Aware Inc (AWRE) 2006 Q3 法說會逐字稿

Welcome to the Aware Inc. third quarter 2006 earnings release conference call. [OPERATOR INSTRUCTIONS] And at this time for opening remarks, I would like to turn the call over to Mr. Keith Farris, Chief Financial Officer. Please go ahead Mr. Farris.

Thank you, welcome to Aware's third quarter 2006 earnings conference call. I'm Keith Farris, the Company's Chief Financial Officer. With me today is Michael Tzannes, Aware's Chief Executive Officer. Thank you for joining us today.

I'll review the financial results for the quarter, then Michael will talk about the business and then we'll take 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 various remarks we may make about future expectations, plans and prospects for the Company and the DSL and biometrics markets constitutes 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, 2005, which is on file with the SEC.

Turning now to the financial results for the third quarter. Revenue increased 31% to $6.7 million, from $5.1 million in the third quarter of 2005. For the nine months ended September 30, 2006, our revenue increased 47% to $17.6 million, compared to $12 million for the first nine months of 2005. We report net income and basic and diluted net income per share in accordance with U.S. Generally Accepted Accounting Principles or GAAP and additionally on a non-GAAP basis. Non-GAAP net income, where applicable, excludes the effect of effected of stock-based compensation expense.

The Company uses the non-GAAP information internally to e evaluate its operating performance and believes these non-GAAP measures are useful to investors, as they provide additional insight into the underlying operating results. However, non-GAAP measures are not stated in accordance with, should not be considered in isolation from, and are not a substitute for GAAP measures. A reconciliation of GAAP to non-GAAP results has been included in today's earnings release. Our GAAP net income for the third quarter of 2006 was $800,000 or $0.03 per diluted share, which included $452,000 of stock-based compensation charges, as this was the Company's third quarter subject to the provisions of FAS 123R. This compared to a GAAP net income of $600,000 or $0.02 per diluted share for the third quarter of 2005.

Our GAAP net income for the nine months ended September 30, 2006 was $151,000 or $0.01 per diluted share, compared to a net loss of $1.3 million or $0.06 per diluted share for the same period a year ago. GAAP results, prior to 2006, do not include a charge for stock-based compensation. Our non-GAAP net income for the third quarter of 2006, which excludes the effect of stock-based compensation, was $1.292 million or $0.05 per diluted share. For the nine months ended September 30, 2006 we had a non-GAAP net income, excluding the effect of stock-based compensation, of $1.845 million or $0.07 per share.

Product revenue for the third quarter was $1.7 million, compared to $1.5 million in the second quarter of 2006, and $2.4 million a year ago. Third quarter product revenue decreased from the third quarter of 2005 as a result of a decrease in software revenue. Contract revenue, which includes patent, license and engineering service fees was $4 million for the quarter, compared to $2.2 million last quarter and $1.9 million in the third quarter of 2005. The increase was primarily due to patent and license fees that we receive under agreements with our customers. Royalty revenue of $1 million declined by $74,000 from Q2 '06 but exceeded Q3 '05 royalty revenue by $200,000.

The increase in royalties over Q3 '05 reflects increasing sales of ADSL2+ and VDSL2 chips by our customers. Third quarter spending was $6 million, including $452,000 of stock-based compensation, compared to $6.5 million in the second quarter of 2006 and $4.8 million in Q3 '05. The decrease in the second quarter of 2006 was primarily due to decreases in stock-based compensation, patent, legal expenses, and severance paid in Q2 2006. Higher spending in this quarter compared to last year's third quarter, was primarily due to stock-based compensation, increases in salary and fringe benefit costs and higher costs of sales related to revenue growth.

We had interest income for the quarter of $490,000. Our available cash and short-term investments were $37.7 million at the end of September. Receivables were $5.9 million at quarter end. And inventory to support new customer orders was and $752,000. We have $1.088 million of deferred revenue related to contracts and maintenance agreements and we have no debt. As of September 30, there were 23,569,937 shares outstanding. At the end of the third quarter, we had 115 full-time employees and 86 of these were engineers. This completes my financial commentary and now, I would like to turn the call over to Michael.

Thank you, Keith. We're happy with the progress we've made this quarter. In DSL, our StratiPHY product has now been licensed to numerous semiconductor companies and our exposure to the ADSL2+ and VDSL2 markets is very good. This exposure is a result of a well positioned product in StratiPHY and the leverage of the licensing business model. We currently have direct exposure to the ADSL2+ service launches by France Telecom and the VDSL2 network buildout and service launch at Deutsche Telekom. We expect to expand our exposure to other opportunities as well through the remainder of 2006, during 2007 and beyond.

Our StratiPHY2+ product supports ADSL2+ and all earlier ADSL standards for CPE solutions and has been widely licensed. Our licensees include Ikanos, Infineon, PMC-Sierra, Thompson and others. We've believe that the ADSL2+ CPE market is entering a period of significant and sustained growth and that we're well positioned to benefit. Our StratiPHY3 product supports ADSL2+, as well as VDSL2 and previous versions of VDSL for CPE and central office modes of operation. Infineon and Thompson, as well as several others, are licensees.

We added a new StratiPHY3 licensee this quarter. We're in discussions with a number of potential new licensees for our StratiPHY2+ and StratiPHY3 products. We believe that we'll sign additional licensees and that this will further improve our exposure to the growing DSL chipset market. This market is expected to be about 750 million units over the next three years according to Infinetics Research. This presents a very significant revenue opportunity for Aware about which we're very excited.

Our StratiPHY product supports all DSL standards, has been broadly licensed to the semiconductor industry. And through our licensees, we are currently well positioned and believe our position will improve over the near and long term future. Next generation DSL standards are currently being discussed at standards bodies to further improve DSL including, among other things, a more reliable and seamless integration of video into DSL services. We continue to maintain a leadership position of standards bodies and continue to bring innovations that we believe will further improve DSL technology.

One of these improvements is dynamic spectrum management, which improves performance by intelligently managing individual or collections of DSL lines. Dynamic spectrum management is currently supports in our StratiPHY products. And dynamic spectrum management is an active area of research for the Company and has the potential to benefit both our licensing and our test and diagnostics products. In our test and diagnostics products line, we continue to see promise and have continued to make progress in our product development efforts and our customer acquisition efforts. We recorded hardware revenue this quarter and expect that this will increase further as our hardware and software products for the automated test head and handheld tester industries gain traction.

We believe that the increased demand for value add high quality service such as IPTV, IP video and triple-play are generating opportunity for test and diagnostics equipment that our products can and will address. As these products gain market acceptance through our OEM business model, we expect the revenue contribution to become more significant. As we outlined in our last conference call, we expect that the revenue opportunity for Aware for these products is in the tens of millions of dollars over the next few years.

Turning to the biometrics products. We've made several announcements in the recent past regarding our personal identity verification products. These products have been approved by the GSA for use in government PIV programs and are consistent with our strategy of providing standard compliant, easy to use software components to OEM customers. The modular, interchangeable nature of our biometrics software products is particularly well suited to the procurement process that's being followed for the development of standard compliant, enrollment, card personalization and biometric identity verification solutions for personal identity verification products. These, along sides our fingerprint enrollment station products, our ePassport products have further broadened our exposure to the biometrics industry.

I would like to change gears for just a moment and discuss one of the new contracts we signed this quarter. We signed a contract this quarter granting a license to patent rights. While we have licensed patents before, it has been a company with a license to software or technology in addition to the patent license. This contract is likely, in our opinion, to generate royalty revenues in the future. We're excited about the on going revenue opportunity this presents and look forward to discussing it more in the future.

Turning to guidance for Q4. We expect the quarter and the year to be profitable. We expect revenues in the quarter to be between $6 million and $8 million. We expect expenses, not including stock-based compensation expense, to be between $5.5 million and $6 million. In closing, our business has had a healthy quarter and we're optimistic that we can continue to be successful during the remainder of 2006, into 2007 and beyond that. With that, we'll open up the call to your questions.

Thank you. [OPERATOR INSTRUCTIONS] We'll take our first question from Stanley Cohen. A few questions.

You mentioned you recognized some testing hardware revenue in the quarter. Did you recognize any testing software revenue in the quarter?

I don't think we said. Let me see if we are in a position to talk about that. Did we? If we did, Stanley, it wasn't significant.

Okay. And given that -- given how high your gross margins were, I assume even the testing hardware revenue wasn't all that large either, mostly --?

Most of the revenue on the product line was again from the biometrics in medical imaging software.

Okay. You announced during the quarter the TELUS agreement, they're going to like the software. This is one carrier out of the hundreds and thousands out there. Is there any reason that longer term this shouldn't apply to more carriers?

It's an opportunity for us, for sure. One of the products that we've developed is -- and actually we have others under development as well that we'll be talking about in the future. But that particular product is a software product that is useful to service providers. And in this particular case, TELUS is a customer. So when we look at the test and diagnostics opportunities, the primary outlet for the products continues to be an OEM channel. And it's a combination of equipment vendors on the test head side as well as on the hand-held side that we see as significant opportunities for us. But there are occasionally and there will continue to be opportunities for us of selling directly to carriers. In particular one characterist of TELUS is that they're really at the sort of leading edge of value-add services and delivering triple-play and IPTV and things like that are very much in their -- in the way that they operate as a service provider. So, the kind of technology that we develop in the test and diagnostics products are particularly attractive to that type of carrier.

But whether it's direct or indirect, there's still a whole slew of carriers that this is applicable too.

Sure, yes, indeed.

Can you say how much of the contract revenue was due to this new patent arrangement?

No, we're not going to talk about it.

Okay, one more try. And you mentioned that there's also royalties associated with it. Is it the same type of model that you previously discussed with royalties?

Well I said that we were optimistic that we would see royalties associated with this down the road. And it's too early at this point to talk much more in detail then I already talked about. At some point in the future, as this becomes more mature, we'll talk more about the specifics but at this point, it's sort of at the early stage.

And back to the products on the biometric side, it looked like it wasn't as strong as previous quarters, is that the lumpy nature?

I don't think there's anything significant there. We have a number of new products that we announced this quarter. There's a number of government activities that we're very excited about. So, nothing in terms a trend or anything like that, we're seeing. In general, we see that business doing well year-over-year and expect it to continue to do that.

Okay and finally, once again, your deferred revenue went up a fair amount. In fact, even with the strong contract revenue. Is there something going on over here?

No, most of that is still on the test and diag contract side. We had a -- there's a long-term item that falls into long-term deferred, which has to do with -- from what I understand, I'll try to cover this and hand it over to Keith if I don't make sense. Has to do with deferred contract -- or deferred revenue that we don't expect to realize over a period of time, which I believe is a year. So, there is some revenue in there that we don't expect to take off of the deferred line for a year. And therefore it shows up on our balance sheet under long-term deferred.

Okay. And that was just the usual amount of new deferred in the course of business.

Right. Okay, thanks a lot.

And next we'll on to Tim Savageaux with Merriman.

Nice quarter.

Thank you.

I had a question about the contract revenue line and I jumped on a little late so I may have missed something there. But I wonder if you could add any color, that moved up pretty sharply here consequently and over the prior year, as to what some of the key drivers were, major new kind of partners the chipset side? Or anything you can give us about both what was driving that and what might keep that at what will apparently be a high level going into Q4? Thanks.

Well, I don't necessarily expect it to stay at this level and this is higher then it's been for some time. And that's really the nature of the technology licensing business we're in. So that revenue, as you're well aware, is a combination of fees we collect for either engineering services or for licenses associated with either patents or technology that we're licensing. Some of it occurs well within our control and other things occur outside of our control.

A lot of these development activities that involve customers require participation by them. And that obviously, starts to cause things to not be entirely within our control. This quarter, we happened to have a number of contractual events take place during the quarter that amounted to a significant increase over last quarter and over last year. It's not the kind of thing where once you hit this revenue level you don't go back below it again necessarily.

So, I wouldn't expect revenue on the contract line to stay necessarily at that level. It may and I wouldn't be surprised if it did again in the future at all. But it's not as if this is a backlog building sort of exercise. Having said all of that, what is going on is a very healthy pipeline of contracts that all have the potential of generating royalty revenue for us in the future. We did add, as I mentioned on the call, and if you got on late maybe you didn't hear that. We added a new StratiPHY3 licensee for the VDSL.

StratiPHY3 is our VDSL product. So we now have an additional VDSL licensee. And in general, contract revenue is a precursor to at least potential and hopefully, likely royalty revenue. Because contract revenue is associated with us delivering technology and then products are developed and hopefully royalties come in as those products are successful. So the general trend over the last year, the first nine months of this year, versus the first nine months of last year, the increase is clearly due to more development projects with our customers, more customers, more activity on the development of products that are very likely and we hope will generate royalties for us.

And understood that the contract revenue can and should be lumpy, however, it looks like you're in the midrange of your guidance, at least up to where we are. Can we then assume that you expect the test and diagnostics and/or royalty portions of your business to ramp up a bit or what is implicit in that?

Yes, I think test and diagnostics has some potential this quarter. One of the things -- again, you look at the range we gave you, it's still pretty broad. And what's really happening -- I think the easiest way to articulate what is happening is all of the various revenue, potential revenue drivers for Aware are gaining a little more steam or gaining a little more traction. So it's fair to say that the contract line is healthier than it's been over the last year or two. I think there continues to be a lot of health in the biometrics products area as well. Royalties should be, should continue to be healthy, the royalties we recorded this quarter are from sales by our customers through June.

So, the market for ADSL2+ and VDSL2 chips has continued to be healthy over the last three months and we expect it to continue to be that. So, we expect royalty revenues to continue to have the potential of being a significant participant. And certainly, being a participant to some extent. So it's a combination of the contract licensing business certainly being a healthy one, but also the test and diag and the biometrics, and medical imaging, which is another series of products that we have, all having good potential. Okay, thank you and congratulations once again.

Thanks.

Thank you and next we'll move onto [Lui Wu] with TGRA Capital.

I was wondering if you can give us background update on the deployments or the launches at French Telecom and Deutsche Telekom, what stage they're at?

I can try it's a good question. We -- despite what everybody may think we don't have a tremendous amount of insight as to what's going at these operators. We license technologies to chip companies, who then sell chips to equipment companies. So, much of what I'm going to talk about is stuff that I read in the press. But the ADSL2+ service launch activity at France Telecom, and really I think it's better to say by France TeleCom because France Telecom is not only deploying in France they're deploying service in other parts of Europe. And that's a deployment on the customer premises side on the CPE side, where we're directly benefiting through the relationship we have with Ikanos, which is a result of a business Ikanos bought from Analog Devices.

So, these are ADSL2+ products on the CPE side that Ikanos has been selling into [Cezem,] primarily is the modem supplier, and France Telecom is one of the largest customers that Cezem has. And beyond just France Telecom, there is a -- I think a generally consensus and again this is from industry research, that ADSL2+ deployments on a service side in particular are going to increase over the near and medium term future anyway. We track sort of what the number of various phone companies are that are turning on service. And there's an increasing number of companies around the world in various countries that are interested in turning on ADSL2+ service. So we think we've got good exposure to those opportunities through Ikanos and through Ikanos and other CPE customers.

On the VDSL2 side of things, the primary deployment in the world right now for VDSL2 is the Deutsche Telekom deployment. They launched the service officially during the quarter, I think it was in August. Most of the activity at Deutsche Telekom prior to that was a network buildout activity where the infrastructure was being put in place, so that service could be turned on. From what I've read, service is expected to be available to some 3 million customers during the year or by the early part of '07. I don't remember exactly what the timeline is. And I believe that means that the infrastructure is going to be in place for those potential customers. And then the service turn-on will commence -- or has commenced as of August, where we'll start seeing service turn-ons throughout Germany.

We've got direct exposure and are benefiting directly from both of these activities, both of network buildout, which involves central office chips, as well as the service launch, which involves customer premise chips. The modem, vendor is a company called [Siferon] that was announced recently. They're the modem vendor for the VDSL2 in Germany and they're using Infineon chips. So these are -- all of this opportunity is being addressed with Infineon chipsets. We think there's going to be other opportunities for VDSL2 through Infineon and through potentially other customers as we look ahead to the future as well.

Okay. Great, a couple of other follow-up -- the VDSL2, the new licensee that you added in third quarter, can we get some more color on that in terms of are they a telco equipment or a semicon?

They are a telecommunications semiconductor manufacturer.

And they mostly focus on central office or customer premises?

They, I think have products on both sides. This particular interest is primarily on the customer side, the customer premises side.

Okay and this presumably is a new licensee that you have haven't had before in the past.

For this particular product, that is correct. For StratiPHY3, that's correct.

And the last thing is on the royalties, there was a tiny decline sequentially.

Right.

And I was just wondering is there a component of your royalties which is legacy DSL royalties, which is still declining? Or was there any kind of unit price decline in this new ADSL or VDSL licensing? What might have caused the decline?

I think, it's a -- as I mentioned earlier when talking to Tim. These are royalties associated with sales through June of '06. It's still at than point and time a combination of old ADSL, new ADSL, and new ADSL -- I mean ADSL2+ and VDSL2, where there are sales of VDSL2 chips now in our royalties. So, I haven't analyzed it in detail. To us, it's -- the trend is in the right direction, the opportunities are there going forward for that revenue line to increase. We expect it will. And you're right, it did go down a little bit but I don't tend to think it's a signal of any type.

Great, thanks a lot.

And next we'll hear from Tom [Kurto] with Pacific Asset Partners.

Hi, I'm sorry I can't believe I did this. I cut myself off at the beginning of the Q&A. So this may already have been asked. But just top follow-up on the new StratiPHY3 customer. I'm still not clear whether you and Ikanos have actually announced a VDSL2 agreement.

We have not announced a VDSL2 agreement and we have not announced that. Ikanos is --.

Is that something you will announce or could this be that new StratiPHY3 licensee?

Well, what I'll say is Ikanos is a competitor of ours on the VDSL

I understand that with plain old VDSL.

And Ikanos has announced their presence in the VDSL2 market as well, so we consider them a competitor in that market as well. So while they're a customer on the ADSL2+ side and I think a terrific prospect for growth for both us and them on that side, I think it's a very -- they've got terrific products focused on a growing market. On the VDSL2 side, we're not -- we don't have the same relationship.

But if their VDSL2 product uses the analog device technology they bought, I think [5-serve] or whatever it was called -- then don't they pay you royalties for any VDSL2 sales they make? I'm not asking that very well.

To the extent that if Ikanos is using technology that Aware licensed originally to Analog Devices, then they are and will pay us royalties. To my knowledge, at this point, that's not true of their VDSL products.

Okay. It seems to me I read somewhere where they have announced the VDSL2 platform that uses the -- some of the Analog Devices' technology they acquired. But let's move on. Maybe what I missed when I cut myself off was, did I understand you say you signed for the first time a contract for a license to patent rights?

Right, well what I said was we had signed a patent license this quarter. And while we have signed agreements that involved patent rights in the past, those agreements also involved license to other technology or software. And this particular agreement is a specifically a patented license. And I thought it was worth pointing out, since it in the past, as I just said we've always included either a license to either software or technology in addition to the patent license.

Michael, I'm still having trouble -- what's the differentiation here?

When we license, for example our StratiPHY product.

Yes.

There are patent rights associated with the StratiPHY products that our licensees get rights to but they also get the product that allows them to build the chipset. In this case, in StratiPHY's case, it's a very comprehensive set of chip design, technology and software that runs on the chip once the chip is fabricated. So patents are part of the agreement but in addition to patents, there's software and chip design and other technology that's being delivered to the customer. This particular agreement involved just patent rights.

Just patent rights. Okay. Again, this may have been asked. But your total deferred revenue account, both short term and long term now, is getting to be a pretty large number. I'm still not quite clear why that's becoming -- I mean we're talking about a $1 million number here.

Most of that, as I think we talked a little bit about, but most of that has to do with revenue associated with test and diagnostics products. Where we have some arrangements that involve delivery of both hardware and software products. And until we deliver all of those products to these customers, we can't recognize revenue for some of the products we've delivered. So, we expect to be completing the delivery of these things in the future and not the distant future, in the near future, the next several quarters, let's say, roughly. So we could expect most of that revenue to be coming off of the deferred line over that time period. Other things are going to be added onto that line as time goes on. Maintenance revenue shows up on that line on a periodic basis. So, we're always going to have some balance on the deferred revenue line. But the majority of it has to do with these test and diagnostics products. And that, as I said, we expect will be coming off in the future.

Okay. I'll ask one more question then I'll let others go ahead if they have any. HDTV, I saw a comment where John Malone was saying AT&T's DSL capability can't handle HDTV. Can you talk about what your technology can handle regarding high definition TV?

Sure. DSL technology in and of itself isn't a TV technology. It's a transport technology. But when you get data rates that ADSL2+ can deliver like 20 plus megabits better second, or certainly when you get to VDSL2 data rates in 50 to 100 megabits per second, HDTV can be delivered over that kind of data rate. The requirement for HDTV is in the 10 megabit per second range. Maybe as high as 12. Maybe as low as 8 megabits per second.

Per channel?

Per channel. So, the VDSL2 network at Deutsche Telekom, which is a 50 megabit per second network, is capable of delivering multiple HDTV channels through a single VDSL2 line. I think it's a critical piece of sort of value that a DSL line can deliver that I question whether wireless or some of the other, clearly widely used technologies can ever deliver. So HDTV is a big driver, in my opinion, for the interest at phone companies to buildout their infrastructure with fiber and deliver fiber [deprint] to their networks and deliver higher data rates using ADSL2+ and VDSL2. The Deutsche Telekom deployment involves HDTV.

Okay. Thank you. I'll let somebody else on the line.

Now, we'll hear from Ken Luskin with Intrinsic Value Asset Management.

Michael, congratulations on a great quarter.

Thank you, Ken.

So, just getting back to this licensing of a patent. What that sounds like to me, you put more a little more color on this, I know you're dancing around this issue. But clearly, they didn't need your other technology transfer. So they already have the technology. The only thing that makes sense to me is there someone already out there with the technology who's competing in the market who decided finally, they'd better pony up and license the patent from you or, because they're infringing. Is that --?

I'm not going to answer. I'm going to say that's not correct.

That's not correct. Okay,

Just to -- but I'm not going to get into any details at this point. At some point in the future, and I know -- I understand you're well intentioned, Ken, and I understand that but at some point in the future, we'll be able to talk more about this and --.

Very good. The new VDSL2 licensee was an existing customer?

I didn't say whether it was an existing customer or not, it's a new StratiPHY3 licensee.

You don't want to say for whatever reason?

No.

Okay. You're getting more tight on -- in the past you would -- is there some reason why that you don't want to -- what's the reasoning for not being more open about -- not even giving the name out but just disclosing whether it's a new customer or existing customer?

Well, I guess one reason is it's just in the spirit of information that I don't think is, at this point, is relevant to the financial status of the Company or --?

Well just get an idea as -- if it is broadening out, we just get an idea of more and more customers are wanting to join in, that's seemingly positive. And there is more competition and just more chances that you guys are going to get royalties because the more competitors out there using your technology, competing against the people who aren't licensing from you, which aren't too many right now, that's all. That's it. So, well, anyways, let me just move on for a second. So, the non-DSL revenue for the quarter is primarily biometrics then?

Yes, on the product line again was mostly -- we talked about some of the hardware revenue coming in the quarter on, from test and diagnostics and that shows up on the product line. The remainder of the product line is biometrics. And as I mentioned, I think earlier, some medical imaging, which is another series of products that we have. But majority of it was biometrics revenue.

Okay. Yes, and the biometrics -- I read about what Germany is doing and -- I don't know if people know about the HSPD-12 announcement you put last week. The enrollments stations are just going to have balloon in order to deal with all of the demand from all of this that's going on. So --?

We think we're well positioned there. We've got a lot of experience in that market, in general that market. Primarily in the past with fingerprint enrollment stations but increasingly, there are other biometrics being incorporated into things like PIV and ePassports and other things. So, I think we've got a good set of products. I think we've got a good understanding of how to sort of operate in that market. I think we have a terrific list of customers, that has continued to grow and is very healthy. So, we're just in, I think, very good shape when it comes to being really well positioned to benefit from a lot of the activities that are going on in the biometrics industry.

Okay. And so, some of the customers for the fingerprint, they're familiar with -- basically, we're looking at a compression again. So it's the same basic technology with a little different use, is that about right?

Well, yes, the compression is part of it. There's a lot of transaction management that goes on inside of our biometrics on the fingerprint side as well. So not just compression, it's a lot more than compression.

All right.

Facial image matching. We've got a probably -- this probably isn't the right place to go into all of the product features but it's a long list of functionalities that we address for that market.

There's -- you're already in there in a big way. You really don't have -- there aren't too many people that really offer what you're offering in this particular piece of the space, right?

I think we've got good OEM relationships as I said earlier. And I think we've got some very unique capabilities and I think we've leveraged those over the years. And we've managed to grow revenues, if you look backwards in time we've managed to grow revenues. And I think we've got a very good position to continue to do so.

Okay. So, the one thing you've mentioned in the past and you've mentioned it again, the medical imaging and a number of calls back you mentioned you would maybe talk in a future call about the opportunities here and try to explain this area. I really don't know what the opportunity here is and I don't really understand --?

That's probably a good idea and we'll do that. It's probably not quite at a point inside the Company and traction-wise, so product development and traction-wise, to be able to paint the kind of picture for example, were able to paint on the test and diagnostics just last quarter. But I understand what you're asking and we'll --.

So down the line we'll get to this, okay. The -- so test and diag, still looking to come on and you still feel very comfortable.

Yes, I feel very comfortable with the caveat that I felt very comfortable with a while back and it did not happen. And I think the reasons that we've still seen delays in the onset of revenue there, from our vantage point, are understandable, we're not happy with it but they're understandable. And the opportunity continues to exist, the drive behind it I know you understand, is a sound drive. The idea that next generation services are deploying and they require better and more sophisticated testing. There are phone companies all over the world who traditionally use this type of technology.

Right.

We've got good customer relations. We've got good products that we have developed and others that are under development. So, yes, we continue to be optimistic that this is going to be a significant generator of revenue for us. Even though that hasn't happened yes.

If these rollouts in the United States is not existent and the rollouts in other areas of the world are just beginning, so one of your competitors in test and diag told me they really didn't see any major pickup until the rollouts were basically well underway.

Right. So that's the same rational we're applying to continue to product develop and customer acquire and try to build this product line up.

And then the royalty line. You would expect, as time goes on, that as the switchover you're still a quarter lag behind, but the legacy DSL chips will be basically gone at the end of this year.

I think we sort of predicted that into the last year kind of time frame and I think it will prove that we were right. Basically by the end of this year, the majority of the deployments will be -- ADSL will be transitioned to ADSL2+. And you're going to see some, obviously, VDSL2 deployments beyond just the few pockets that there are now.

You mentioned dynamic spectrum management and I've seen some papers written where they were talking about some crazy numbers of like 1 gig or something like that. Well beyond probably what most of us consumers would need. I mean 100 megs would be -- so in other words your point is that components of that technology, you're already using, essentially?

Right. Yes, we support that technology already.

Okay.

In our StratiPHY products and we continue to work as does a number of folks in the industry. The opportunity is really a performance-enhancement that is going to be very different, depending on sort of the deployment characteristics and the service -- the nature of the service that a certain service provider wants to deliver. It's an area where incremental, at least, and marginally significant improvements can be delivered into a network without a major increase in costs. The stuff that you would need to do to get the gigabit kind of things, although it's very interesting area and we are looking into it, I think requires a level of coordination in the network that is very likely to be unrealistic in a cost-effective way.

So, it's kind a theoretical maximum. And it's less likely that would actually materialize. Whether it's because of costs or because of what you're saying, that you don't really need that kind of data rate. But it's an area that -- that along with, I also mentioned on the call a little bit about where we think the new standards are going, which are more likely to address the more efficient delivery of video and HDTV in particular over VDSL2 or ADSL2+. To date, these technologies were developed independent of each other and I think there is an opportunity potentially to improve, in particular video over DSL or IPTV over DSL by making changes to the DSL technology itself. And that's one of the things we've been looking at and that's one of the things that's been discussed in standards bodies.

Interesting. All right. Even though you've touched on it, you don't want to discuss it in depth but you continue to see interest from other chip companies to enter into agreements.

Yes, we do. You bet. Yes, indeed. For both ADSL2+ and VDSL2 technology.

It would appear from what you're saying that your revenue forecast for next quarter -- or for this quarter that you guys -- it looks like you've really turned the corner on -- well two of your businesses anyways and the testing and diag could add to that at any point in time essentially?

I think that's what we're saying.

Excellent. Good job, Michael. Thank you.

And now we'll move back to Stanley Cohen with Atrium Advisers.

Have you recognized any contract revenue as of yet from the AFP product?

We haven't discussed that, Stanley, so I'm not going to talk about it yet at this point. It is a -- as you know, it's a product we've been developing and expect to be able to -- we've been marketing it to select folks and expect to be able to sort of add it to the arsenal of technology that we have. So that folks in particular, they're most likely candidate customers, someone who doesn't have any analog technology of their own. And we don't usually -- and I'm not going to get into that level of detail, in what we do in our contracts.

Well, but it's definitely safe to say that it hasn't shown up in royalty revenue yet?

It is safe to say that, yes.

And that would be additive.

Yes, that would be the objective of that. That there would be additional technology that we would license. And whether it means new customers who wouldn't have entered the market without that offering from Aware or an incremental royalty -- so yes.

And one last bigger picture question. It's no secret and not mentioning any names, but in the past two quarters there's been a slew of communication chip companies whether your customers or competitors, that have announced financial problems. And I was wondering if these financial constraints are making it easier to get them as customers. Your long term pieces there just makes sense to leverage compression doing the R&D. And now that they're actually seeing the margin pressure, are you actually see more interest?

Are we seeing more interest? I suppose it's in the mix. These discussions that we have with potential customers are long and touch on all kinds of topics. And certainly, to some members these companies, in particular the management of these companies, the economic argument and the economic benefit of a license from Aware is a very compelling one.

Okay. Well, it sounds like you have all of your ducks lined up.

Thank you. And next we'll go to a follow-up from Tom Kurto with Pacific Asset Partners.

Michael, let me try this. So, you've raised your guidance, the low end from, I think, $5 million to $6 million. So, in that, are you expecting in the September quarter -- I'm sorry, the December quarter, a sequential increase in royalties?

We don't -- to be honest, to answer the question very frankly, I don't know. To answer it more specifically, we don't ever give that sort of guidance. So we don't give guidance on either a product line or a revenue line by revenue line basis.

Okay. Now can you -- I know there's a quarter lag, during that quarter, for instance during the current quarter, are you starting -- don't you get a feel during the quarter what the royalties will be?

Yes, we do. So, we recognize royalties. We'll recognize royalties in Q4 based on payments that we'll receive usually in the early to mid-November time frame for this particular quarter. So it's not always in November but -- and it really depends on a lot of things. In the past, when Analog Devices was one of the licensees, they have a different quarter alignment.

I remember.

Versus the calendar quarters. But generally speaking, within the next two or three weeks, we'll know what royalties are going to be for this quarter, but prior to that we generally don't know.

Okay. So, if it is a material thing that you notice in a couple of weeks, I don't know how we would define material, but I guess you would have to announce that?

Well, if we thought the $6 to $8 million range was no longer -- and it's a wide range for a reason, Tom. It's not -- we're still a -- we still have a number of product lines with -- around which there's uncertainty. The general position of these product lines has improved if you were to compare say the last year for sure. And that's why we can look at the quarter and say it looks like if things go okay, we should be able to hit If $6 million. And if they go better, we should be able to hit $8 million. But it's -- these forecasts are not forecasts that you would see at larger companies with a lot of revenue in backlog. These are forecasts based on still a lot of business that has to take place during the quarter.

Right. Okay. Completely changing things here. I may have missed this. We talked about the deferred revenues increasing to be a substantial amount. Receivables have also jumped the last two quarters and this quarter significantly. You may have already answered this. But why would that happen?

Tom, this is Keith. Basically, the receivables is a timing issue. We had several large invoices go out towards the end of the quarter that sat in receivables at the end of the quarter, we have actually collected since. So, it's really a timing on some of these license agreements and billings. We actually looked at our DSO and our current receivables and we're in fine shape, we're pretty consistent. It's just a timing.

So, receivables should go down sequentially -- well, maybe --?

That depends. it depends on the level of business.

We could say we collected a bunch of stuff and since the quarter ended between then and now but we don't know what's going to happen again next quarter. But we don't see a receivables problem.

Okay, thank you.

And Mr. Tzannes, it appears there are are no further questions at this time. I would like to turn the conference back to you for any additional or closing remarks.

All right, thank you, everybody we'll and the the AeA Classic Conference next week on Tuesday afternoon and Wednesday in Monterey and we'll be Webcasting the 11:00 a.m. Pacific Time presentation. Thank you again and we'll talk to you next quarter.

And that does conclude today's conference, we thank you for participating in the Aware Inc. conference call. You may now disconnect.