AuthenTec Inc. Q3 2009 Earnings Call Transcript

AuthenTec Inc. (AUTH)

Q3 2009 Earnings Call

November 4, 2009 5:00 pm ET

Executives

Brett Parry – Investor Relations Agency

Scott Moody – Chairman, Chief Executive Officer

Gary Larsen – Chief Financial Officer

Analysts

Steve Smigie – Raymond James

Brian Ruttenbur – Morgan Keegan

Steve Dyer – Craig-Hallum Capital Group

Presentation

Operator

Welcome to the AuthenTec’s third quarter 2009 financial results conference call. (Operator Instructions) I would now like to turn the call over to Brett Parry, with Investor Relations Agency of record for AuthenTec.

Brett Parry

Thank you everyone for joining us today to discuss AuthenTec’s third quarter 2009 financial results. With me today on the call are Scott Moody, Chairman and CEO, Gary Larson, CFO and Larry Ciaccia, President.

As the operator mentioned, this call is being recorded. It is also being broadcast live in voice mode over the internet and may be accessed over the internet in the investor relations section of AuthenTec’s web site at investor.authentec.com.

After the market closed today, AuthenTec issued a press release discussing the financial results for the third quarter ended October 2, 2009. By now everyone should have access to the press release and financial tables. However, if you do not, they are available on the company’s web site.

Please be advised that the matters discussed in this teleconference contain forward-looking statements regarding future results or events. We caution you that such statements are in fact predictions that are subject to risks and uncertainties that could cause actual events or results to differ materially.

Additional risks and uncertainties that could cause events or results to differ materially from these forward-looking statements may be found in the company’s filings with the Securities and Exchange Commission. Forward-looking statements are based on the company’s beliefs as of today, November 4, 2009. AuthenTec undertakes no obligation or responsibility to publicly update any forward-looking statements for any reason except as required by law even if new information become available or other events occur in the future.

Additionally in the company’s press release and during this teleconference management will discuss certain measures and information in GAAP and non-GAAP terms. A reconciliation of GAAP to non-GAAP results is provided in the financial tables following the text of the press release.

I will now turn the call over to AuthenTec’s Chairman and CEO, Scott Moody.

Scott Moody

I want to thank everyone for taking the time to listen in today. On today’s call I’d like to focus my comments in two areas, starting with our financial results for the quarter, a quarter in which we achieved a 22% in sequential sales.

In addition, I’d also like to address our plans and strategies as we continue to transition from a component supplier to an identity and security solutions oriented company.

Looking first at our financials, our revenue for the quarter was $10.3 million, exceeding our previous guidance of $9.2 million to $9.8 million. Our revenues during the quarter were driven by both the continued improvement in the PC market as well as increased sales associated with new phone introductions.

Turning to our net income, our non-GAAP loss for the quarter was $1.5 million or $0.05 per share. This an improvement of almost 40% compared to Q2 and at the high end of our guidance. And finally with regards to our expense management, expenses were essentially flat with last quarter. I would note they are down some 25% from our peak in Q2 of last year and we currently expect a further reduction this quarter of roughly $.5 million and more in Q1 of 2010.

While our revenues were up over 20% over last year, they continue to trail last year’s revenue due to the overall economy and its impact on the high end of the PC market where our tax rates have historically been the highest. Recognizing this fundamental shift in the market, as you know we have worked aggressively over these last several months to develop a product offering more tailored for lower cost laptops and net books as well as the cell phone market.

Staying on the cell phone market for a minute, there is no doubt that we are seeing increased interest and I would expect our wireless revenue to climb as a percent of our business over the coming year. I would note that we continue to move forward with a top tier hand set OEM towards the launch of an AuthenTec enabled phone outside of Asia in the next few months.

Although I have cautioned many times in the past that the design win does not necessarily lead to full production, we have already delivered tens of thousands of production units to this customer with the final trial scheduled to be completed sometime this quarter.

This is the first of several cell phone design opportunities that we have world wide that have the potential to turn into full production programs during 2010, particularly in the latter half.

With regards to new products in the wireless market, while we have not officially announced our Rogers ship, I am pleased to say that we have already secured our first design for this product in Japan and expect to record its first revenues in Q1. This is our first product designed specifically using our new touch tone packaging technology that takes the fingerprint sensor market to an entirely new level.

Touchtone technology is not only a very thick coating that materially improves durability but is importantly, completely changes the aesthetics of the sensor. With touchtone, one gets a completely flat and smooth sensor surface that looks like if you will, a very small touch pad.

Moreover, we can provide touchtone in a number of colors to match the cell phone casing and in the future the PC casing, something that is important in markets where aesthetics continue to grow in importance.

In the PC market, we announced two new products during the quarter that together form the basis of our first complete product solution including both a sensor and the software. Of particular interest is our new TrueSuite Identity Management software, specifically targeted for the consumer space.

This product, a year in development and based on a small acquisition we did last year, is our first endeavor into the application market. We’ve had the opportunity to show and demonstrate this solution to a number of leading PC OEM’s during the quarter and their feedback has been extremely positive.

We continue to add new features and functionality to TrueSuite which will begin shipping this quarter on a new PC equipped with Microsoft’s recently released Windows 7 operating system.

Although these initial TrueSuite revenues will be small, we fully expect to see these increases over the next year.

We also introduced our new AES 1660, formerly code named Marcie, also targeted for consumer laptops and net books. By TrueSuite we will see our first revenues from this product in Q4 and has several design wins that will help drive additional revenues starting in Q2 of 2010 as new designs are brought to market by our OEM customers.

If you’ll remember, the 1610 is a small and low cost sensor that offer integrated LED drivers that help with sensor discovery and make the user experience together with TrueSuite that much better.

We will also be introducing a sister version of the AES 1660 this quarter, although we are already shipping that product in low volumes to our first customer.

Lastly, with regards to our new products for the PC market, we are well on our way in the development of our next enterprise class product with a planned take out in the next couple of months.

Of course, it goes beyond simply the products, but it’s also the team here at AuthenTec that’s key to driving success. To that end, I am pleased to note some notable additions to our team that we have recently made.

First, back in August we announced the appointment of Dr. Lungi Qiu as the VP and General Manager of our China operations including our staff of 28 located in Shanghai. Prior to joining us, Dr. Chu was the general manager of the Atrua China operations and before that was GM of Broadcom China. His experience in management, fingerprint sensor technology and mobile hand sets will help us further pursue the tremendous growth opportunities we see in China and the rest of the world.

Shortly after Dr. Chu joined us, we announced the hiring of Greg Kerr as our new VP of Software Development. Greg was the vice president of engineering with Sonic Solutions where he and his team were responsible for the creation and launch of several successful and ubiquitous products for today’s PC’s and mobile devices.

Here at AuthenTec, Greg will direct our software development teams in the U.S. and China and leads a significant expansion of our new TrueSuite offering.

Lastly, in September we were delighted to add industry veteran Masatoshi Morishita to lead our expansion efforts in Japan. Morishita San is a well known and respected industry veteran who is the president of AMD Japan and before that was the president of ATI Technologies also in Japan. He will oversee all aspects of our Japanese operations including business development, sales, marketing and application support.

As I’m sure everyone on this call knows, we will see some market share shift as the PC market moves from the Monevita platform to the integrated Calpella platform which was delayed from its original roll out plans in Q3 of 2009 to Q1 of next year. While this will affect our sales over the next few quarters, we have used this time diligently to not only materially reduce our costs but also to make sure that the monies we did spend were targeted toward the growth markets.

It takes some time to develop these products and go through the design cycle with customers, but we have seen a lot of progress of late and believe these new products will drive revenues in both 2010 and 2011.

We will continue to manage or quite frankly reduce our costs as well. However, our key objective at this point is not simply a matter of market share, although we remain the largest in the market, but more importantly to expand the available market so as to achieve our full potential. We believe that our new products and others still in the pipeline will do just that.

Lastly, before I turn this over to Gary, let me note two other items. First, following the close of the quarter, we announced the shipment of our 50 millionth sensor. This industry milestone underscores our leadership position in providing advanced technologies and products to a broad cross section of leading OEM’s in the cell phone and the PC markets.

But although we’re proud of this achievement, we’re more focused on the shipment of our next 50 million sensors as a complete solution provider rather than solely a sensor supplier.

And finally, I’m pleased to note that both the shareholder and the patent infringements suits were dismissed during the quarter. As we said from the beginning, we felt that the shareholder suit should have never been brought and think that its quick dismissal in relative terms at least, highlight that fact.

And in the Atrua case, as with the Atwell case earlier in the year we are strong believers in protecting our IT and will continue to do so as required in the future. I am pleased to note that all of the biometric patents in both of these cases are now the property of AuthenTec along with all of the intellectual property of Atrua Technologies.

And with that, let me turn it over to Gary.

Gary Larson

Revenue for the third quarter of 2009 was $10.3 million, an increase of 22% compared to $8.4 million in the second quarter of 2009. This compares to $18.4 million reported in the third quarter a year ago. The sequential increase in third quarter revenue was primarily due to two factors; a return to more traditional buying patterns by PC customers following a reduction in inventory levels and growth in wireless product sales in the quarter.

On a non-GAAP basis, gross margin in the third quarter was 46% compared to 46.9% in the second quarter of 2009 and $47.3% in the third quarter of 2008. The sequential decrease in gross margin was primarily due to higher inventory provisions for planned product transitions partially offset by cost reduction actions during the quarter.

On a non-GAAP basis, operating expenses were $6.3 million during the third quarter compared to $6.2 million in the second quarter of 2009 and $7.9 million in the third quarter of 2008. The slight sequential increase in operating expenses was primarily due to hiring costs related to the executive additions discussed earlier by Scott, partially offset by lower litigation related legal costs in the quarter as a result of the dismissal of the Atrua lawsuit.

On a GAAP basis, net loss for the third quarter of 2009 was $4.2 million or $0.14 a share. This includes a charge of $1.7 million or $0.06 a share associated with the Atrua transaction which was finalized during the quarter.

This compares to a GAAP net loss of $5.8 million or $0.20 in the second quarter of 2009 and net income of $550,000 or $0.02 in the third quarter of 2008. GAAP gross margin in the second quarter was 45.3% compared to 46% in the second quarter of 2009 and 47.1% in the year ago period.

On a non-GAAP basis, net loss for the third quarter of 2009 was $1.5 million or $0.05 per share which excluded the Atrua charge and other expenses related to stock based comp, a reduction in work force and amortization of certain acquired intangible assets. This compares to a net loss of $2.2 million or $0.08 per share in the second quarter of 2009 and net income of $1.4 million or $0.05 in the third quarter of 2008.

Non-GAAP net loss per share for the third quarter of 2009 was computed using 28.7 million outstanding shares.

Turning to the balance sheet, we ended the third quarter with $57.4 million in cash and investments, reflecting the payment during the quarter of $4.9 million to acquire the assets of Atrua Technologies. This compares to $64.2 million in cash and investments at the end of the second quarter of 2009.

As of October 2, 2009 accounts receivable were $4.5 million which is an increase from the $4.2 million as of the end of the second quarter of 2009.

Day sales outstanding for the third quarter was 39.8 days, down from 45.7 days during the second quarter of 2009. The decrease in DSO was primarily due to strong collections during the quarter.

At the end of the third quarter inventory was $3.2 million which represents 51 days on hand. This reflects a decline of $200,000 as compared to $3.4 million or 68 days on hand at the end of the second quarter of 2009. These reductions are a significant improvement from over 100 days on hand at the end of the first quarter of 2009 and reflect improved ordering patterns of our customers and tight management of our production planning.

Capital expenditures for the third quarter were $213,000 and depreciation was $314,000.

During the third quarter we finalized the purchase of the assets of Atrua Technologies and completed our valuation of the acquired tangible and intangible assets. Of the $4.9 million paid we recorded approximately $160,000 as tangible assets primarily inventory, and approximately $800,000 of intangible assets predominantly for the acquired patents.

We recorded the remaining $3.9 million as a charge related to the dismissal of the lawsuit between AuthenTec and Atrua. Of this charge, $1.6 million was recorded in the third quarter upon completion of the valuation. As disclosed previously, we recorded $2.3 million of this charge in the second quarter of 2009.

Looking ahead to the fourth quarter of 2009 where visibility remains challenging, we expect revenue to decrease sequentially to a range of $7.5 million to $8 million. The decline reflects reductions in channel inventories in anticipation of the previously disclosed transition to certain Intel Calpella based notebooks that do not integrate on AuthenTec fingerprint sensors.

Also impacting revenue in the fourth quarter is a cell phone product transition at one of our key accounts as they ramp down an existing design prior to ramping up a new AuthenTec enabled phone.

The revenue decrease will be partially offset by lower operating expenses resulting in a non-GAAP net loss per share of between $0.07 and $0.09 in the fourth quarter.

To further clarify our EPS guidance, I’ll walk through the various P&L lines. First, we expect our non-GAAP gross margins to be in the 45% to 50% range in the quarter as we expect a higher mix of lower priced products and the forecasted lower revenues will impact the absorption of manufacturing support costs.

Regarding non-GAAP operating expenses, we expect our fourth quarter expenses to be approximately $5.8 million, down half a million from the third quarter. The lower OpEx reflects reductions in hiring related expenses, outside services and other costs.

Earnings on our investments continue to be impacted by low interest rates. We expect our interest income earned in the fourth quarter to be approximately $50,000.

We’ll now turn the call back to the operator who will facilitate the Q&A session.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Steve Smigie – Raymond James.

Steve Smigie – Raymond James

I was hoping you could talk a little bit about what the mix looked like in the quarter split between PC’s versus handsets versus access for other stuff.

Scott Moody

PC was 78% of the revenue. Wireless was 17% and then access control was the remaining 4%.

Steve Smigie – Raymond James

Also ASP?

Scott Moody

ASP was $3.14 which was between 10% and 11% down from the prior year.

Steve Smigie – Raymond James

On the handset opportunity that you discussed, I guess you gave some decent color there but are there more of these announcements to come? You’re usually pretty cautious so I guess you’d have to be pretty far along to be discussing this and the stuff out of Japan, can you say whether it’s Europe versus U.S.?

Scott Moody

With respect to the, even talking about it, you are right. It is relatively far along, but it’s not quite there and I’ll feel very good about it when I actually it on the store shelves. But we have delivered and have been delivering production units, so it’s certainly something that’s been going on quite awhile.

We have other opportunities that are similar to that and we have a number of opportunities as well in Asia, most of which though we would probably see in the latter half of next year in terms of new accounts and new phones versus the first half of the year. But there are a number of other going forward.

In fact, we certainly have more opportunities in the cell phone space probably by a long shot than we’ve ever seen before. I think part of that is, of course they’re all looking to differentiate the Smart Phone market is growing substantially. Security is very important whether you’re a business person or a consumer in that market.

And I think that we have really driven a lot of interest because of the new Rogers sensor and that would probably be the product that would be the predominant one in the latter half of the year. That product really solves a lot of the issues that people were always looking at.

Obviously it provides the security and personal identification function. It now does NAV and works exceedingly well. The aesthetics have been solved. The costs have come down. So I think we really checked all the boxes there and that’s why we’re seeing a lot of the interest as well as the market itself, i.e. Smart Phones and just a very competitive market and all those people looking to differentiate.

With respect to Europe and U.S., my expectation would probably be both.

Steve Smigie – Raymond James

As we look out to Q1, could you talk a little bit about what you would think would be normal seasonal pattern there and anything you see in the orders at this point that leads you to believe you could be above or below normal seasonality? Is there anything in the roll up here of the large customer that would make you, does that continue into the March quarter? How will that impact early next year?

Scott Moody

I addressed that a little bit in my remarks. I think that in the first quarter and into the second, I don’t know that we’ll be as affected by normal seasonality as what I refer to as the switch between the Monavita and the integrated Calpella platforms and that’s why we’ve focused so aggressively on developing these new products, the 1660, it’s sister product which we’ll eventually call the 1660, the Rogers chip, TrueSuite, all of these capabilities are things to help us drive revenues as we go through that transition.

So I think we’ll actually be more affected by the transition itself than normal seasonality. But as I mentioned we do have a lot of opportunities in cell phone, the consumer notebook and the low end notebooks are doing relatively well, even enterprise as long as you’re below the $800 number.

So that’s where we really focused our new products and new efforts. That’s where the growth is. Actually if you look back, we’re talking about a transition, but we’re down this year from last year although I think, and you probably know this better than I do, the total number of PC’s has not dropped as much as our revenue. It’s probably been flat or just down a little bit.

What has happened is it’s transitioned from the high end to the low end. So our real focus is not necessarily market share as I mentioned. We do want that, and of course we are the largest in the market and expect to stay there. But it’s to really grow the market and that’s where our new product focus has been.

Steve Smigie – Raymond James

Does that ramp down affect Q2, Q3 all that much?

Scott Moody

It’s more complete certainly by Q2 and Q3, but again hopefully, and we’re not providing guidance but hopefully we’ll see some of the other products make up for that, and in markets that are growing faster.

Operator

Your next question comes from Brian Ruttenbur – Morgan Keegan.

Brian Ruttenbur – Morgan Keegan

The question I have is about your competition. How has it changed? Did anybody else come in beside UPek?

Brian Moody

It’s actually one less now with the acquisition in the quarter. It’s generally been the three companies that, you probably know the space as well as I do almost. It’s us. It’s UPek and its Validity. I obviously would have put Atrua at least in terms of the people that we see the most in the accounts.

There are others but those are the three companies that I’m sure we would all say those are the guys that we see the most. Obviously we compete aggressively for market share, but if you look at it as compared to a few years ago, five years ago, that’s significantly fewer competitors.

I think our challenge in the industry which is what we’re focused on with our new products is to grow the market and serve the available market. This market is certainly big enough for three competitors. The thing is to get this market to grow to the kind of billion unit markets that I think we all envision.

So we’d like an unfair share of that if you will, but the fact of the matter is that we’re down to virtually three competitors. Again, there are others, but three competitors that you see the most.

Brian Ruttenbur – Morgan Keegan

Can you talk about any kind of fall off that you expect to see in 2010 from loss of any major customers? Give us some kind of visibility. Do you expect 2010 to be up, down, the same?

Scott Moody

Generally our objective is to make up for that revenue and we really talk about it associated with the platform change between Monivita and Calpella for the high end, and I think we’ve done the right things to go do that.

We’re working on design wins. We have a number of design in, including in the wireless space, but again I’m always cautious about even talking about those and certainly committing to them until such time as we’re practically shipping and in production volume with them. So certainly that’s our objective.

Brian Ruttenbur – Morgan Keegan

That expected fall off is going to happen mid way in 2010. Can you talk about how much it would negatively impact you in 2010?

Scott Moody

Actually if you remember when we first announced that, which was forever ago, Calpella was planned to come out in Q3 of last year, so that has slipped generally speaking to 2010 in Q1. So that’s why I was saying the next few quarters we would see that transition.

We’ve been actually very fortunate in that in that we obviously had more time to come out with new products to start the design cycle, and so on. So I think you’re actually going to be seeing the transition a little bit this quarter, Q1, Q2, but we’re already trying to make it up and are making it up with the introduction of new products. We’ll do that through the course of the year as designs go into production.

Brian Ruttenbur – Morgan Keegan

Can you talk then how much in your third quarter was due to Calpella and all that in the third quarter?

Scott Moody

Last third quarter if there was any, it was gnat. I think that the down turn if you look at Q3 of last year to Q3 of this year was almost wholly associated with the fact that higher end laptops have not been selling as well, and that’s where we and others were primarily in. In the last Q3, the one we just finished and just announced, I don’t thing we were that affected by anything like that.

Operator

Your next question comes from Steve Dyer – Craig-Hallum Capital Group.

Steve Dyer – Craig-Hallum Capital Group

If I can ask one more question on this transition so I have it straight in my mind. Is that customer effectively gone just given this inventory rebalance there or is there potentially another step down in terms of revenue from this customer in Q1?

Scott Moody

In terms of that transition, we’re seeing a little bit of it now. I think we’ll see a little bit more of it in Q1 and then basically, at least we’re assuming in our own planning, we’re done in Q2 and then we’re seeing the ramps and the make up with other products in what I believe are probably higher growth markets anyway.

So you’re really seeing, it really tracks kind of the Calpella roll out for customers, for this customer in Q1 and Q2.

Steve Dyer – Craig-Hallum Capital Group

And then is your thinking in light of how the mix has shifted towards smaller notebooks, is your thinking at all about the eventual size of that market change or are you still a believer that a fairly decent percentage of all notebooks shipped can have sensors at some point?

Scott Moody

Frankly I do believe that all notebooks will eventually have a fingerprint sensor. In fact I firmly believe that. The thing that we’re seeing now though is that nobody could have predicted in essence a year ago, that high end laptops were really impacted with the downturn, and whether its consumer enterprise, when laptops are being bought, maybe they’re not all for $299 but they’re all below $800. That’s a substantial part of it.

So I think we’re seeing a shift, but whether you’re $249 net book or if there’s any such thing as a $2,000 lap top any more, I think we have the opportunity in all those markets. We’ve gotten our costs down. The aesthetics is there, and I think most importantly it goes beyond just the w whole idea of security, and it’s around identity management.

If you look, whether it’s Face book connect, Open ID and so on, identity is very important and nothing is better at identity than a fingerprint sensor. So I think that’s where we really see our opportunity on any notebook and in fact, really any Smart Phone or higher end feature phone. That’s why we still believe this market is a1 billion units.

We’re disappointed that we had the downturn this year but there’s reasons outside our control in that. But the other reason that we did believe that the market wasn’t taking off was around the software, and it’s great to say that our fingerprint sensor can do all these things, but it wasn’t doing all these things because often the software wasn’t being developed or the software that was being developed was not particularly easy to use.

I think TrueSuite turns that all around, and that’s why we’ve talked about going from a sensor supplier or only a sensor supplier to a complete solution provider that’s really focused on identity management and personal security.

Steve Dyer – Craig-Hallum Capital Group

Cash from operations in the quarter, did you give us that?

Gary Larsen

Technically the operating cash flow number we report is minus $5.7 million but that did include this part that we had allocated to the Atrua lawsuit dismissal, $3.9 million so if you take that out, it’s about $1.8 million is what we’re looking at. We have roughly $57.4 in cash and investments.

Operator

There are no further questions. I would like to turn the call over to Mr. Scott Moody for closing remarks.

Scott Moody

I want to thank everyone for taking the time to listen in today. We look forward to sharing progress on our new products, design wins and our continued transition to a solution provider focused on identity management, personal security and multi-touch functionality. We believe that our new smart sensors and TrueSuite application software, as well as our key new additions to our executive team position us well to further diversify our solution offering and better address the opportunities in our targeted PC and wireless market not only in 2010 but well beyond.

Thanks again everybody and God bless.

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