AuthenTec (NASDAQ: AUTH), the world’s leading provider of fingerprint sensors and solutions to the PC, Wireless and Access Control markets, released their Q2/2008 earnings and held their analyst conference call Monday, July 28th after the market closed.

AuthenTec’s ability to consistently deliver results and beat analyst’s expectations both on the top and bottom line continue to bolster my faith in the company, their management team, and continued execution.

An investment in shares of AuthenTec, especially at today’s prices, are warranted, and their latest conference call and earnings announcement do nothing but crystallize my investment thesis.

What follows is a summary of AuthenTec’s earnings announcement, conference call highlights, and my take on the company’s latest quarter and results.

Click here to read my complete AuthenTec research report and buy recommendation

 

I’ll break down this report into 4 parts:

• Hit Me With The Numbers: Sales, Earnings, Margins: All Up
• Other Business Highlights: Slightly Lower Guidance, Higher Operating Margins
• Conference Call Highlights: Litigation Update, New Design Wins, Economic Impact
• Bottom Line: Nothing’s Changed: AuthenTec Still a Strong Buy

Hit Me With Some Numbers

AuthenTec Beats Estimates Once Again

Here are some of AuthenTec’s earnings highlights (growth from previous year’s Q2/analyst’s estimates where applicable):

• Record quarterly sales of $18.4 million (up 49.6% from prior year/vs. $17.37 million projected by analysts)
• Non-GAAP quarterly income of $1.2 million (up from a -$.57 million loss in the prior year)
• GAAP quarterly income of $.65 million, or $0.02 per diluted share (up from a -$6.7 million, or $7.37 per diluted share, loss in the prior year)
• Non-GAAP $0.04 earnings per share (up from a -$.03 loss in the prior year/vs. $.03 projected by analysts)
• Gross margin improves to 48.5% (up from 45.0% from prior year, but down sequentially from 49.6% in Q1/2008)

My Take: Another solid quarter for AuthenTec in every sense of the word. I would never dare say this is old hat because in this market environment, a company the keeps delivering results like this quarter after quarter is hard to find, and never gets old!

Revenues came in much higher that what AuthenTec had guided last quarter and clocked in about 6% higher than analyst’s estimates, which is a solid top line number.

Earnings per share also beat estimates, and the improvement in gross margin year over year was a huge bonus.

One small downside was the slight decline in gross margin from the first quarter.

This was simply the result of new product introductions (of which AuthenTec has had many in the last few months) that always lower margins initially before they scale, and more and more efficiencies are squeezed out of the manufacturing process and volume, thus increasing margins in later quarters.

Other than that, everything looks very nice, and I have no complaints at all, even with AuthenTec’s slightly lowered guidance for next quarter and in-line guidance for the year, I’ll explain more below.

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Other Business Highlights

Slightly Lower Guidance, Otherwise Solid Business Trends

• For the 3rd quarter of 2008, AuthenTec is projecting sales of between $19.0-$20.0 million ($19.5 mid-line) vs. analyst’s estimates of $20.22 million.
• For the 3rd quarter of 2008, AuthenTec expects non-GAAP earnings per share to range between $0.04 to $0.05 per share, compared to a profit of $0.03 per share in the 3rd quarter of 2007, vs. analyst’s estimates of $.05 per share.
• For the entire fiscal year of 2008, AuthenTec is projecting sales of between $72 million-$78 million ($75 million mid-line), which is in line with previous projections, vs. analyst’s estimates of $77.1 million.
• The 50% year-over-year revenue growth primarily reflects growth in the PC segment of AuthenTec’s business driven by increasing attach rates and the initial ramp of the new AES2810 sensor.
• Operating expenses as a percent of revenue decreased to 45% from 49.6% in the year-ago quarter.
• Margins expected to range from 47-49% for the rest of 2008 because of the ramp-up of new chips with lower yields and inefficiencies typical of new product introductions and scaling.
• $66.6 million in cash and investments vs. $67 million in Q1/2008.
• Operating cash flow was $545,000 in the quarter
• Capital Expenditures (CAPEX) were $779,000 in Q2, which was an increase from the $190,000 reported in Q1. The increase is primarily related to equipment purchases supporting the manufacturing and test of AuthenTec’s new products.
• Cash Flow: about $400,000
• Inventory increased to $7 million which represented 68 days on hand, compared to Q1/2008 which was $4.1 million or 48 days on hand. AuthenTec says that this increase is primarily due to the build up of inventory to support their customers ramp up for the third quarter of this year.
• Sales breakdown was as follows: PC segment about 85% of total sales, Wireless segment about 13.5% of total sales, and Access Control was about 1.5% of total sales.
• Top five customers in Q2/2008 accounted for 70% of revenue vs. 87% in Q2/2007.

My Take: Everything checked out just fine this quarter in AuthenTec’s business segments and other business trends.

Some of the good: 50% year-over-year revenue growth, continued margin expansion, continued penetration into the PC market (more below), reiterating guidance.

Some of the not-so-good: At least in the market’s eyes, is that AuthenTec slightly lowered guidance for Q3, and the mid-line of their previous guidance for all of 2008 was slightly lower than what Wall Street was expecting, also there was increased inventory and capital expenditures.

So, overall, I am quite pleased with the quarter’s more finite details.

AuthenTec’s guidance was in line with their previous guidance, especially for the entire year, but slightly less than what Wall Street was looking for, but that’s nothing at all to be alarmed about, and one of the reasons I hate when companies give guidance at all.

At one time or another, you are going to “miss” guidance, whether real or perceived, and it looks like analyst’s got a little carried away for the entire year forecast and AuthenTec is just managing those expectations in light of possible economic factors (more below).

I was a little bit alarmed by the greatly increased inventory, but because AuthenTec had introduced 3 new products, they obviously had to ramp up production to make sure they had enough of the sensors on hand that were going to be the most popular with the highest attach rates.

In fact, this bears itself out by the mere fact that AuthenTec ’s revenues were even higher this quarter than they had previously guided, which was also increased significantly from the quarter before!

It’s obvious they are gaining massive traction in the PC market with several wonderful design wins (more below), and their products are being incorporated in about 55-60% of all PC laptop models shipping with fingerprint sensors and they are taking more and more market share from their competitors.

I’m ok with the increased inventory, and higher CAPEX, as AuthenTec is taking advantage of improved business trends and demand for their sensors to increase production, and be ready when their customers come calling for more sensors.

There is nothing in these numbers that alarm me at all at this time.

Finally, as for operating margins, it’s obvious that AuthenTec is really starting to leverage more of their top line to the bottom line.

They are managing their expenses and Research and Development (R&D) spending wisely so that whenever they do get a bump in orders, instead of just keeping that money in the form of profits and cash flow, they are smartly reinvesting it into more R&D and their sales team.

It could be that Wall Street might get impatient for the “big payoff” down the road, but I am more than happy with the way AuthenTec is handling their extra cash, and sales to further distance themselves from the competition, and increase their product offerings, improve the products they already have, and take the opportunity to increase their sales force to get more of their fingerprint sensors into more and more PC’s and wireless devices.

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Conference Call Highlights

CEO Talks About How Economy Might Impact AuthenTec Going Forward, New Design Wins and Product Expansion

The following are the highlights from AuthenTec’s analyst conference call:

• The Economy and its Affect on AuthenTec: Speaking of the economy, an analyst asked if AuthenTec was still seeing things remain strong for them in light of what is going on in the consumer market and the overall economy, and the CEO stated that even though every day we hear more horror stories about things being bad, they are seeing continued strong interest as well as demand in their products and future products and are even seeing more traction in the cell phone market.

He finally stated that as they went into the year they were relatively pessimistic about the overall economy, and he was pleased that they have been able to attain or retain the guidance they have provided.

Another analyst then came straight out and asked why, with the slowdown of the economy, it does not seem to be slowing AuthenTec down.

The CEO then answered that one of the reasons is because they are in many of the higher end laptops, which are more immune to downturns, and although they are not in some of the more cyclical consumer laptops, that frankly over time, they would like to be, regardless of their potential to be affected by slowing economic times because of the large market opportunity.

Along those same lines, he also mentioned that AuthenTec has introduced new customers to new products, which in turn means that they are in more laptops than they were last year, so the attach rate is up.

The CEO then admitted that the slowing economy probably has to be having some effect on them. He stated that if the economy was better, their numbers in Q2 could have been higher, in addition to being higher for the year.

So, that being said, he stated that one of the big reasons why they haven’t appeared to be affected yet by the slowing economy is because they did a reasonable job going into the year with lowered expectations of the economic outlook.

Then the second factor the CEO stated to AuthenTec remaining strong in this environment is that whatever effects the economy or the markets are producing overall, AuthenTec is making that up with new customers and a higher attach rate.

An analyst also asked if the CEO could give some insight into how AuthenTec was able to win those new design integrations and what those customers saw from AuthenTec that made them make the change from a previous supplier.

The CEO stated that AuthenTec basically took what had previously been a two-chip solution (where the fingerprint sensor would have to interact with another chip either within the computer or attached to the fingerprint sensor to verify the user’s identity), and made it a one chip solution which made the process much more secure and attractive to those PC manufacturers.

My Take: Finally after about a year or so of asking the same question, CEO Scott Moody finally gave analysts what they were looking for.

Namely, a straight answer as to how AuthenTec is able to keep kicking butt and raising guidance and growing sales astronomically, when it looks like every other business, and especially those in the semiconductor industry, are getting crushed right now by the declines in the economy and consumer spending.

It’s obvious to anyone that pays attention to these things that if PC sales or cell phone sales decline, then it tends to follow that PCs and cell phones with fingerprint sensors in them would also not sell as well.

But here’s the important thing to remember: Even with this slowdown, AuthenTec just reported a quarter where they increased sales 50% year over year!

Not only that, but management was able to have the visibility and foresight to manage their guidance to Wall Street such that they have NEVER missed earnings expectations in every single quarter as a public company, and have usually always guided revenues in line to higher as well.

In this environment where Wall Street is always waiting for the other shoe to drop, a smartly run company like AuthenTec is uniquely positioned to take advantage of growing consumer trends towards higher levels of security in their PC’s, laptops and cell phones, while at the same time managing sales and profit expectations.

As you can see from analyst’s comments on the call, they were completely perplexed as to how the heck AuthenTec keeps increasing sales, margins and profits while other semiconductor manufacturers are getting hammered.

It’s obvious that AuthenTec is doing things right in this department, and are running a tight ship, with good visibility in their business.

• Patent Infringement Suit Update: AuthenTec briefly updated their patent infringement suits that were pending with Atmel Corp. (NASDAQ: ATML) and Atrua Technologies, one of which has been ruled in favor of AuthenTec.

The CEO ended his prepared remarks be stating that:

“…while patent litigation can be expensive, I see it is something more akin to an investment than simply a tactical exercise.”

While AuthenTec didn’t go into great deal about the pending litigation, they gave a little color on the suits that were being filed.

First off, as I previously reported, AuthenTec’s patent litigation that was brought about against them by Atmel Corp. has since been dismissed and AuthenTec has won the summary judgment.

You can read all about that verdict here.

The CEO went on to explain AuthenTec’s latest summary judgment win against Atmel, and their most recent case against Atrua Technologies in which they have now modified their original suit by adding two additional AuthenTec patents to the original three patents cited in the March 2008 lawsuit, which brings to 5 the total number of patents that AuthenTec is alleging Atrua infringes upon.

He also noted that AuthenTec is also considering further additional modifications to this suit.

You can read the whole background on AuthenTec’s latest suit by and against Atrua Technologies here.

My Take: Well, here we go again I guess. Just when AuthenTec lifted a burden off their back by winning their suit that was brought against them by Atmel, now they are suing, and being sued by, Atrua Technologies.

Hey, might as well go for it right? If you are going to be brining all these infringement suits against a company, you might as well list all of them at once and see which ones stick.

Patent litigation is messy and oftentimes expensive. While it is clear that AuthenTec should defend their intellectual assets, characterizing these lawsuits as “investments” is probably not quite the right terminology.

We’ll have to stay tuned to see where these latest infringement suits lead AuthenTec and how they turn out.

As it stands, look for AuthenTec to spend about $150,000 in legal fees this quarter, rising to potentially $.5 million in the back half of 2008.

• New Product Design Wins: AuthenTec stated that two sensors, the AES2810, and the AES1610, have now been designed into a number of Centrino 2 models being introduced by their OEM customers in the second half of this year.

You can read about AuthenTec’s three newest sensors and sensor packaging technology called TouchStone, here.

AuthenTec also stated that the three newest PC sensors that were introduced recently, are now being designed into new PC models from eight of the world’s top 10 notebook PC OEM’s.

The CEO also stated that within the PC market, their AES2810 sensor has been integrated into actual products from manufacturers that they previously couldn’t mention, but have turned out to be: HP (NYSE: HPQ), who introduced five business notebook PC models featuring the AES2810 sensor, Dell (NASDAQ: DELL), which announced the first of their new laptops featuring the AES2810 sensor which included the new Studio 15 and Studio 17 notebooks, and Lenovo’s ThinkPad series of laptops.

Also noted on the integration front was AuthenTec’s sensors being integrated into many laptops now offering the AES1610 sensor such as Toshiba’s new Protege R550, reportedly the world’s lightest laptop, as well as two new ASUS ultra-mobile portable PC’s, the R2 and the R50.

There were several other product wins and integrations including new integration into more tablet PC’s among others.

As far as the wireless market, AuthenTec spoke about their product wins in the Japanese wireless market and the continued interest outside of Asia. The CEO didn’t announce any new wins outside of Japan, but he said they were cautiously optimistic that they would see continued expansion in this market in the coming quarters.

AuthenTec also reiterated that their newly opened offices in Japan were created and staffed with the sole purpose of supporting their customers in the wireless and PC markets there that included: Fujitsu, Toshiba, Lenovo Japan, Hitachi, JRC, Sony, along with several others.

My Take: These are some huge PC wins, and as I’ve stated before, once AuthenTec’s sensors are integrated into a client’s products they are likely to stay there for a long time to come.

With this added traction, notoriety and design wins, AuthenTec is further positioning themselves to take more market share in the PC segment, and get their chips into more and more large, high volume PC manufacturer’s designs.

So far so good in this segment, with volume shipments really starting to take off in the back half of this year, and into 2009.

• Average Selling Price (ASP) Declines: ASP this quarter was about $3.50, which is about a 12% decline from the prior year, mostly because of losses in the Access Control market which has 3-4 times higher ASP’s than the PC and wireless segment.

AuthenTec stated that they do expect ASP’s to increase sequentially.

When talking about the Access Control market and why sales have declined to this segment for AuthenTec, the CEO stated that there were two primary reasons for this decline: 1) they have very aggressively focused on the PC and the wireless side of their business, 2) most of the access control companies are small companies, that are “here today, gone tomorrow”.

He further commented that he didn’t feel that AuthenTec has the bandwidth to really start to agressively market and enhance their product offerings to this market until probably 2010 because they are agressively targeting PC’s and especially the wireless market for next year.

In addition, AuthenTec does see future growth in the Access Control market in that it takes longer to get designed in and usually, as with many of AuthenTec’s other products, once you are designed in and although individual socket volumes are smaller, they last a long time and they drive greater margins.

According to the CFO, sensors sold to the Access Control market are usually 3-4 times more expensive than those sold to the wireless and PC markets, and thus represent much higher margins f or the company.

The CEO finished by saying that: “I do not think that there is any doubt in my mind, as well as most of our team here at AuthenTec, that access control is an excellent market opportunity for us”

My Take: This is slightly dissapointing, but I can see where AuthenTec is coming from. They are going for the low hanging fruit, which is the huge PC and wireless market where billions of units are shipped each year and incremental value can be added for OEM’s and other manufacturers by including AuthenTec’s sensors into their designs.

• EzValidation Discussion: I had spoken previously about what this deal meant for AuthenTec, but in this and their previous conference call, management added more color to the discussion.

First off, the acquisition cost AuthenTec $250,000 in cash which was only for EzValidation’s client based software that resides on the PC, which will allow AuthenTec to enhance the user experience with their current fingerprint sensors.

We will see integration of this software in the 3rd quarter of 2008 as a value-added service to AuthenTec’s customers.

EzValidation’s software uses a Graphical User Interface (GUI) and other feature representation to allow customers using cell phones and PC’s that use AuthenTec sensors, to help them be more aware of the sensor and to also make it easier for them to actually use the sensor and understand it, etc.

From what I gather, AuthenTec will offer this as a value-add, and make some incremental revenue from it.

In this conference call, CEO Scott Moody touched once again on the integration of EzValidation into AuthenTec’s TrueSuite application software.

Key attributes of the EzValidation software are now being integrated into AuthenTec’s planned TrueSuite application, which is a new addition to their growing portfolio of products and capabilities.

What this essentially means and was touched on last quarter, is that AuthenTec will now provide a more complete PC client offering, as AuthenTec can now provide everything for their customers from the actual sensors in their PC’s or wireless devices, to the application software to better utilize those sensors.

My Take: This is just AuthenTec’s way of broadening their appeal to more customers by making it easier on them to provide not only the core technology for enhancing their offerings, but also the user interface and software to make those offerings better utilized and add more value to having the sensors on PC’s and wireless devices in the first place.

Current clients either already use their own software to feature AuthenTec’s sensors and its capabilities, or that of a partner or 3rd party.

For the first time, once EzValidation is incorporated into AuthenTec’s client software, the choice of what software to use will include an offering from AuthenTec, rather than clients having to create their own, or use a 3rd party.

This will be a great way for AuthenTec to garner some incremental revenue as things move forward and more customers decide to use AuthenTec’s ready-made software solution.

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Bottom Line

When I had written previously discussing what I expected from AuthenTec, what was delivered in this quarter couldn’t have been scripted any better had I personally written the earnings press release and analyst conference call.

You know, Wall Street has its ups and downs for various reasons: overall market turmoil, problems in the credit markets, weakness in the semiconductor sector, perceived shortfalls in business trends and economics, etc., but one thing will always trump all of that over the long haul.

A company that is executing on all cylinders.

That’s precisely what we have with AuthenTec.

Here’s a quick recap of what we got this quarter:

• Revenues up 50% year over year
• Gross and Operating margins increased
• Record profits and revenue
• Revenues and profit guidance were in line with the company’s original guidance
• That same guidance has been cultivated beautifully in light of economic forces to appease the ravenous hoards of Wall Street analysts
• Management continues to execute with new design wins into some of the world’s leading PC manufacturer’s products
• AuthenTec has already released 4 new products this year, as opposed to 1 per year in past years, thus showing the fruits of their accelerated R&D spending
• Visibility into the next 12 months allows AuthenTec to project client demand well in advance and work with clients on products and features that will most benefit them and their hardware designs
• An excellent and confident management team that has thus far never fallen below expectations, continued to execute and continues to show strong and dependable leadership
• A stock price BELOW IPO levels
• A valuation that is starting to get “cheap” in relation to AuthenTec’s growth

This doesn’t even include my original investment thesis of why we should own shares in AuthenTec in the first place: the fingerprint sensor technology that AuthenTec is creating will become as ubiquitous in PC’s, laptops and wireless devices as cameras are now in cell phones.

This quarter’s results did nothing to change my stance, and in fact, have bolstered it in light of all the considerable headwinds that AuthenTec is facing, and yet remaining strong on all fronts.

I reiterate that this company, especially at these valuation levels, is one that you need to be adding to your long term portfolio now.

Once all this market freakishness turns, and people start looking for growth stocks again, AuthenTec will be at the very top of the list due to its continued excellence, strong management, and innovative and patent protected products, not to mention increased profitability and reasonable valuation levels.

AuthenTec is a company you keep.

One that you add to your portfolio for years to come, and purchase more shares of on any weakness, like we have now.

Nothing has changed with the AuthenTec story, and in fact, with 5 quarters as a public company in the books, AuthenTec has flown by profit targets every single quarter and solidified their position as a leader in their field.

Now that you can get the stock for less than the IPO price with over a year in the books of continued revenue and profit growth, the stock price is way cheaper now than it was back then both in relative and absolute terms.

I am once again pounding the table for AuthenTec.

It’s time to add shares to your portfolio and ride the gains for years to come.

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New to the AuthenTec story?

Click here to read my complete AuthenTec research report and buy recommendation

 

*Variables You Should Know About AuthenTec (Nasdaq: AUTH)
Current Recommendation:	STRONG BUY
The Company:	AuthenTec, Inc., is a fabless mixed-signal semiconductor company that provides fingerprint authentication sensors and solutions to the high-volume personal computer (PC), wireless device, and access control markets.
Why Buy Now:	Proprietary and Patented Technology Low-Cost Advantage Continuous Technological Innovation Huge Growth In an Expanding and Rapidly Developing Market CEO Founder With Sizeable Stake in Company Strong Relationships With Leading Global PC and Wireless Device Manufacturers Addressable market of over 1 Billion units per year New Company on the Precipice of Fundamental Breakout Fantastic Stock Price, around IPO level High Margin Business Multiple Revenue Streams
Market Cap:	$256.99
Revenue (TTM):	$58.60
Cash/Debt:	$67 / $0
Current Price:	$10.00
Risk Rating (?):	7.5 (Moderate-High)
Position Size (?):	1/4 (12-17-07), 1/4 (1-17-08), 1/4 (1-23-08), 1/4 (7-3-08)
Buy Around Price (?):	$13.50 (12-17-07), $13.25 (1-17-08), $12.00 (1-23-08), $10.00 (7-3-08)

*As of 7-29-08. Except share price, all values in millions.