the Company from October 1990 to December 1990. From 1986 to
1990, he was a Staff Engineer at Signatron, Inc., a telecommunications
technology and systems developer. Dr. Tzannes received a Ph.D. in electrical
engineering from Tufts University, an M.S. from the University of Michigan at
Ann Arbor, and a B.S. from the University of Patras, Greece.



ITEM 11. EXECUTIVE COMPENSATION

     Information with respect to this item may be found in the section captioned
"Compensation of Directors and Executive Officers" appearing in the Company's
definitive Proxy Statement to be delivered to shareholders in connection with
the Annual Meeting of Shareholders to be held on Wednesday, May 21, 1997. Such
information is incorporated herein by reference.



ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     Information with respect to this item may be found in the section captioned
"Security Ownership of Certain Beneficial Owners and Management" appearing in
the Company's definitive Proxy Statement to be delivered to shareholders in
connection with the Annual Meeting of Shareholders to be held on Wednesday, May
21, 1997. Such information is incorporated herein by reference.



ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     Information with respect to this item may be found in the section captioned
"Certain Transactions" appearing in the Company's definitive Proxy Statement to
be delivered to shareholders in connection with the Annual Meeting of
Shareholders to be held on Wednesday, May 21, 1997. Such information is
incorporated herein by reference.


                                       39




<PAGE>   40



                                     PART IV



ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K

(A)  (1) INDEX TO FINANCIAL STATEMENTS


The following consolidated financial statements are included in Part II, Item 8:

                                                                           Page
                                                                           ----

 Report of the Independent Accountants ................................     23
 Consolidated Balance Sheets as of December 31, 1996 ..................     24
 Consolidated Statements of Operations for each of the three                25
     years ended December 31, 1996 ....................................     
 Consolidated Statements of Cash Flows for each of the                      26 
     three years ended December 31, 1996 ..............................
 Consolidated Statements of Stockholders Equity for each of                 27
     the three years ended December 31, 1996 ..........................
 Notes to Consolidated Financial Statements ...........................     28


(2) INDEX TO FINANCIAL STATEMENT SCHEDULE

                                                                           Page
                                                                           ----
 Schedule II - Valuation and Qualifying Accounts ......................     42



 Schedules other than those listed above have been omitted since they
 are either not required or not applicable or the information is
 otherwise included.


(3) INDEX TO EXHIBITS

 EXHIBIT NO.  DESCRIPTION OF EXHIBIT
 ----------   ----------------------
 3.1           Amended and Restated Articles of Organization (filed as Exhibit 
               3.2 to the Company's Registration Statement on Form S-1, File No.
               333-6807 and incorporated herein by reference).
 3.2           Amended and Restated By-Laws (filed as Exhibit 3.3 to the 
               Company's Form 10Q for the quarter ended June 30, 1996
               and incorporated herein by reference).
 10.1          1990 Incentive and Non-Statutory Stock Option Plan (filed as 
               Exhibit 10.2 to the Company's Registration Statement on Form S-1,
               File No. 333-6807 and incorporated herein by reference).
 10.2          1996 Stock Option Plan (filed as Exhibit 10.3 to the Company's 
               Registration Statement on Form S-1, File No. 333-6807 and
               incorporated herein by reference).
 10.3          1996 Employee Stock Purchase Plan (filed as Exhibit 10.4 to the 
               Company's Registration Statement on Form S-1, File No. 333-6807
               and incorporated herein by reference).
 10.4          License Agreement with Analog Devices, Inc., dated 
               September 25, 1993,



                                       40



<PAGE>   41

               together with appendices thereto (filed as Exhibit 10.5 to the
               Company's Registration Statement on Form S-1, File No. 333-6807
               and incorporated herein by reference).
 10.5          Development Contract with Analog Devices, Inc., dated 
               September 25, 1993, together with amendments thereto (filed as
               Exhibit 10.6 to the Company's Registration Statement on Form S-1,
               File No. 333-6807 and incorporated herein by reference).
 10.6          Agreement with DSC Telecom L.P., dated March 6, 1996, (filed as 
               Exhibit 10.7 to the Company's Registration Statement of Form S-1,
               File No. 333-6807 and incorporated herein by reference).
 10.7          Lease Agreement dated April 3, 1995, with respect to real 
               property located at One Oak Park, Bedford, Massachusetts, between
               R.W. Connelly as lessor and the Company as lessee (filed as
               Exhibit 10.11 to the Company's Registration Statement on Form
               S-1. File No. 333-6807 and incorporated herein by reference).
 10.8*         Employment Agreement of James C. Bender, dated October 27, 1994,
               together with amendment thereto dated December 20, 1996.
 10.9          Form of Director Indemnification Agreement (filed as Exhibit 
               10.13 to the Company's Registration Statement on Form S-1, File
               No. 333-6807 and incorporated herein by reference).
 10.10*        Sublease Agreement dated November 15, 1996, with respect to real
               property located at 39 Manning Road, Billerica, Massachusetts,
               between Bay Networks, Inc. as sublandlord and the Company as
               sublessee.
 11.1*         Computation of primary and fully diluted net income (loss) per 
               share.
 21.1*         Subsidiaries of Registrant
 23.1*         Consent of Independent Accountants



* Filed herewith.


(B)  Reports on Form 8-K

       No reports on Form 8-K were filed during the fourth quarter of 1996.


                                       41



<PAGE>   42


                                                                    SCHEDULE II

                                   AWARE, INC.


<TABLE>
                        VALUATION AND QUALIFYING ACCOUNTS
                    YEARS ENDED DECEMBER 31, 1996, 1995, 1994

<CAPTION>
- ---------------------------------------------------------------------------------------
         COL. A              COL. B     COL. C (1)  COL. C (2)   COL. D      COL. E
- ---------------------------------------------------------------------------------------
                                              ADDITIONS
                                       ---------------------
                           BALANCE AT   CHARGED TO   CHARGED   DEDUCTIONS    BALANCE
                           BEGINNING     COSTS AND  TO OTHER   CHARGED TO     AT END
                           OF PERIOD     EXPENSES   ACCOUNTS    RESERVES    OF PERIOD
- ---------------------------------------------------------------------------------------
Accounts receivable
    allowances:
<S>                           <C>        <C>        <C>          <C>         <C>
1996 ....................     $5,300     $ 19,698   $20,000      $ 9,998     $ 35,000
1995 ....................          -     $  5,300         -            -     $  5,300
1994 ....................          -            -         -            -            -
                                     
                                     
                                     
Inventory reserves:                  
                                     
1996 ...................           -     $365,000         -      $65,000     $300,000
1995 ...................           -            -         -            -            -
1994 ...................           -            -         -            -            -
                                   
</TABLE>





                                       42




<PAGE>   43



                                   SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.


                                 AWARE, INC.



                                 By:  /s/ James C. Bender
                                     --------------------
                                 James C. Bender, Chief Executive Officer &
                                 President

                                 Date: March 26, 1997


Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities indicated on the 26th day of March 1997.



       SIGNATURE                                  TITLE
       ---------                                  -----

/s/ James C. Bender             Chief Executive Officer, President, and Director
- ---------------------------     (Principal Executive Officer)
James C. Bender                 


/s/ Richard P. Moberg           Chief Financial Officer, Treasurer
- ---------------------------     (Principal Financial and Accounting Officer)
Richard P. Moberg               


/s/ Charles K. Stewart          Chairman of the Board of Directors
- ---------------------------
Charles K. Stewart


/s/ Jerald G. Fishman           Director
- ---------------------------
Jerald G. Fishman


/s/ John K. Kerr                Director
- ---------------------------
John K. Kerr


/s/ John S. Stafford, Jr.       Director
- ---------------------------
John S. Stafford, Jr.




                                       43






<PAGE>   1
                                                                 EXHIBIT 10.8




                                  AWARE, INC.
                               ONE MEMORIAL DRIVE
                              CAMBRIDGE, MA  02142


                                             October 27, 1994


Mr. James C. Bender
272 Farley Road
Hollis, New Hampshire 03049

         Re:  Employment Agreement

Dear Mr. Bender:

         The purpose of this letter is to set forth our agreement with respect
to your employment by Aware, Inc. (the "Company"), as follows:


1.   TERM OF EMPLOYMENT.  Subject to sections 5 and 6 of this agreement, the
term of your employment shall begin on October 31, 1994, and end on December
31, 1997, except that the term shall be extended for up to ten one-year
periods, the first to begin on January 1, 1998, unless the Company has given
you written notice of non-extension at least twelve months before the date on
which the one-year extension would otherwise begin.

2.   SALARY AND BONUS.  During the term of your employment, you shall be paid a
salary at the annual rate of $180,000.00, payable monthly.  The Company, at the
discretion of its board of directors, may award you a bonus based upon the
Company's financial results and/or achievement of corporate objectives.

3.   TITLE AND LINE OF AUTHORITY.  The Company agrees that during the term of
your employment you shall have the title "President" and "Chief Executive
Officer" and agrees to use its best efforts to cause you to be
 appointed to its
board of directors as soon as possible after the date of this agreement and to
be reelected to the board at each election for directors held during the term
of your employment.  You agree to resign from the board of directors upon
expiration of your term of employment or its termination in accordance with
this agreement.  You shall report to the Company's board of directors.
Presently, the Board has designated Charles Stewart to act for the Board in
this reporting arrangement.

4.   EMPLOYEE BENEFITS.  You shall be entitled to participate in all Company
sponsored insurance or other employee benefit programs, on the same basis as
other employees.  If you elect not to participate in the Company's health
insurance program, the Company shall reimburse you for such health insurance
(medical/dental) as you elect to obtain from another source, up to
reimbursement of $500/month.  The Company shall also pay or reimburse you for:

<PAGE>   2
Mr. James C. Bender
October 27, 1994
Page 2



annual dues for your membership in the Harvard Club (Boston); access and use
charges for one cellular telephone in each of two automobiles owned or leased
by you; monthly and use charges for a telephone line for operation of a fax
machine in your home and the cost of acquiring such machine; and other ordinary
and necessary expenses incurred by you in pursuit of the Company's business for
which you provide the Company with receipts appropriate to support deduction
thereof by the Company for federal income tax purposes to the extent permitted
by law.  You shall be entitled to three (3) weeks paid vacation for each year
of your employment.

5.   TERMINATION:

         (a)     EXPIRATION OF TERM, ETC.  The term of your employment shall
end upon your death or your disability (as defined herein) or upon expiration
of your term of employment on December 31, 1997, or as extended pursuant to #1.
In the event of termination by reason of your death or disability, the Company
shall continue your compensation and benefits for a period of six (6) months
thereafter.  All vested options may be exercised until the second anniversary
of your death.  All vested non-statutory options may be exercised until the
third anniversary of your disability.  All vested incentive options may be
exercised until the first anniversary of your disability.  For the purpose of
the provision, "disability" shall mean your inability to perform any of the
material duties of your position with the Company, continuously for a period of
90 calendar days or for 120 days in any one year period, as mutually determined
by the Company and you or by a physician selected by the Company (for which
purpose you agree to submit to an examination by any such physician).

         (b)     TERMINATION WITH CAUSE.  The Company may terminate you for
"cause" (as defined herein), provided that you have been given at least 10
days' prior written notice, specifying the cause in reasonable detail, and the
opportunity to appear with your legal counsel at a meeting of the Company's
board of directors or at a meeting of the Executive Committee of the Company's
board of directors, at which at least a quorum is continuously present, to
explain or refute the alleged actions or omissions specified in such notice.
For the purpose of the provision, "cause" shall mean solely (i) negligent acts
or omissions that have been or will be the sole or primary cause of material
harm, financial or otherwise, to the Company, or (ii) conviction of a crime
involving moral turpitude or conviction of a crime the principal victim of
which is the Company.

<PAGE>   3
Mr. James C. Bender
October 27, 1994
Page 3



6.   TERMINATION WITHOUT CAUSE.  The Company may terminate your employment at
any time without cause, but in that event you shall be entitled to a severance
payment upon such termination equal to the salary that you would have been paid
pursuant to #2 of this agreement had your employment continued to the
expiration of its term, but not less than $180,000.00 nor more than
$270,000.00.  Such payment shall be made irrespective of any other employment
that you may have and any effort that you may, or may not, have made to seek or
obtain other employment.  For this purpose, the Company shall be deemed to have
terminated your employment without cause if the Company materially changes any
of your job titles or if there is a Change in Control of the Company.  Change
in Control means the occurrence during the Term of any of the following events:

         (a)  The Company is merged, consolidated or reorganized into or with
another corporation (or other legal person) and as a result of such merger,
consolidation or reorganization less than a majority of the combined voting
power of the then-outstanding securities of such corporation (or person)
immediately after such transaction are held in the aggregate by the holders of
voting stock of the Company immediately prior to such transaction;

         (b)  The Company sells or otherwise transfers all or substantially all
of its assets to another corporation (or other legal person) and as a result of
such sale or transfer less than a majority of the combined voting power of the
then-outstanding securities of such corporation (or person) immediately after
such sale or transfer are held in the aggregate by the holders of voting stock
of the Company immediately prior to such sale or transfer.

The dissolution of Novon, L.P. (or any other entity now holding stock in the
Company) and the resulting distribution of the Company's stock to the holders
of an interest in Novon, L.P. (or any other entity now holding stock in the
Company) shall not constitute a Change in Control during the Term hereof.  If
the Company elects to terminate your employment without cause during the Term
hereof, the effective date of termination of your employment for purposes of
the exercise of your stock options shall be thirty days after written notice is
given to you that the Company has elected to terminate your employment without
cause, even though you are no longer receiving compensation during said thirty
day period other than the severance pay referred to above.

7.   STOCK OPTIONS:  The Company does not currently have sufficient stock
available in its stock option plan to grant you the stock options that you
desire.  The Company will use its best efforts to

<PAGE>   4
Mr. James C. Bender
October 27, 1994
Page 4



have the stockholders agree to increase the amount of stock available in the
Company's stock option plan.  If the stockholders agree to the appropriate
increase in the amount of stock available in the stock option plan, the Company
will use its best efforts to have the Board of Directors grant you the
following stock options:

         (a)     FIRST OPTION.  an option to purchase 230,769 shares of its
common stock for $1.30/share.  This option shall become exercisable
cumulatively (i.e., "vest") at the rate of 6,410.25 shares at the end of each
consecutive calendar month starting with November 1994, such that it shall be
fully-vested and exercisable upon the last day of October 1997 and thereafter
until expiration.  The options to be granted pursuant to this #7(a) shall be
incentive stock options as defined in Section 422 of the Internal Revenue Code
of 1986 and shall be granted pursuant to the Company's Stock Option Plan.

         (b)     SECOND OPTION.  an option to purchase 269,231 shares of its
common stock for $1.30/share.  This option shall become exercisable
cumulatively (i.e., "vest") at the rate of 7,478.64 shares at the end of each
consecutive calendar month starting with November 1994, such that it shall be
fully-vested and exercisable upon the last day of October 1997 and thereafter
until expiration.

         (c)     THIRD OPTION.  an option to purchase 300,000 shares of its
common stock for $1.30/share.  This option shall become exercisable (i.e.,
"vest") at the rate of fifty (50) shares for each $1,000 of pre-tax profit
realized by the Company during the period October 1, 1994 - December 31, 1997,
as such profit is shown on the statements of operations prepared by the Company
for each year and examined and reported upon by such independent accountants as
the Company engages for such purpose.  If you are still employed by the
Company, on January 15, 1998 this option shall become exercisable as to 150,000
shares, even if the Company has not realized a pre-tax profit.

         (d)  The options to be granted pursuant to this #7(b) and (c) shall be
non-statutory stock options and shall be granted pursuant to the Company's
Stock Option Plan.  Prior to execution of this Agreement, the Company has
provided you with a copy of the forms to be used for the options to be granted
to you pursuant to this Agreement.  The options shall be granted as of November
1, 1994 and expire on the eighth anniversary of their date of grant.

         The options shall become exercisable in full (i.e., "vest") upon any
Change of Control of the Company.

<PAGE>   5
Mr. James C. Bender
October 27, 1994
Page 5



8.   NON-COMPETITION, ETC.  You agree to execute and be bound by the Company's
standard "Employee Agreement" concerning inventions, confidentiality and
non-competition.  A copy of this Employee Agreement is attached hereto.

9.   SECURITY CLEARANCE.  If requested to do so by the Company, you agree to
apply for a federal security clearance and to comply with all the regulations
regarding the same.

10.   INDEMNIFICATION.  The Company has provided you with a copy of the
provision(s) of its by-laws or articles of organization providing
indemnification to officers and directors of the Company in respect of their
acts and omissions as such.  The Company agrees that you shall be entitled to
the indemnification provided thereby.  A copy of such provision(s) is attached
hereto and incorporated herein.

11.   ARBITRATION.  Any dispute arising hereunder or related hereto shall be
resolved exclusively by arbitration by a single arbitrator in Boston in
accordance with the rules for commercial arbitration of the American
Arbitration Association, except that the Company shall be entitled to seek
injunctive relief from any Court of competent jurisdiction for any violation by
you of your obligation under Sections 8 and 9.  Such arbitration shall be final
and binding.  Judgment may be entered upon any arbitral award in any court of
competent jurisdiction.  No arbitrator may award punitive, multiple, statutory,
or other non-compensatory damages.

12.   MISCELLANEOUS.  This Agreement is to be construed and enforced under the
laws of Massachusetts.  This Agreement expresses the complete understanding of
the parties with respect to the subject matter hereto and is intended to
supersede any prior or contemporaneous written or oral agreements.

                                        AWARE, INC.


                                        By:/s/ Charles Stewart
                                           --------------------------
                                              Charles Stewart,
                                              Chairman of the Board

Accepted and agreed to:


/s/ James C. Bender           
- --------------------------
     James C. Bender

<PAGE>   6
                              [AWARE, INC. LOGO]


                                   A W A R E


December 20, 1996


Mr. James C. Bender
Aware, Inc.
One Oak Park
Bedford, Massachusetts 01730

RE:  Amendment to Employment Agreement
     ---------------------------------

Dear Mr. Bender:

     The purpose of this letter is to set forth our agreement to amend the
employment agreement between Aware, Inc. (the "Company") and yourself dated
October 27, 1994 (the "Original Employment Agreement"), as follows:

1.   TERM OF EMPLOYMENT. Section 1 of the Original Employment Agreement is
hereby amended to read as follows in its entirety:

        "1. Term of Employment. Subject to Section 6 of this agreement, the
        term of your employment shall begin on January 1, 1997 and end on
        December 31, 2000, except that the term shall be extended for up to
        (5) one-year periods, the first to begin on January 1, 2003, unless
        the company or you has given the other written notice of non-extension
        at least six (6) months before the date on which the one-year extension
        would otherwise begin."

2.   SALARY AND BONUS: Section 2 of the Original Employment Agreement is hereby
amended by deleting the term "$180,000.00" and replacing it with the term
"$200,000.00.

3.   EMPLOYEE BENEFITS. Section 4 of the Original Employment Agreement is
hereby amended to insert the following phrase in the third sentence:
"initiation fees up to a maximum of $40,000, and annual dues up to a maximum of
$6,000, at a golf or country club;"






<PAGE>   7
4.   TERMINATION. Section 5(a) of the Original Employment Agreement is hereby
amended by deleting the date December 31, 1997" from the first sentence and
replacing it with the date "December 31, 2002.

5.   TERMINATION WITHOUT CAUSE. Section 6 of the Original Employment Agreement
is hereby deleted in its entirety and the following new Section 6 is
substituted therefor:

        6. TERMINATION BY YOU. You may terminate your employment with the
        Company by providing the Company at least three (3) months' prior
        written notice. If such termination occurs on or before December 31,
        1997 you shall forfeit thirty percent (30%) of the portion of each of
        the stock options described in Section 7 that is vested and unexercised
        on the date on which you give the Company such notice and no further
        vesting of any such option shall thereafter occur. If such termination
        occurs between January 1, 1998 and December 31, 1998 you shall forfeit
        twenty percent (20%) of the portion of each of the stock options
        described in Section 7 that is vested and unexercised on the date on 
        which you give the Company such notice and no further vesting of any
        such option shall thereafter occur.

7.   LIFE INSURANCE. A new Section 6A is hereby added to the Original
Employment Agreement, to read as follows in its entirety:

        "6A. LIFE INSURANCE. During the term of your employment by the Company,
        the Company shall pay or reimburse you (as you may elect) for premiums
        on a term life insurance policy (renewable to age 65) on your life in
        the principal amount of $1 million, subject to the Company's prior
        approval of the insurance contract (including amount of premiums 
        payable), which shall not be unreasonably withheld or delayed."

     If this letter accurately sets forth our agreement regarding amendment of
the original Employment Agreement, please sign and return to the Company the
enclosed copy of this letter.

                                   AWARE, INC.


                                   By: /s/ Charles K. Stewart
                                       -----------------------------------------
                                       Charles K. Stewart, Chairman of the Board


Accepted and agreed to:

/s/ James C. Bender
- -------------------
James C. Bender
President & CEO





<PAGE>   1

                                                                   EXHIBIT 10.10




                               SUBLEASE AGREEMENT

     THIS SUBLEASE AGREEMENT (the "Sublease" or "Sublease Agreement") is entered
into on this 15th day of November, 1996 by and between BAY NETWORKS, INC., a
Delaware corporation with its principal business address at 4401 Great America
Parkway, Santa Clara, CA 95052 ("Sublandlord") and AWARE, INC., a Massachusetts
corporation having an office address at One Oak Park, Bedford, MA 01730-1413
("Subtenant").

     WHEREAS, Wellfleet Communications, Inc., which was merged into Bay
Networks, Inc. on October 21, 1994, entered into a Lease Agreement dated as of
October 22, 1991 (the "Original Lease") which Original Lease has been amended by
that certain First Amendment to Lease (the "First Amendment") dated August 31,
I992 and that certain Second Amendment to Lease (the "Second.Amendment") dated
October 20, 1993 and that certain Third Amendment to Lease (the "Third
Amendment") dated June 30, 1995 and that certain Fourth Amendment to Lease (the
"Fourth Amendment") dated September 1995 and that certain FitSh Amendment to
Lease (the "Fifth Amendment") dated April 1996 (said Original Lease as amended
by the First Amendment, the Second Amendment, the Third Amendment, the Fourth
Amendment, the Fifth Amendment is hereinaRer collectively
 referred to as the
"Master Lease") with respect to certain Premises located in the Building known
as 39 Manning Road, Billerica, MA;), a copy of which is attached hereto as
Exhibit A, under which it leases 80,000 rentable square feet of office space
from WRC Properties, Inc. as assumed by Teachers Insurance Corporation,
("Landlord") in the building known as 39 Manning Road, Billerica, MA as provided
in the Master Lease, together with certain appurtenant fights, the provisions of
which Master Lease, portions of which are incorporated herein by reference; and

     WHEREAS, Sublandlord desires to sublease to Subtenant and Subtenant desires
to sublease from Sublandlord the premises leased by Sublandlord under the Master
Lease on the. terms and conditions hereinafter provided,

NOW, THEREFORE, in consideration of the mutual promises herein provided, the
parties agree as follows:

     1. PREMISES AND TERM. Sublandlord hereby subleases to Subtenant and
Subtenant hereby subleases from Sublandlord a portion of the premises consisting
of approximately 15,953 rentable square feet, located and configured as shown on
EXHIBIT B hereto (the "Premises"), upon and subject to the covenants,
agreements, terms and conditions herein provided, for term commencing on the
later to occur of: (a) Landlord's consent to this Sublease; or (b) completion of
Subtenant's Work by Sublandlord (as defined on Exhibit's B & C, "Sublandlord's
Work"); or (c) December 1, 1996 (the "Commencement") and terminating on November
30, 1997. Such Term may be extended under the same terms and conditions through
February 28, I998, by written notice from Subtenant on or before August 31,
1997.

     2. RENT. Subtenant covenants and agrees to pay net rent to Sublandlord for
the Premises as follows: Annual rental of $63,812.00 in net rent plus
$111,671.00 for operating expenses and real estate taxes, due and payable in
advance on the first day of each month in monthly payments of $14,623.58. The
parties acknowledge that the operating and real estate tax expense is a good
faith estimate by Sublandlord and Subtenant agrees to pay and Sublandlord to





<PAGE>   2



                                     Page 2

         

receive such amount without further documentation and/or adjustments. Payments
for any partial month shall be calculated on a prorated basis based on the
number of days in the month.

               All payments shall be made to:

               Bay Networks, Inc.
               8 Federal Street
               Billedca, MA 01821
               Attention: Real Estate Lease Administrator

     3. USE. The Premises shall be used for offices and uses accessory thereto
light manufacturing, research and development, and warehousing and distribution,
but in no event for any uses not permitted under the Master Lease.

     4. INCORPORATION OF MASTER LEASE. Except as otherwise provided herein, all
of the rights, remedies, covenants, agreements, terms and conditions of the
Master Lease relating to or applicable to the Sublandlord under the Master Lease
with respect to the Premises are incorporated herein and made a part hereof with
the same force and effect as if set forth at length herein, except to the extent
the same are modified or amended by this Sublease, it being understood and
agreed that said provisions shall fix the obligations, rights and remedies of
the Subtenant with the same effect as if the Subtenant were the tenant named in
the Master Lease. Except as otherwise provided herein, Subtenant agrees that
Sublandlord shall have all of the rights and remedies of the Landlord under the
Master Lease relating to the Premises with respect to Subtenant as if such
rights and remedies were fully set forth herein. To the extent of a conflict
between the terms of the Master Lease and this Sublease, the latter shall
control.

     5. CONDITION OF PREMISES. Subtenant represents that it has inspected the
Premises and agrees to accept possession of the Premises in their present
condition without any obligation on the part of Sublandlord to make any
alterations, decorations, installations or improvements, other than the work
outlined and described in Exhibit C "Sublandlord's Work", to be completed by
December I, I996. Subtenant may make alterations and improvements to the
Premises beyond those described in Exhibit C, in accordance with the applicable
provisions of the Master Lease; provided, however, Subtenant will be required to
remove such alterations and improvements and restore the Premises upon the
expiration or termination of this Sublease Agreement to the extent required by
the Master Lease. With respect to Sublandlord's Work, Sublandlord will notify
Subtenant thirty (30) days prior to the expiration of the initial term and/or
the extension term, as to the extent, if any, to which the Subtenant shall
remove the Sublandlord's Work and restore the Premises to its initial condition
ordinary wear and tear or casualty damage excepted.

     6. ADHERENCE TO MASTER LEASE. (i) Subtenant covenants and agrees (a) to
perform and observe all of the agreements, covenants, terms and conditions of
the Master Lease with respect to the Premises (and the buildings and common
areas, to the extent applicable) to the extent that the same are not modified or
amended by this Sublease, and (b) that it shall not do or suffer or permit
anything to be done which would constitute a default under the Master Lease with
respect to the Premises, and (c) that notwithstanding any other provision of
this Sublease to the contrary, any act or omission which constitutes a default
under the Master Lease with respect to the Premises also constitutes a default
hereunder.





<PAGE>   3

                                     Page 3



(ii) Sublandlord covenants and agrees (a) that it shall not do (or fail to do)
or suffer or permit anything to be done which would constitute a default under
the Master Lease, or which would cause a termination of the Master Lease, and
(b) that it shall not modify or amend the Master Lease in such a manner as to
adversely affect Subtenant's use, occupancy and/or enjoyment of the Premises,
without Subtenant's consent, which shall not be unreasonable withheld.

     7. DEFAULT. If any default by Subtenant continues, in the case of payment
of rent or any other sum owned by Subtenant, for more than ten (10) days after
written notice from Sublandlord, or in the case of any of Subtenant's other
covenants, agreements or obligations under this Sublease or the Master Lease for
more than thirty (30) days after notice by Sublandlord or such additional time
as may be necessary if such default is not susceptible of cure within 30 days,
provided Subtenant promptly commences to cure and diligently prosecutes the same
until completion. Sublandlord may immediately or at any time thereatSer and
without further notice terminate this Sublease and take any and all actions
permitted to be taken by the Landlord under the Master Lease in respect of a
default by the tenant thereunder or any termination as a result thereof.

     8. PARKING. During the term of this Sublease, Subtenant shall be entitled
to use a proportionate share in common with Sublandlord.

     9. INDEMNITY. Subtenant and Sublandlord shall indemnify and hold harmless
from and against any and all cost, expense or liability (including reasonable
attorneys fees) incurred on account of either party's actions or the actions of
its employees, agents, licensees or contractors on or about the Premises or on
account of any breach or violation by Subtenant or Sublandlord of this Sublease,
or the Master Lease, unless the same is due in substantial part to the
negligence of either party's employees, agents, licensees, or contractors.
Subtenant and Sublandlord hereby releases and waives any fight or claim against
the other for loss of business, loss of profits, inconvenience, or for any other
incidental or consequential damages.

     10. ASSIGNMENT. Subtenant shall not assign this Sublease nor further sublet
the Premises in whole or in part, and shall not permit Subtenant's interest in
this Sublease Agreement to be vested in any third party by operation of law or
otherwise. A change of control of Subtenant shall not be deemed to be an
assignment for the purposes of this Section I0, except, if the acquirer of
Subtenant is a direct competitor of the Sublandlord.

     11. AUTHORITY. Subtenant represents and warrants that it has read and is
familiar with the terms of the Master Lease. Subtenant and Sublandlord represent
and warrant that each has all requisite corporate power and authority to enter
into this Sublease.

     12. LATE CHARGES. Other remedies for non-payment of rent notwithstanding,
any rental payment not received within ten (10) days of the date it was due
shall bear interest at 18% annually from the date the rent was due, which fee is
a service charge intended to compensate Sublandlord for the additional
administrative and other costs and expenses it incurs by reason of such late
payment.








<PAGE>   4

                                     Page 4

     13. BROKERS. Sublandlord and Subtenant each represent to the other that
they have not retained or dealt with any broker or agent in connection with this
Sublease Agreement other than Avalon Partners, Inc. whose commission shall be
paid entirely by Sublandlord. Each party agrees to indemnify and hold the other
harmless from and against any breach of the foregoing representation.

     14. INSURANCE. During the term of this Sublease Agreement, Subtenant shall
maintain public liability and property damage insurance in accordance with the
provisions of the Master Lease. Subtenant shall maintain fire and extended
coverage insurance on its fixtures, equipment and leasehold improvements in
amounts equal to the full insurable value thereof. Sublandlord and Subtenant
each release the other from any liability for loss or damage sustained by it to
the extent the' same would be or is covered by insurance as herein provided.
Subtenant shall name Sublandlord and Landlord as an additional insured on its
comprehensive liability insurance policy and shall provide Sublandlord and
Landlord with a Certificate of Insurance certifying said coverage prior to
taking possession of the Premises.

     15. SERVICES AND REPAIRS. (i) Except as provided in subparagraph (ii)
herein, it is understood that all work, services; repairs, restorations,
equipment and access which are required to be provided and made by Sublandlord
hereunder or by Landlord under the Master Lease, will, in fact, be provided by
the Landlord under the Master Lease, and Sublandlord shall have no obligation
during the term of this Sublease Agreement to do any such work, to provide any
such services, equipment or access, or to make any such repairs or restorations
or otherwise perform any obligations or observe any conditions required to be
observed or performed by Landlord under the Master Lease, and Subtenant agrees
to look solely to the Landlord under the Master Lease for the performance and
observance of the same. Sublandlord shall in no event be liable to Subtenant nor
shall Subtenant's obligations hereunder be impaired or the performance thereof
excused because of any failure or delay on the part of the Landlord under the
Master Lease in performing or observing the obligations of the Landlord under
the Master Lease, provided, however, that if a failure by the Landlord under the
Master Lease materially interferes with Subtenant's use and occupancy of the
Premises, and Subtenant so notifies Sublandlord in writing, Sublandlord shall
use its best efforts to cause the Landlord under the Master Lease to promptly
correct the failure.

Not withstanding the foregoing, if (a) Subtenant's use, occupancy and/or
enjoyment of the Premises is adversely affected as a result of (1) Landlord's
failure or delay to perform its obligations under the Master Lease, or (2)
Sublandlord's failure or delay to perform its obligations under the Sublease, or
(3) by reason of interruption, suspension or delay of work, services repairs,
restorations, equipment and access, and (b) Sublandlord shall be entitled to an
abatement of rent under the Master Lease as a result of the foregoing, then
Subtenant shall be entitled to an equitable abatement of rent under this
Sublease.

(ii) Any maintenance required of Subtenant under the Master Lease (including
without limitation Section 7.2 of the Master Lease) will be performed by
Sublandlord and paid by Sublandlord unless such repair or maintenance is the
result of Subtenants negligence in which the cost will be billed to Subtenant.





<PAGE>   5



                                     Page 5

     16. ACCESS. Subtenant agrees to allow Sublandlord and its agents access to
the entire Premises at any time, with reasonable advance notice to inspect
Subtenant's compliance with the terms of this Sublease.

     17. SURRENDER OF PREMISES. Subtenant agrees that time shall be of the
essence with respect to Subtenant's obligation to surrender possession of the
Premises to Sublandlord upon the termination of the term of this Sublease, and
further agrees that in the event that Subtenant does not promptly surrender
possession of the Premises to Sublandlord upon such termination, Sublandlord, in
addition to any other rights and remedies Sublandlord may have against Subtenant
for such holding over, shall be entitled to bring summary proceedings against
Subtenant, and Subtenant agrees to reimburse Sublandlord for all Sublandlord's
damages sustained by reason of such holding over (subject to the provisions of
Paragraph 9 of this Sublease), including without limitation, Sublandlord's
reasonable attorneys' fees and disbursements incurred in connection with the
exercise by Sublandlord of its remedies against Subtenant.

     18. NOTICES. Any notice, approval, consent or election made pursuant to
this Sublease or the Master lease shall be in writing and shall be deemed duly
delivered upon receipt if delivered personally or if mailed by registered or
certified mail, return receipt requested, or by a reputable nationally
recognized overnight carrier, addressed

     if to Sublandlord: to the attention of the Real Estate Manager, Bay
Networks, Inc., 8 Federal Street, Billedca, MA 01821.

     if to Subtenant; to the President of Aware, Inc., One Oak Park, Bedford, MA
01730

Either party may, by notice as aforesaid, direct that future notices be sent to
a different address.

     19. ENTIRE AGREEMENT. All prior understandings and agreements between the
parties with respect to the subject matter hereof are merged within this
Sublease. The covenants and agreements herein contained shall bind and inure to
the benefit of Sublandlord, Subtenant, and their respective successors and
permitted assigns.

     20. EFFECTIVENESS. This Sublease shall be effective only when executed by
Sublandlord and Subtenant and approved by the Landlord under the Master Lease.

     21. MISCELLANEOUS.

(a) If any dispute should arise between Sublandlord and Subtenant with respect
to interpretation or performance of this Sublease, the non-prevailing party
shall pay the prevailing party's reasonable attorneys' fees and costs.

(b) This Sublease shall be governed by and interpreted under and construed and
enforced in accordance with the laws of the State Massachusetts.





<PAGE>   6




                                     Page 6


(c) No modification, change or amendment of fids Sublease shall be binding upon
either party unless such modification, change or amendment is in writing, duly
authorized and signed by Sublandlord and Subtenant and consented in writing by
Landlord.

(d) Notwithstanding anything to the contrary contained herein, the parties
rights and duties herein are subject and subordinate to the requirements of the
Consent To Sublease among Sublandlord, Subtenant and Landlord.

     IN WITNESS WHEREOF, the parties hereto have caused this Sublease Agreement
to be executed under seal by an officer duly authorized, as of the day and year
first above written.


                         SUBLANDLORD:   BAY NETWORKS, INC.
                                          
                                        By: /s/ Berry E. Beswick
                                            ---------------------------
                                            Berry E. Beswick  
                                            U.S. Real Estate Manager

                         SUBTENANT:     Aware, Incorporated

                                        By: /s/ Richard Moberg
                                            ---------------------------
                                            Richard Moberg
                                            Chief Financial Officer


     As Landlord under the Master Lease, this Sublease Agreement is hereby
consented to and approved in accardance with the applicable provisions of the
Master Lease, by Landlord's duly authorized officer.

                                    LANDLORD

                                    By:
                                        -------------------------------
                                        Its





                                      

<PAGE>   7

                                    EXHIBIT B

                                      MAP

PROPOSED SPACE  -  AWARE, INC.
39 MANNING ROAD
BILLERICA, MA          1/8" = 1'0"




21   HARD WALL OFFICES
41   CUBICAL OFFICES
 1   CONFERENCE
 1   LAB
 1   RECEPTION AREA
 1   VESTIBULE

- ----------------------
15,404 SQ.FT.  USEABLE SPACE
    549 SQ.FT.  BATHROOMS / CORE AREA

- ----------------------
15,953 SQ.FT.  SPACE TO BE LEASED




<PAGE>   8


                                    EXHIBIT C
                        Description of Sublandlord"s Work


Sublandlord shall construct and install the items as described below on behalf
of the Subtenant in accordance to the mutually agreed upon floor plan outlined
on Exhibit B. All work shall be performed in good workman like manner in
accordance with all applicable local, state and federal codes.

1. Construct eleven (11) 10 x 12 full height offices, framed and finished to the
underside of the ceiling using existing carpet, lighting and ceiling.

2. Construct common vestibule on the southwest wall approximately 320 square
feet (16 x 20) including all framing, doors & Hardware and security system.

3. Convert large conference room on the southwest wall into two private offices
of equal size, framed to the underside of the ceiling using existing carpet,
lighting and ceiling.

4. All necessary mechanical, electrical and plumbing for each office will be in
accordance with building standards and all building codes.

5. Remove approximately 4,500 square feet of existing carpet and replace with
VCT tile floor as outlined in the shaded area on Exhibit B.

Both Sublandlord and Subtenant agree the final cost for the above work will be
$39,855.00 and payable by the Subtenant within thirty (30) days from the
completion of such work.

The Subtenant agrees that all change orders and punch list items or any other
construction issues during and after construction will be resolved between the
Subtenant and Siena Construction. The Sublandlord agrees that it will use
reasonable efforts to assist in the resolution of any issues between these
parties.

Any change orders shall be approved by Subtenant and Sublandlord. In addition,
Sublandlord shall construct the demising wall, and necessary fire exits at its
own expense.





<PAGE>   1

                                                                    EXHIBIT 11.1

                                   AWARE, INC.


<TABLE>
                    COMPUTATION OF PRIMARY AND FULLY DILUTED
                           NET INCOME (LOSS) PER SHARE


<CAPTION>
                                                                   YEARS ENDED DECEMBER 31,
                                                                  --------------------------
                                                                      1996          1995
                                                                  -----------   ------------

<S>                                                               <C>           <C>
Net income (loss) .............................................   $   259,382   ($  342,962)
                                                                  ===========   =========== 


Weighted average number of common and common stock
  equivalent shares outstanding:
    Common stock ..............................................    10,841,919     1,162,717
    Convertible preferred common stock equivalents ............     5,467,106             -
    Option common stock equivalent shares .....................     1,682,421             -
    Effect of SAB 83 ..........................................       402,949       882,289
                                                                  -----------   ----------- 
      Common and common stock equivalent shares outstanding for
        purpose of calculating primary net income per share ...    18,394,395     2,045,006
    Incremental shares to reflect full dilution ...............       234,003             -
                                                                  -----------   ----------- 
      Total shares for purpose of calculating fully diluted net
        income per share ......................................    18,628,398     2,045,006
                                                                  -----------   ----------- 

Primary net income (loss) per share ...........................   $      0.01   ($     0.17)
                                                                  ===========   =========== 

Fully diluted net income (loss) per share .....................   $      0.01   ($     0.17)
                                                                  ===========   =========== 

</TABLE>








<PAGE>   1



                                                                    EXHIBIT 21.1
                                                                  

                           SUBSIDIARIES OF REGISTRANT



     NAME OF ORGANIZATION                              JURISDICTION
     --------------------                              ------------

     Aware Security Corporation......................  Massachusetts











<PAGE>   1

<
                                                                    EXHIBIT 23.1



                       CONSENT OF INDEPENDENT ACCOUNTANTS



We consent to the incorporation by reference in Registration Statement 
No. 333-15805 of Aware, Inc. on Form S-8, of our report dated January 30, 1997,
appearing in this Annual Report on Form 10-K of Aware, Inc. for the year ended
December 31, 1996.




/s/  Deloitte & Touche LLP

Boston, Massachusetts
March 26, 1997







<TABLE> <S> <C>

<ARTICLE> 5
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
       
<S>                             <C>
<PERIOD-TYPE>                   YEAR
<FISCAL-YEAR-END>                          DEC-31-1996
<PERIOD-START>                             JAN-01-1996
<PERIOD-END>                               DEC-31-1996
<EXCHANGE-RATE>                                      1
<CASH>                                          36,719
<SECURITIES>                                         0
<RECEIVABLES>                                    1,801
<ALLOWANCES>                                        35
<INVENTORY>                                        448
<CURRENT-ASSETS>                                38,956
<PP&E>                                           1,725
<DEPRECIATION>                                     558
<TOTAL-ASSETS>                                  40,123
<CURRENT-LIABILITIES>                              676
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</TABLE>