Aware Inc (AWRE) 2005 Q2 法說會逐字稿

Good day, everyone. Thank you for your patience. We would like to welcome you to the Aware, Inc. second quarter 2005 earnings release conference call. As a reminder, today's call is being recorded.

At this time, I would like to turn the conference over to the CFO, Robert Weiskopf. Mr. Weiskopf, please go ahead.

Thank you. Welcome to Aware's second quarter 2005 earnings conference call. I am Robert Weiskopf, the Company's CFO. With me is Michael Tzannes, Aware's CEO. Thank you for joining us today.

The agenda for the call will be as follows. I will review financial results for the quarter. Next, Michael will (technical difficulty) present. And finally, we will take your questions. A recording of this call will be available on our website at Aware.com after the call is completed.

First, I would like to point out that various remarks we make about future expectations, plans and prospects for the Company and the DSL market constitute forward-looking statements for purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in the section titled "Factors that May Affect Future Results" in our annual report on Form 10-K for the year ended December 31, 2004, which is on file with the SEC.

Turning now the financial results, second quarter 2005 revenue was 2.7 million, and EPS was a loss of $0.07 per share. Last year in Q2, revenue was 3.7 million, and we lost $0.04 per share. Product revenue was 0.8 million this quarter, which compares to 1 million last quarter and 1 million a year ago. Product revenue this quarter consisted of software sales for biometrics and medical imaging, as well as hardware sales for ADSL tests and diagnostics.

Contract revenue was 1 million this quarter, which compares to 2.2 million last quarter and 1.8 million a year ago. Contract revenue was down this quarter primarily because fewer milestones were achieved under contracts with existing or new customers.

Royalty revenue was 0.9 million this quarter, which compares to 1.1 million last quarter and 0.9 million a year ago. For the quarter, Analog Devices and Infineon continued to be top customers.

Q2 spending was 4.5 million, which compares to 4.8 million last quarter and 4.6 million in last year's second quarter. The sequential decrease in spending was predominantly due to higher product development costs incurred last quarter. Lower spending in this quarter compared to last year's Q2 was primarily due to decreased cost of sales on lower hardware product sales and lower depreciation costs, partially offset by higher salary and fringe benefit costs.

Interest income was $272,000 for the quarter at a 2.8 annualized interest rate. Our balance sheet is in excellent shape. Cash and investments were 38.7 million at the end of June. Receivables were 1.9 million at quarter end, which translates into days sales outstanding of 65 days. Our inventory levels were minimal, and we have no debt.

On June 30, we had 104 full-time employees. 74 of these employees were engineers. And finally, regarding capital stock, there were approximately 23.1 million shares outstanding at quarter end.

This completes my financial commentary. Now, I would like to turn the call over to Michael.

Thank you, Rob. Our conference call today is going to lay out in a lot of specific detail our road map for Aware's DSL licensing products. The emphasis today will be on DSL licensing. We will also present a general discussion of our tested diagnostics and biometrics and medical imaging products.

There are a number of changes underway in the ADSL industry and at Aware that make outlook for Aware's o licensing business very positive. These are the emergence of new standards, which is introducing a new level of complexity in the industry so that it is difficult to stay competitive at the silicon level without a large and focused effort. ADSL2+ was standardized several years ago, and VDSL2 was standardized in May of this year.

New chips must be designed, and new performance and interoperability requirements must be met. This can only be accomplished with a dedicated, large team effort. Most companies do not have the resident experience to develop this technology.

Another important change that is underway is that demand for new applications to deliver additional value to consumers is driving steady growth in lines in (ph) service. Infonetics estimates that DSL chipset sales will grow from about 90 million in 2004 to over 140 million in 2006, and over 180 million in 2008. The number of new lines deployed in these years will be about 30 to 40 million per year. This is according to Yankee Group, Infonetics and our own estimates here at Aware.

This means that new services and/or new devices are being deployed in large numbers on lines already in service. This market for DSL chipsets is new, and is being driven by new applications being delivered by service providers. The delivery of television over DSL is an example. The combination of video and other services, known as triple play, is another example.

This means that the new versions of DSL are bringing a capability to the phone company that today they cannot deliver. While some companies may opt to deploy fiber all the way to the home, the largest volume of deployments will involve fiber delivered to points closer to homes, and then new DSL technology such as ADSL2+, bonded ADSL2+, and VDSL2. This new world is opening new revenue opportunities for phone companies, telecommunications equipment companies, and consumer electronics companies.

Another important change that is underway, and this one is something that we have had direct impact on, is our StratiPHY product family. StratiPHY2+ is a complete digital solution for the customer premises equipment chipset market. It supports ADSL2+, ADSL2 and legacy ADSL standards in a cost-effective silicon implementation that, through a licensing model, can be easily integrated by any semiconductor company. This product is the engine in the Analog Devices, Infineon, Thomson, Atmel, as well as other unannounced customers' ADSL CPE products.

In addition to StratiPHY2+, we also now have our StratiPHY3 product, which supports both customer premise equipment and central office configurations for VDSL2, VDSL1, ADSL2+, ADSL2, and legacy ADSL. We have VDSL2 running at 100 megabits per second in our labs today. We will work with Alcatel and other leading DSLAM suppliers just as we have with ADSL2+ and bonded ADSL2+ to ensure interoperability and establish performance goals.

StratiPHY3 and Infineon's VINAX-CO and CPE VDSL2 chipset are some of the first products in the market that support these new standards.

We also intend to continue to aggressively pursue product development in our StratiPHY product line. During 2006, we will be making available analog companion silicon intellectual property for our StratiPHY2+ and StratiPHY3 products. This is based upon product developments that have been underway for several years, and we expect to see mature solutions available in the early 2006 timeframe.

The addition of the analog front-end to our digital StratiPHY product line will improve our value proposition to our customers by making an analog front-end available to those who do not have access to analog technology or do not desire to purchase from the third-party market.

To summarize, then, the following important changes are underway. Aware's products support all the ADSL standards, including VDSL2, and will support the necessary analog functionality in the near future. This means that our products will deliver our customers the ability to provide conductivity to any flavor of DSL from a network interface, whether it is ATM or IP-based to the tip and ring of the telephone wire.

A second important summary is the ADSL chipset market continues to grow at a healthy pace, and a replacement market is forming. Chipset sales, according to Infonetics, are estimated to grow from 90 million last year to over 180 million in 2008. And finally, new standards are a requirement because they support the deployment of new value-added services and open up new revenue opportunities for phone companies, equipment companies and consumer device companies.

Our goal at Aware is to develop a very profitable business by licensing IP into this market. In the near future, we intend to deliver a complete solution from network interfaces supporting either IP or ATM deployments all the way to the telephone wire. We will deliver this to our customers in a licensing package that allows them to develop a standard compliance solution that is highly interoperable and has broad standard support.

By using a licensing model, we are able to spread the very costly R&D activities that are required to lead across a large number of companies' products. We create pull (ph) for our technology by supporting and driving standards, and we follow that up by delivering the best silicon solution for those standards in the form of licensable intellectual property. We have a more dedicated effort than any other company on all flavors of DSL. We have a leadership technology position in ADSL2+, bonded ADSL2+, and VDSL2. These standards are the future of the industry.

We align ourselves through our model with the best companies in the world. We also know that the DSL transitions and deployments often take longer than we would like, and we have the financial resources to wait for it to play out. When phone companies and mass deployments of new services in the millions and millions of lines involved, it can take time. But we intend to be there when that time comes.

A brief technology aside. The consent of the VDSL2 standard in May was one of the greatest milestones in the history of the DSL industry. It came after more than a decade of drawn out debate between many tens of companies, and it represents the road map that the world needs to enter the next phase of deployments. With VDSL2, a phone company knows that solutions that solutions that deliver 100 megabits per second will be there when they need them. It gives them the confidence that if they invest in infrastructure, the underlying technology and products will be there to support them.

We have a solution that meets that standard now. And Infineon, our long-standing customer, has the VINAX-CO VDSL CO and CPE chipset family available today. This puts our technology in a leadership position in the emerging VDSL2 market.

ADSL2+ is the flavor of DSL which will dominate the next wave of DSL deployments. We expect ADSL2+ to take over most deployments by the end of next year. It provides better access speeds and higher reliability. There are solutions today available from Analog Devices, Infineon, and soon from that Atmel, Thomson and others based upon StratiPHY2+.

In order to understand why we believe we are in such a position of strength, we need to review the economic challenges that the DSL semiconductor industry is facing. Semiconductor suppliers in the DSL industry are struggling. And here's why.

Over the last year, the low end of the DSL market -- i.e., DSL conductivity solutions without significant additional functionality -- have been selling for what we believe is between $5 and $8 per chipset. Let's assume for purposes of modeling, and taking a conservative approach, that that price was $5, and that there was an annual market of 100 million units for those $5 ADSL chipsets.

If we assume a gross margin of 30%, the total DSL chipset market over those 100 million chipsets can produce $150 million in margin. For this model, let's assume the market is split between 10 companies, and each captures one-tenth, on average per year, of the market. In other words, $50 million in sales and roughly $15 million in gross margins.

To support the development effort, recall ADSL is a very complicated, rapidly changing technology with new standards, interoperability challenges, and a very diverse set of deployment scenarios. To support this effort, a conservative estimate of 100 engineers costing $20 million per year is needed at each of these companies. The calculation is that an average engineer costs about $200,000 per year.

Under the scenario we just presented, none of these companies can show profits in their DSL business units. They have $15 million of potential margin, and they need to spend $20 million on development. And while this scenario is just an illustration, it represents the nature of the challenge that DSL chipset companies are facing.

And the reality is that a number of companies decided to cut back their R&D activities in DSL. STMicroelectronics did this. The combination of Conexant and Globespan has resulted in major cutbacks in R&D and DSL programs. Texas Instruments has cut back their developments. The reason is not a mystery. The numbers speak for themselves.

It might seem that a stable state would be reached if one company could capture a majority of this market. In other words, if one company were to capture 80% of the market, that company's DSL business unit would certainly be profitable. But the only way for this state to be reached is if everyone else gives up. And that is not going to happen, because if you are a chip company, you cannot ignore DSL.

The DSL is a wide area network window to the world. There are today, and will very possibly always be, more broadband connections in the world using DSL than any other technology, possibly of any -- than all other technologies combined. And by that, I mean cable, power line, WiMAX broadband and fiber.

As a semiconductor supplier, you cannot ignore DSL. You need to offer it or put yourself at a disadvantage vis-a-vis your competition. The strategic value of DSL is very high, because without DSL your other product offerings are weakened.

If you are a company that sells network processors like Intel, Freescale, Phillips, STMicroelectronics, Infineon, Texas Instruments, Broadcom, and many others, established and upstart alike, ADSL and VDSL present a real quandary.

Funding the development of the technology it is difficult to justify. The costs for development are very high, and the returns very uncertain. But the combination of ADSL and VDSL presents a strategic value to the other products that each of these companies sells. The integration into system on a chip, of DSL functionality with video or wireless WAN or network processing functionality is very likely an inevitability. A license from Aware solves this problem.

If you are a semiconductor company that sells video processor chips or wireless LAN chipsets, you will be facing a similar quandary. Cost of development is high. Return on investment is questionable. But not having the functionality is a strategic disadvantage, and a license from Aware solves the problem. We solve this problem in a way that a stable and sustainable. Here's how.

We collect contract revenues for delivery technology and engineering services. In 2004, this amounted to $7.5 million. It has also been $7.5 million in the last 12 months of revenue.

In addition to that, we collect royalties, which are typically a percentage of our chipset average selling price, or our customers' chipset average selling price, and the middle of the range is 5%. In order to illustrate how we solve the problem, let's return to the 100 million unit, $5 chipset illustration I used earlier.

Let's assume that all 10 of these suppliers -- and this is an extreme case, but it is for the purpose of illustration -- that all 10 of them used Aware's technology instead of their own. Instead of having to support internal development teams costing $20 million per year, they pay Aware contract fees and royalties. There is a stable economic model where each company pays Aware enough in combined contract fees and royalties for Aware to be profitable, and still shows a positive gross margin on their respective DSL business units.

Even more importantly, each of these companies now has access to the strategic value of DSL in their product portfolio. DSL functionality complements their other products such as net processors, video or voice processors, and opens up new opportunities for revenues. The strategic value of DSL conductivity and the integration of DSL and other functionalities on system on a chip architectures is enabled by a license from Aware at a cost far less than internal development.

As a licensor of intellectual property, Aware provides the answer to this industry. We have spent hundreds of man years developing StratiPHY. And with it, we enable companies who could not be in the industry to be there in a profitable, healthy way. We have taken sophisticated technology and simplified it to the point where a whole new set of companies not in the business today can enter the market. In our view, this is the path that the industry is likely to follow.

I will now lay out some general estimates for the future which will illuminate why we are still got am excited and about our prospects. Until royalty revenues ramp, our licensing business will depend largely on contract revenues. Revenues for technology licensing and engineering services. As I mentioned earlier, over the last 12 months contract revenues totaled roughly $7.5 million.

We are optimistic that, based on new StratiPHY developments, such as StratiPHY3, which is our VDSL2 product, and analog functionality that we intend to integrate, we will be able to grow this number over the next 12 months by adding new customer development projects. Because of the productization (ph) around StratiPHY, we are able to expand the number of customer products that use StratiPHY without significant growth in development spending.

This economy of scale is another important part of the success of our model. But for the illustration I want to make today, I will very conservatively assume that contract revenues remain at $7.5 million per year.

Let's turn to our outlook for royalty revenues. Infonetics estimates a number of numbers that I gave earlier. I am going to use 140 million units at some point in time as the total chipset market for both ADSL and VDSL. I am going to assume 115 million are ADSL chips, and 25 million are VDSL chips. This is a very likely chipset market size in the 2006/2007 timeframe.

We will very conservatively assume that ASPs, average selling prices, in the ADSL market dips as low as $3 per chip for the very low-end products, and as high as $9 for the higher end products. For the VDSL market, we assume that the chipset sells in the $7 to $15 range -- again, intending to be very conservative.

Assuming our customers' product mix captures portions of both the low-end and high end of this market, and assuming a range of around 5% of ASP for our royalties, our licensing products generate the following margins. First, we break even if we capture 20% of the market. We are profitable at over 30% operating margin if we capture 50% of the market. And we are profitable at over 50% operating margin if we capture 75% of the market.

The underlying assumptions with these numbers, as I pointed out, have been very conservative. We have assume the contract revenues remain in the $7.5 million per year, which is where they have been in the recent past. We are optimistic they are going to grow.

And we are assuming a pretty conservative set of ASPs for DSL chips that are adding a number of new functions and supporting new standards in the market. But what these numbers tell us is that using these conservative estimates for contracts and royalty amounts, we are in a position to build a very profitable business in our DSL licensing product line.

I would like to now talk about the reasons why we are confident that we are on the right track. The future pipeline for licensing business looks very strong. This is today being mainly driven by ADSL2+ bonding and VDSL2 technology demand. We are looking at roughly $15 million in potential business for contract revenues. This is a larger revenue potential than we have seen in many years.

On the royalty side, we continue to see an increase -- slight this quarter, but an increase -- in percentage of ADSL2+ royalties as a percentage of total royalties. We expect this to continue to ramp as ADSL2+ rollouts take over the majority of rollouts over the coming years.

We are involved in a majority of the initial deployments in ADSL2+ in France, we believe, through Analog Devices, as well as in other parts of Europe. Analog Devices today sells a series of Eagle products and its Fusiv communications processors, both based upon StratiPHY2+. These were recently also adopted by Comtrend and Netopia modem suppliers in their bonded modem solutions. Analog Devices also continues to have modem supplier Sagem as a large customer.

Infineon has announced design wins with Alcatel, ADTRAN, ZTE, and Siemens on the central office side using our technology. We expect to these to improve Infineon's market share over time. Infineon is also sampling its Amazon ADSL CPE product, and has announced its VINAX-CO CPE VDSL2 chipset. These are very well-positioned, and we expect that they will improve Infineon's share in the overall DSL market, as well.

Thomson, Atmel, and two others are developing products based upon StratiPHY2+. These products should become available as the ADSL2+ market ramps. StratiPHY2+ is one of the best solutions in the world in terms of performance, interoperability, and feature support, which should enable these products are rapidly gain traction in the marketplace.

Turning now to our other product development areas very briefly, our testing and diagnostics products are positioned so that we expect them to build a presence in the tested (ph) market for service assurance solutions that support the new standards that we are seeing being deployed -- namely, ADSL2+, bonded ADSL2+, and VDSL. There is a tremendous challenge and opportunity to address new services, including video, that will be deployed by phone companies.

The transition to new standards is an opportunity that we expect to be able to capitalize on. Our goal is to build a profitable product line in this area by leveraging our core DSL expertise and the need to cost effectively maintain and provision DSL services.

Our biometrics and medical imaging biometrics and medical imaging product had a healthy quarter. Our core business in the law-enforcement area was solid, and we continue to be optimistic about our opportunities for growth. New areas such as e-passports and personal identification verification are areas of potential growth in this business for us.

In summary, we are very optimistic about our position in the DSL industry. We look at the economic realities of the DSL semiconductor industry, and we know that we are in a unique position of enabling companies who are on the sidelines today to enter the market. We have simplified a complicated, diverse set of technologies so that it can easily and cost effectively be used by any semiconductor company. This winning combination of simplifying complicated technology and making it available under an attractive business model is why we are so optimistic about our future prospects.

For the coming quarters, on the development front we will be bringing our analog front-end technology to the market, adding new features to our DSL solutions and pushing the next generation of standards at standards bodies. On a sales front, we will be focused on enabling new suppliers to enter this exciting market, growing our contract revenue line. And most importantly, and over the longer-term, we will be looking for improved royalty revenues from our customer base. As we presented in great detail earlier, as we grow market share, we expect to grow shareholder value as well.

We are also very excited about the prospects we see for our test and diagnostics and biometrics and medical imaging activities. Our goal is to continue to build the Company's prospects for future success in these areas. Our test and diagnostics and biometrics and medical imaging product lines are also being developed to improve their contribution to our top and bottom lines.

Turning for a moment to quarter 3 2005 details, we expect expenses this quarter to remain in the $4.5 to $5 million range. And we expect revenues this quarter to be better than last quarter, and hope that we can break even again. That would put us in the range of $2.8 to $5 million. But we are most keenly focused on building for success as ADSL2+ and VDSL2 take over the industry.

With that, we will open up the call for questions. I want to make one more comment before we do that. After we take your questions today, we will also describe how you can email questions to us between tonight and Monday night, and we intend to post both questions and answers on our website later this week. We are doing this because we felt that there was a lot of information in this call, and we wanted to give people a chance to consider questions even after the telephone call is finished today.

So with that, I will turn the call over to the operator, and open it up for questions.

(OPERATOR INSTRUCTIONS) Ken Luskin, Intrinsic Value.

I was wondering if we couldn't discuss your intellectual property patents as they relate to your StratiPHY2+ and StratiPHY3.

Okay. Well, we have spent a lot of time and money, investing a lot of technology that is certainly in those products, but also that is part of the standards that have been adopted over the years. And we think we have a very strong patent portfolio, which protects the inventions that we have made and introduced to the industry.

The goal of the Company is to build market share by selling our products on a broad base. And I tried today to give a picture of how we see that playing out and why we are confident that, despite not such a great quarter revenue-wise in Q2 of 2005, it really in our view doesn't affect the long-term prospects for the Company.

The patents are an important asset for the Company. They are not front and center in the value proposition today because what is front and center is our silicon and electric property.

Okay. So I guess what I am getting at is the -- you have patents on certain enabling technologies which are part of the standards for the ADSL2+ and VDSL2, if that's correct.

That's correct.

So down the line, whenever you -- whatever made economic sense, you believe that you could -- you would, if it made economic sense, go to court to defend that and infringers who were not willing to negotiate a decent royalty agreement, you would then have (multiple speakers)

We have a couple of obligations. One of them as with the standards bodies themselves, which is very typical and common. And that is that we will license any technology required for a standard under what is known as fair, equitable and nondiscriminatory terms. So that is one obligation.

The other obligation we have is to our customers who are paying, potentially, royalties hopefully in the large numbers. We have an obligation to protect them, as well, in the sense that if there are competitors to them in the market who are not licensors of ours and are not paying for intellectual property that they are using, and that enables them to be in the market, I feel we will very likely have an obligation to our customers to right that situation.

Now whether we have to go to court, or whether we can address it by generating a larger licensing pool of customers, which is really my first choice, I cannot comment. But I think first of all, we have the obligation to the standards body that we can't tell someone you can't ship this product. We have to offer our patents on reasonable terms. But second, like I said, we have an obligation to our customers who are paying us for this technology to not be at a disadvantage to people who are not paying us for the technology.

Reasonable terms would be similar terms to your existing customers?

Reasonable terms is an area of pretty heavy debate. But if you want to go study that, you can see what, for example, QUALCOMM has considered reasonable and a lot of the rest of the industry didn't consider reasonable. So it is almost a legal debate as to what reasonable is. It in some cases could be construed as similar to what customers are paying us. You could argue, I suppose, that it is more.

So essentially though, your position is that as time goes on, you would expect that everyone essentially would have to have some kind of licensing agreement with you, because the standards are based upon enabling technologies which you have patents on.

We have to see ADSL2+ become the dominant technology in the industry. That is not the case today. It is still ADSL. But -- and then, there is all sorts of issues with where patents are filed and where use is made and things like that. But we have spent a significant amount of money making sure, through our patent prosecution program were we file patents, that we have good protection of this technology. And if indeed the technology is deployed and these patents are what we say they are, which we believe they are, what you're saying is correct.

All right. So you would like to wait for the market to get more mature before taking enforcement actions.

Well, I would like people to not look at Aware as a patent threat, but as an enabling technology supplier, which is what I just spent a half an hour talking about. And the patents are a defensive asset for us. The thing we are on offense with is our StratiPHY product family.

Right, you are offering that to folks. And then there are a few folks out there who have already invested quite a bit. So they would say, well, maybe a Broadcom or Conexant who would say, well, why do we need to pay you? And you would say because --

Well, my first approach to them would be because you are spending too much money on R&D. And I think it is a really compelling argument, which is why I went through all the detail. And in fact, there are a number of companies in the list of folks that we are talking to now who have R&D DSL development activities underway and are looking at it for precisely this reason.

Right. In other words, you are saying we would like to do business in a nice way, a way that would save you money. Of course, if you do not want to let us help you save money, we can of course cause you to accrue legal fees. (laughter)

Yes, and we would accrue them as well.

Yes, which is not -- no, no -- going to court is definitely the last thing that --

If you are asking me whether we would under any circumstances do that, I suppose we would. I think we have got a strong patent portfolio. I have talked about in many times in the past. It is not anything new. But our focus is on developing products that enable the industry to really become a healthy, viable and vibrant industry using StratiPHY everywhere.

Got it. Okay. Right, so the concept is first, you would go to them and say we have a value proposition for you. You don't need all these customers. We can save you a lot of money by signing up with us.

Right.

Right. Well, that would seem to make a lot of sense.

Tom Kurtow (ph), Pacific Asset Partners.

I think you made a great case for why your value to the customer should keep going up. My question relates to contract revenues. That suggests to me that the contract revenues should keep going up. And you mentioned you are looking at 15 million. I don't know whether you call that kind of a pipeline or whatever. But --

Yes -- potential.

In the opening statement, you mentioned the contract revenues were down because certain milestones were not met. I am confused why contract revenues went down sequentially. And the visibility you have regarding contract revenues into September and December quarter --?

Okay. Well, the best way to look a contract revenues, and I did this a few times during the remarks, is not necessarily it on a quarterly basis, but on -- over a larger window of time. And in fact, we looked at what contract revenues were over the year 2004, the calendar year, and they were $7.5 million. And they were $7.5 million over the last 12 months, as well.

And based on that, we used that reasonably conservative number, in our opinion, to model where some general estimates might be in the future.

The reason contract revenue was down this quarter versus last quarter is because, as we said, fewer revenue-bearing milestones, which are things that we deliver to customers either in the form of a piece of technology which could be the chip design or software that runs on the chip or some other aspect of the silicon intellectual property being delivered to a customer, or services being delivered by Aware. We provide support services to a number of our customers, and they pay us for those engineering support services on an ongoing basis. There were fewer of those events this quarter than in the previous quarter.

It is -- the timing of those events are not based on calendar quarters. They are based on development schedules that chip companies have underway, and they are based on our ability to complete developments or complete services that we have been contracted to do.

So the typical term that you will hear it is that this line in our revenue and our financials can be lumpy. There will be some quarters where a number of milestones fall in place, and other quarters where they don't.

The goal that we have is to add new customers. And if we had added new customers in this quarter, we would have very likely been able to deliver new milestones. We didn't add new customers in the second quarter; otherwise, you would have heard about it. As we add new customers, it is another opportunity for us to deliver the milestones under our contracts and deliver services under those contracts.

So there is a key connect, there is an intimate link between how many products are under development and the milestones that are reached in a given quarter. And the more products that we have under development, whether they are with new customers or existing customers, the higher those contract revenues are going to be.

Regarding visibility, we have some, because there are a number of customers in the pipeline that are signed contracts where what needs to take place is the deliverable -- the delivery of a milestone. So when we signed a deal with a customer, we don't get all of the revenue for the licensing upon signing, or even close to upon signing. It is spread over reasonably long period of time, typically 6 to as long as 18 months.

So there is some revenue in what we would consider true backlog, assuming that we could deliver those milestones in the September or December quarters.

Okay. So in your guidance, are you assuming contract revenues will be up sequentially in September?

I didn't say. I said that we expect to be able to generate more revenues this quarter than last, which I wouldn't say that that is a tremendous accomplishment because last quarter wasn't very good.

I would say that without looking at any specific numbers, because I don't have them in front of me, the most likely event is that in order for us to have a better quarter this quarter than last quarter, there will be more contract revenue.

Okay.

And that will be some combination. It may be all backlog, it may be some combination of backlog and new business. Obviously, the new business is a very important focus for us, because the more customers we have developing chipsets, even if they are existing customers developing new chipsets or new customers developing new chipsets, the higher the likelihood that we actually capture the higher end of those market shares that I was talking about, which is the real return on the whole model here.

Right. I certainly understand that. Okay, I have a feeling the queue may not be that long. Let me ask one more question, completely different, showing my stupidity. When companies like Verizon talk about going from fiber all the way into the home, are they talking about going photon -- are they talking about fiber right to the television? Right to the telephone? Or is there a point where you, Aware, can benefit from a transition from -- I guess I would say photons to electrons?

Yes, that's right. You are right. That is a great way to say it. The answer to the question is it really depends on where that transition takes place. In Verizon's case, the thing they talk about the most is fiber going all the way to the premise, and then inside the premise I am not even actually not even sure what they use. Probably some form of Ethernet or common short range wired communication. They wouldn't necessarily need DSL technology.

If you look at what most phone companies are planning on doing in the United States and outside United States, it is delivering fiber to points closer to the home, but not all the way to the home. And then that transition is where we see the demand for ADSL2+ and ADSL2+ bonded and VDSL2, because they are using the telephone wire to get access to the home. It is a shorter distance of wire, so they can take advantage of these new standards, improved horsepower. But the fiber to the premise that Verizon is very actively marketing and talking a lot about doesn't present an opportunity for DSL technology.

Does not?

Does not.

But doesn't there have to be some -- okay --

I think what they are using is probably -- it may be cable comes out of that, like CAT 5 cable thing, and then an RJ-11 for the -- or a little phone jack. And so they have the transition from the photons to the various common interfaces for television, for Ethernet, and for telephone. But they go directly -- they don't go through the DSL part.

I understand we you're saying. Okay. I will get off. Thank you.

And due to time constraints, we are unable to take any more questions. For closing remarks, I would like to turn the conference over to our presenters. Mr. Weiskopf?

We are trying something that we would really like to see success and interest in. We have asked anyone who is interested in asking us a question to send us an email. The email address is investorquestions@aware.com. That is presented on the press release we put out earlier. We have actual web -- the email address there, if you want to read it instead of trying to hear what I am saying. And we encourage people to email us any questions they may have.

What are going to do is that assemble a collection of questions and answers and post them on our website sometime after Monday night, when we are going to close the reception of questions up. And we hope that this presents an opportunity for folks who think about additional questions to be able to contact the Company and have those questions answered.

Final point. We are going to beat presenting at the AEA conference in November in San Diego. We will post more details on that on our website as time gets closer. And we invite anyone who happens to attend that conference to come and see one of our presentations.

We look forward to talking to you all next quarter. Thank you very much.

Thank you for participating in the Aware conference. You may now disconnect.