AuthenTec (NASDAQ: AUTH), the world’s leading provider of fingerprint sensors and solutions to the PC, Wireless and Access Control markets, released their Q4/2008 and full year 2008 earnings and held their analyst conference call Tuesday after the market closed.
While the 4th quarter earnings and sales were below expectations, it’s the outlook that came in light, as I had previously expected, and in order to remain solvent, AuthenTec is taking drastic measures to cut costs and staff to conserve cash, and see things through to the other side.
What follows is a summary of AuthenTec’s earnings announcement, conference call highlights, and my take on the company’s latest quarter and results, and what you should do if you own the stock.
New to the AuthenTec story?
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.
AuthenTec offers a range of fingerprint sensors that enable users to access and control multiple functions on an electronic device by touching or sliding their finger across the sensor.
The company’s fingerprint sensors utilize unique information in fingerprints to verify the identity of the individual, as well as the unique, individual fingers on the same person.
With more than 40 million sensors sold worldwide, AuthenTec’s award-winning sensors take full advantage of The Power of Touch® by utilizing the company’s patented TruePrint® technology to deliver the most convenient, reliable and cost-effective means available for enabling touch-powered features that extend beyond user authentication.
These sensors are used in various applications related to security, password replacement, financial transaction authentication, and personalization applications.
The company’s products are used in a range of PC products and related peripherals, including laptops, desktops, memory keys, hard drives, keyboards, mice, and other devices.
In addition, AuthenTec’s products also integrate into various wireless devices, such as mobile phones, and personal digital assistants and personal navigation device, as well as access control devices comprising door locks, time and attendance devices, and remote wireless entry keys.
AuthenTec primarily offers its products to original equipment manufacturers, original design manufacturers, and contract manufacturers and sells its products through a direct sales force, a network of independent sales representatives, and distributors.
- Read: my last quarterly earnings and conference call breakdown here.
I’ll break down this report into 4 parts:
- Hit Me With The Numbers: Q4 was bad, margins deteriorating
- Other Business Highlights: Lower Q1 guidance, reduction in workforce, cost cutting
- Conference Call Highlights: Management talked about steps company is taking to conserve cash
- Bottom Line: AuthenTec is on the border, it might be time to sell
Hit Me With Some Numbers
AuthenTec Misses Estimates, Margins Decline
Here are some of AuthenTec’s earnings highlights (growth from previous year’s Q4 or full year 2008/analyst’s estimates where applicable):
- Q4/2008 sales of $11.6 million (down 26% from prior year/vs. $12.9 million projected by analysts)
- Non-GAAP Q4 income of (-$.49 million), or (-$.02) per share (down from $1.3 million, or $.04 per share in the prior year/vs. (-$.02) per share projected by analysts)
- GAAP Q4 income of (-$1.3 million), or (-$0.05) per share (down from $.89 million, or $03 per share in the prior year)
- Gross margin of 45.8% (down from 50.0% from prior year, and down sequentially from 47.4% in Q3/2008, 48.5% in Q2/2008, and 49.6% in Q1/2008)
- Full year 2008 sales of $63.9 million (up 22% from prior year/vs. $65.2 million projected by analysts)
- Full year 2008 Non-GAAP income of $2.9 million, or $.09 per share (up from a loss of (-$.17 million), or (-$.01) per share in the prior year/vs. $.08 per share projected by analysts)
- Full year 2008 GAAP income of $45,000, or $0.00 per share (up from a loss of (-$10.9 million in the prior year)
My Take: AuthenTec came in light on the top line, but managed to meet analyst’s estimates for the bottom line for both the Q4 time period and all of 2008.
On a year over year basis, sales did increase 22% which is still a nice figure in aggregate, but the disturbing trends of the last 2 quarters, as well as guidance (more below) make this a fleeting number.
Finally, gross margins are falling precipitously, and have dropped pretty significantly in each of the last 4 quarters sequentially.
This is a very disturbing sign, but relates to the economies of scale as AuthenTec enjoys a bump in gross margins when times are good, and a drop when times are bad.
It doesn’t hurt that competition is heating up as well.
Overall it was a rather bland earnings release, with a decidedly negative bent.
Other Business Highlights
Lower Guidance, Serious Cost Cutting in the Works
- Q1/2009 revenue expected to range from $6 million to $7 million ($6.5 million midpoint) vs. analyst’s estimates of $12.65 million.
- Q1/2009 non-GAAP loss per share to range between (-$0.14) and (-$0.16) vs. analyst’s estimates of (-$.03) per share loss.
- Total Q4/2008 operating expenses, excluding stock-based compensation charges, were $6.2 million, a decrease of 16% compared to $7.4 million in the fourth quarter of 2007 and a decrease of 22% compared to $7.9 million in the third quarter of 2008. The decrease in operating expenses resulted from cost controls on discretionary spending and reductions in personnel, hiring and commission expense.
- Margins expected in the “mid-40% range” for the rest of 2009 because of the ramp-up of new chips with lower yields and inefficiencies typical of new product introductions and scaling, as well as the overall slowdown in the marketplace.
- No guidance for Q2/2009, but expect better results as a result of lower costs and increases in demand
- Operating cash flow: $1.5 million
- Ended Q4/2008 with approximately $68.7 million in cash and investments vs. $67.8 in Q3/2008
- Inventory in Q4/2008 was $5.8 million down from $6.9 million which represented 69 days on hand in Q3/2008
- Days Sales Outstanding (DSA): 31, down from 45 days in Q3/2008
- Sales breakdown was as follows: PC segment about 83% of total sales, Wireless segment about 12% of total sales, and Access Control was about 5% of total sales.
- Focused on reducing discretionary expenses such as travel, consultants, etc. Will reduce headcount by 20%, cash bonuses are being eliminated, and they are canceling raises.
- $5 million in savings in 2009, offset by legal expenses and other costs, which will rise to about $2.9 million in 2009.
My Take: Revenue was cut by half from analyst’s expectations as AuthenTec is getting crushed by the slowing demand of the PC market, and the glut of inventory that still needs to be worked through.
At the same time, the fact that they are reducing headcount, cutting costs and conserving their cash makes me feel a little bit better.
They also increased their cash collection rate as evidenced by their lower accounts receivable balance, which is down to $5.8 million now.
No matter what though, over time, they will be tapping into their cash reserves, so this might represent one of the last quarters of positive free cash flow generation for awhile, at least until things turn around in a big way for the company.
At the same time, management talked on the call how they expected Q2/2009 to be better than Q1 as a result of increases in business and working through their inventory issues and getting into the next cycle of products by PC manufacturers.
When I previewed AuthenTec’s earnings, I specifically talked about this, and how I thought that there was absolutely no way that the company would be escaping the grip of the failing semiconductor industry caused by weak consumer demand worldwide.
Things were pretty bad at AuthenTec and look to get worse before they get better.
This was not entirely unexpected.
I also wrote that what I really wanted to see was cash conservation, and being conservative in their cash use, and AuthenTec did exactly that.
It is the only reason they are still in my portfolio right now.
The rest of the story dictates what we should look for in the coming months, and predicates my decision whether to hang on or just cut bait and let this one go.
Conference Call Highlights
Conserve cash, reign in expenses, get new products out ASAP
- Management talks about conserving cash and reining in expenses, and future growth: CEO Scott Moody talked about the challenging times that we are in now, and how revenues would be down in Q1. He stated that there were 4 factors that are contributing to this: macroeconomic conditions, sensors are already being included on higher end laptops, sensors are offered on a build to order ($3-4 sensor is being offered for $30-40), high inventory and sales challenges.
Other than macroeconimic conditions, nothing else has changed with AuthenTec’s business and customers: they still have more customers than ever before, but they are buying less.
In response to this slowdown, AuthenTec has begun to reduce their headcount (20% of workforce is being cut), they have also cut cash bonus programs, and have instituted salary reductions of 5-10% for their whole workforce.
If these measures don’t work, they will no doubt have to take further action to reduce their cost structure.
The CEO then talked about the three strategies that would lead to increasing their results:
- Lowering their overall cost structure: reducing headcount further, reducing costs such as travel, what they pay consultants, etc.
- Increase low end sensor sales: The sweet spot of the market going forward is for AuthenTec to cater to the new netbook craze and other lower end laptops. They are working on a sensor now that will fill that niche.
- Expand adoption of sensors in wireless space: This is more tricky and will take more time as the U.S. as well as other countries outside of the Pacific rim, have relatively slow adoption rates for new technologies such as paying for goods with your cell phone where a fingerprint sensor would be a requirement for security reasons. Further, the CEO talked about how until recently, sensor adoption was following traditional paths of other technologies, but that slowed down recently.
My Take: It’s clear that things are slowing down dramatically for AuthenTec.The question is, is AuthenTec’s technology at fault, or is it their cost structure, or both?
It’s obvious that they already lost a large customer which is why their stock initially cratered last year, but as we don’t know the full story as to why this happened, we can only assume that it might be a little bit of both.
Perhaps AuthenTec’s form factor is too large, and PC and wireless makers want a much smaller chip set that takes up less space.
At the same time, it could also be that AuthenTec’s average selling price, now at $3.60, is still to high for cost conscious consumers and the vendors that serve them.
Finally, as for the cost cutting maneuvers, I am curious to see how cuting salaries from 5-10%, cutting bonuses, etc., will affect morale, and the overall construct of the company.
I know that most companies that I have spoken with, or rather the employees past and present, always tell me that there is a clear decline in morale and passion for the business and working at a company when things like this start coming down the pipe.
Is it really worth holding onto AuthenTec’s stock at these levels if they are just skimming off the top to live and fight another day, but by the very nature of those actions undermining the loyalty of those that work diligently for them?
I have to wonder…
- New fingerprint sensors on the horizon: The CEO stated in their press release:
At the same time, we are accelerating the development of our newest products for the PC and wireless markets that are critical for expanding our penetration into these markets.
We have made very good progress on the development of our new low-cost product for the PC market, codenamed ‘Marcy,’ and the complementary TrueSuite™ PC client application tailored for consumer PCs and the growing segment of low-cost PCs and netbooks.
In the wireless market, we are nearing completion in the development of our newest product, codenamed ‘Rogers.’ This product is designed to take full advantage of our TouchStone™ packaging technology and will be offered in multiple colors.
Additionally, this product can replace the navigation buttons on a phone with its integrated TrueNav capability and will offer a much lower integration cost than our existing products.
Further, on the conference call, the CEO talked about the progress of Marcy, which will cost 30% less than the products it will replace, and feature a more aesthetically pleasing form that is essential for its widespread adoption.
When asked how they would increase their netbook adoption rate for their sensors, the CEO stated that they have to work on their higher value added convenience in order to increase adoption, such as using their TrueNav suite and using the sensor as more than just a security feature.
They are in turn focusing their attention on increasing that discovery and learning process for customers in knowing that the sensor is there for them, and that it can increase functionality and value proposition.
Also, TrueSuite should start shipping in Q2, with a full roll out later this year with Marcy (their new sensor), and will support Win 7, the first Microsoft OS with native fingerprint sensor support.
In addition, the CEO commented that wireless is their next bastion for growth: they announced that ACER announced their first smartphone which incorporates one of AuthenTec’s sensors.
Rodgers and Marcy go beyond regular sensors, and act as a fully functioning navigational device and have other touch-pad capabilities for personalization and protecting your documents, and applications.
These added features are necessary to add value to their sensors and make them more economical.
My Take: It looks like AuthenTec is pinning their hopes more and more on these latest sensors that will be coming out later this year and into next year.
It remains to be seen if they will garner a larger market share, and/or be incorporated into more and more wireless devices.
I know that paying for stuff with my cell phone is an extremely attractive feature for me, but is the U.S. consumer ready for that?
- Cash flow outlook going forward: The CEO and CFO discussed what it would take the company, in its current state, to be cash flow even/positive and what their burn rate would be in the coming quarter, since it was obvious from their lowered sales projections that they would be burning through some of that hard earned cash.
Management stated that they needed revenues in the high $13 million range for cash revenue break even.
Further, they predicted that they would burn cash in the $3-3.5 million range in Q1, and less in Q2.
Q1 will likely be the trough, and Q2 will have some revenue recovery, and less expenses leading to a lower cash burn rate.
- Discussion of their large customer loss: The CEO talked about how they expected they would see a material impact in Q3/09, but is looking like Q4/09 or Q1/2010.
With things changing so rapidly, he said that a lot of things can change from now till then. They assumed their market share with this customer would be $0 by then Q3/09, but they now believe that not to be the case, as they feel they will continue to be a vendor with this customer into 2010.
On a follow-up, an analyst asked why the view improved with this customer? Strategy, supply, etc.? CEO stated that they continue to have a good relationship with the customer, but they didn’t want to get into specifics.
My Take: Each time they have spoken about it, they have been more upbeat and raised expectations, and on this call they upgraded that by saying that they feel they will be a supplier to this customer even into 2010, but they wouldn’t comment on what volumes. Either way, it is better than the $0 that they thought they would get wen they announced the customer loss late last year.
- Atrua lawsuit update: Management thinks they are in a very good position in terms of the patent aspects and the overall litigation, and they think it will play out for quite some time and extend well into 2009 or longer.
AuthenTec still a hold, barely
It’s clear that AuthenTec is suffering from the same malaise as the rest of the market and semiconductor stocks in particular.
What isn’t so clear, is if and how AuthenTec will correct, and survive this downturn to live and fight another day.
I’ve argued before that because of their cash position, and because the stock is trading for less than cash on hand, even if you account for the upcoming $3.5 million burn in Q1/09, the company could essentially give all existing stockholders a small premium on their shares, and walk away from the public markets.
The stock sits at about $1.50 today, and the company has cash on hand, after subtracting the $3.5 million from the just announced ending cash of $68.7, of $65.2 million by the end of Q1/09, or $2.28 per share.
In other words, AuthenTec could offer us a 50% premium and get no additional financing, and take themselves private!
Of course, that would leave them with no cash on hand, but you get the idea of the rediculousness of where the stock sits.
Let’s take it one step further and say that AuthenTec does not earn a penny this year, and loses about $14 million in cash (Q1/09 run rate) from their coffers, and ends the year with $54.7 million in the bank. That still leaves us as shareholders with $1.91 in cash per share, or a premium of 27%!
At the same time, because the company is trading at such a low valuation and contains such a rich and deep pocket of patents, technology and infrastructure, AuthenTec is definitely on the radar of at least a couple of large semi companies that would look to expand their offerings and take AuthenTec under their wing, and nurture their technology while not paying hardly anything for them at all (AuthenTec has a market cap of about $42 million).
Let’s look at the cold hard facts:
- AuthenTec is trading for less than $1.50 per share.
- AuthenTec’s Tangible Book Value (TBV) is about $2.60 per share.
- AuthenTec has about $2.28 in cash per share (accounting for Q1 burn)
- AuthenTec still offers a compelling intellectual property (NYSE:IP) pipeline, patented products and systems, a large customer base, and has steady design wins. This makes them an extremely attractive acquisition target for a larger PC manufacturer, or stand alone semiconductor company.
- If such an acquisition were to take place, it would be at a significant premium to today’s valuation and price seeing as AuthenTec trades for less than cash value.
What’s the downside?
There are several points of contention:
- AuthenTec might steadily lose market share, as they already lost a large customer which accounted for 30-40% of their revenue.
- AuthenTec might not be able to compete in this market as demand rises for smaller and smaller fingerprint sensors that use less silicon that are cheaper to install and produce.
- AuthenTec’s fingerprint technology might not be enough to differentiate them and fight off their fierce rivals as the market becomes more commoditized.
- Further macroeconomic headwinds might force some of AuthenTec’s other customers to cut back on spending even more than they have already, and throw AuthenTec into larger cash depletion cycle.
- As a result of these conditions among others, AuthenTec might be forced to reduce their average selling prices further, eat into margins, and not be able to sustain a profitable business model.
- Fingerprint sensors might never become mainstream, and the growth curve could be at its zenith.
So where does that leave us?
It leaves me scratching my head wondering how this company could be trading for such a low valuation even with its deterioration in conditions.
It also leaves me ready to cut bait because of the aforementioned problems with lower sales, margins, and the potential for mutiny among AuthenTec’s ranks.
I do know for sure that selling a stock once it has already declined 80% and is trading below its cash value on hand when there is a high chance of the company being bought out, is not a wise thing to do.
At this point, AuthenTec represents a small sliver, regrettably, of my overall portfolio, and therefore, holding shares to gather more information, and wait for my new thesis to play out, doesn’t cost my overall returns, but could greatly enhance them should things play out as I feel they will.
Once again, if you own shares of AuthenTec, especially at much higher levels, I would advise you hold onto them for now, with an eye towards selling if you think your money could be better served somewhere else, which could very well be the case for my own portfolio as well as I continue to vet other names.
If you don’t own shares, I would advise not purchasing any, UNLESS you are a seasoned trader, or market veteran that has good liquidity, and would only buy shares as a speculative gamble on a takeover, or for the shares to realize their true worth in terms of cash on hand and book value.
Even then, a purchase of AuthenTec should represent the smallest portion of your portfolio, and should represent no more money than that which you can afford to lose completely.
As for me, I’m content to hold on to my shares for now but I am getting itchy with the trigger finger.