AuthenTec: Ripe for Acquisition?

| About: AuthenTec, Inc. (AUTH)

AuthenTec Logo

AuthenTec (NASDAQ: AUTH), the worlds leading provider of fingerprint sensors and solutions to the PC, Wireless and Access Control markets, released their Q1/09 earnings and held their analyst conference call May 12th after the market closed.

As I wrote on my Twitter feed, 3 of the companies in the portfolio reported last week, and all things considered, AuthenTec was not the highest on my priority list by any means.

Sure, I guess that speaks to the status of the company, and I’m seriously considering shuttering the entire position as I’ll discuss below, but for now, it looks like with AuthenTec’s huge cash position (the stock currently trades at less than the $2.31 per share in cash on hand), as well as their intellectual property (IP) and client roster, a larger company can swoop in and buy AuthenTec for pennies on the dollar, and we would get an easy double from here with no sweat.

Results this time around came in ahead of expectations and it appears that things are bottoming out, and that AuthenTec’s cost cutting measures are paying off.

The questions is, will this be enough to see the company through to the other side, will it at least be enough for them to take advantage of their upcoming products or be acquired by another semiconductor company?

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.

AuthenTecAES22550.jpgAuthenTec 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.

I’ll break down this report into 4 parts:

  • Hit Me With The Numbers: Beats expectations, slightly higher margins
  • Other Business Highlights: Higher Q2 guidance, reduction in workforce, cost cutting
  • Conference Call Highlights: Management discusses market, new chips
  • Bottom Line: AuthenTec remains a hold

Hit Me With Some Numbers

AuthenTec Beats Lowered Estimates, Margins Slightly Higher

Here are some of AuthenTec’s earnings highlights (growth from previous year’s Q1/analyst’s estimates where applicable):

  • Q1/09 sales of $7.03 million (down 54.6% from prior year/vs. $6.54 million projected by analysts)
  • Non-GAAP Q1/09 net loss of (-$3.6 million), or (-$.12) per share (down from $587,000 million profit, or $.02 per share in the prior year, and a net loss of $493,000, or (-$0.02) per diluted share, in Q4/08 / vs. (-$.14) per share projected by analysts)
  • GAAP Q1/09 net loss of $4.5 million, or (-$0.16) per share (down from a net income of $188,000, or $0.01 per diluted share in the prior year, and a net loss of $1.3 million, or (-$0.05) per share in Q4/08)
  • Gross margin of 48.8% (down from 49.6% from prior year, but up from 45.8% in Q4/08, 47.4% in Q3/2008, and down from 48.5% in Q2/2008)

My Take: AuthenTec had stronger order flow towards the end of Q1/09, which allowed them to come in above their expected guidance.

In addition, margins ticked up a bit as product mix was more favorable for the company.

The takeaway from these results, as well as the conference call which I’ll go over in more detail below, was that conditions seemed to point towards a steadying of order flow and demand.

That does not mean however, that things are picking up in any meaningful way, and management was still very cautious, but at the very least, it appears that things have stabilized and that order flow and inventory are getting pushed through the system.

In other words, it appears that we are in the early stages of a bottoming process at the very least.

Other Business Highlights

Raised Guidance, More Cost Cutting in the Works

  • Q2/09 revenue expected to range from $7.8 million to $8.3 million ($8.05 million midpoint) vs. analyst’s estimates of $7.62 million.
  • Q2/09 non-GAAP loss per share to range between (-$0.8) and (-$0.10) ((-$.09) midpoint) vs. analyst’s estimates of (-$.09) per share loss.
  • Ended Q1/09 with approximately $66.1 million in cash and investments, compared to $68.7 million in cash and investments at the end of 2008.
  • Operating expenses, excluding stock-based compensation charges and costs related to a reduction in workforce, were $7.2 million, compared to $7.9 million in the first quarter of 2008 and $6.2 million in the fourth quarter of 2008.
  • Margins mid-40% range in Q2/09, $6.4-$6.6 million in operating expenses, about 10% less from Q1/09, plus lower interest on their cash.
  • $2.5 million expected cash burn in Q2. $13 million revenue run rate keeping margins the same gets them to cash flow break-even.
  • Inventory: $4.6 million, 114 days on hand, decline of $1.2 million, compared to $5.8 million or 83 days in Q4/08, expect levels to decline further.
  • Days Sales Outstanding (DSO): 40 days, up from 31 days in Q4/08 due to timing of shipments in Q1, weighted towards the end compared to Q4/08.
  • Sales breakdown per segment was as follows: PC segment about 69% of total sales, Wireless segment about 23% of total sales, and Access Control was about 8% of total sales.
  • Focused on reducing discretionary expenses such as travel, consultants, etc. Is reducing 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.
  • Litigation costs, $700,00 so far in ‘09, but expect about $500,000 for the rest of the year.

My Take: You will note that the days of inventory on hand went up, even though the actual inventory went down.

This is simply a function of slower sales and lengthening of the sales cycle, which means that the inventory that they do have on hand takes longer to sell.

The good news is that they have lowered the overall inventory levels, thus increasing cash flow, and becoming more lean.

At the same time, the savings that the company was to realize from cutting costs through attrition, layoffs, and freezing bonuses, is going to be offset by their ongoing litigation with Atrua as well as new product introductions which will siphon off some of that extra cash.

What is most pressing now, is that AuthenTec ate into their cash hoard in Q1 for the first time as a public company, and are expected to do so again in Q2.

Their run rate in revenue has to be at least $13 million to break even on a cash flow basis, and they are far from that at the moment.

If sales don’t start to ramp up now, the investment thesis for holding shares on a pure value basis as a result of cash and assets vs. liabilities, starts to diminish.

We knew that this day would come, and AuthenTec has done a nice enough job shaving costs, and coming in a little bit ahead in margins and burn rate, but now we have to see where the supply/demand side of things kicks into gear, and when the PC market turns around.

The introduction of AuthenTec’s 2 new chips (Rogers and Marcy, more below), won’t be revenue generators for the company for at least another 10-12 months, so AuthenTec has to fly with the birds that got them here for now.

Conference Call Highlights

Conserve cash, reign in expenses, get new products out ASAP

  • Discussion of Current Market Conditions: When talking about current market conditions for their fingerprint sensors, the CEO stated that inventory glut is less of an issue than it was a quarter ago.

He further stated that he wouldn’t call it a “snapback”, but merely that inventories are stabilizing now, and are reaching a more sustainable and normal level.

When talking about the higher end laptop market demand, he said they expect weakness in this segment for the foreseeable future, however they do expect to see a gradual increase in revenues for the remainder of the year as inventories continue to adjust and volume patterns return to a certain extent.

Further, he said that Q2’s revenues will have more to do with the overall economic conditions and product demand than with actual design wins.

My Take: Nothing revelatory here. Demand is soft, people are cautious and it might be awhile before things really start to pick up in the fingerprint sensor market and PC/wireless market overall.

For now AuthenTec has worked through their inventory, lowered costs, and battened down the hatches in preparation for a long winter ahead.

  • New Product Discussion: On the call CEO Scott Moody outlined AuthenTec’s product roadmap for the future in both the wireless and PC segments.

In the PC segment he reiterated that they are making continual improvement in their “Marcy” sensor, and TrueSuite application. The Marcy chip will be significantly cheaper than the older chips that it will replace, and be cheaper to integrate into products.

This new chip is still in the development stage, but now has “working demos” that AuthenTec has been showing customers, along with the Beta version of their TrueSuite software that makes it easier for customers to integrate AuthenTec’s chips into their products and highlight the functionality of those chips via special integrated software.

He also talked about ASUSTek integrating one of AuthenTec’s sensors into the first netbook to contain a fingerprint sensor.

When asked about the adoption rate in the new netbook category, the CEO said that netbooks are at essentially ‘nil’, but that they are moving in that direction as they are seeing it as more important, but that their focus with their “Marcy” chip is targeted more towards lower end laptops, rather than the netbook space.

As for the wireless segment, he stated that interest continues to increase rapidly, and their “Rogers” sensor is creating buzz among some of the world’s leading cell phone manufacturers

Finally, he reiterated that this chip is being designed utilizing the company’s TouchStone technology, creating a more durable chip design with a smooth surface that can come in any color the customer wants.

My Take: The CEO once again reiterated that interest does not equal demand, but that he was cautiously optimistic that AuthenTec could garner some additional design wins with some of these manufacturers in the coming year as demand picks up, and their product offerings are closer to being completed.

It will be at least another 6-12 months before AuthenTec realizes any revenue from these new chip sets, so they better be damn good, and really give the company some type of competitive advantage going forward.

  • Update on Customer Loss: As far as the loss of a major customer, which accounted for about 1/4 of AuthenTec’s sales, the CEO talked about how the loss of that customer and their sales has shifted to Q1/2010, instead of Q2/2009 of this year as had been originally expected, so it keeps getting pushed back because of shifting product trends, the economy, etc. He also mentioned how they continue to have a good relationship with this customer, and they are still ordering AuthenTec’s products.

Bottom Line

AuthenTec still a hold

There was nothing in AuthenTec’s latest earnings release and conference call to disuade, or persuade me one way or another for either selling the entire position, or holding on.

Because the stock still trades at a discount to cash on hand (even though that cash is being tapped into right now), as well as book value, and net-net assuming assets and liabilities, there isn’t a compelling reason to own shares if you don’t already own them, unless you are into deep value plays that might take months to turn around based on current market conditions.

So we are left with a stock that is stable, in a market that is stabilizing, and a sector that is bottoming out.

I’m willing to give AuthenTec a few more quarters to see if things improve as they’ve already shown, or deteriorate further.

Again, since the position is now a small part of my overall portfolio, I’ll hold on for now, until I have researched another company to put our money in that provides a much better upside potential.

Don’t get me wrong, as it stands now, there are many companies out there that fit this bill, I’m just not ready to pull the trigger yet as I feel that AuthenTec’s patents and IP are worth something to someone, at least double what the stock is right here, right now.

Bottom Line: If you own shares of AuthenTec and have ridden them down from the teens as I have, you don’t have very much equity left.n’t have very much equity left.

Unless you need the cash and want to put it towards more productive names, hold on for now as I feel that AuthenTec is at or near a bottom considering their cash on hand and assets/liabilities, and could be seeing a rapid turnaround in the coming months.

At the very least, their intellectual property and current client roster is very attractive to someone, and their dirt cheap valuation would make a buy out price have to come in above $3-4 per share, I feel closer to $5 per share, and still be a bargain for a deep-pocketed acquirer.

Yep, that’s what we’ve been reduced to as shareholders.

It might be time to move on from this one, so don’t be surprised if I issue a sell order within the next few months when something better comes along.

If you don’t own shares and are adventurous and know something I don’t, a small position playing a turnaround in the industry and/or AuthenTec’s product pipeline, or the chance of the company being acquired, might be worth your time, but only for a small part of your assets.

New to the AuthenTec story?

  • Read: my last quarterly earnings and conference call breakdown here.