Executives
Brett Perry – IR, Shelton Group
Scott Moody – CEO
Gary Larsen – CFO
Analysts
Steve Dyer – Craig-Hallum
Steve Smigie – Raymond James
AuthenTec, Inc. (AUTH) Q2 2010 Earnings Call Transcript July 29, 2010 5:00 PM ET
Operator
Welcome to AuthenTec’s second quarter 2010 financial results conference call. At this time, all participants are in a listen-only mode. At the conclusion of today’s conference instructions will be given for a question-and-answer session. As a reminder, this conference is being recorded today, Thursday, July 29, 2010.
I would now like to turn the call over to Brett Perry with Shelton Group, investor relations agency of record for AuthenTec. Please proceed.
Brett Perry
Thank you, everyone for joining us today to discuss AuthenTec’s second quarter 2010 financial results. With me today on the call are Scott Moody, AuthenTec’s CEO; Gary Larsen, CFO; and Larry Ciaccia, President and COO.
As the operator mentioned, this call is being recorded. It’s 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 Website at investors.AuthenTec.com.
After the market closed today AuthenTec issued a press release discussing its financial results for the second quarter ended July 2, 2010. 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 Website. 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 actual events or results to differ materially from these forward-looking statements may be found in the company’s filings with the Securities & Exchange Commission.
Forward-looking statements are based on the company’s beliefs as of today, Thursday, July 29, 2010. AuthenTec undertakes no obligation or responsibility to publicly update any forward-looking statements for any reason except as is required by law even if new information becomes 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’d now turn the call over to AuthenTec’s CEO, Scott Moody.
Scott Moody
Thanks, Brett. Good afternoon, everyone. Thanks as always for taking the time to join us for our second quarter earnings call. I’ll first touch on some of our top level financial results for Q2 before focusing on some of our design wins as we move into 2011 when the investments we’ve made over the last year will form the basis for our future growth.
As I noted in our earnings release, our revenues came in at $10.7 million in Q2, up almost 30% from the same quarter last year and just over 15% sequentially. Our non-GAAP net income showed a loss of $0.08 per share, which is roughly equal to last quarter, as well as the year ago quarter.
This was the first full quarter of revenues for our new Embedded Security Solutions business or Embedded with revenues finishing at 2.8 million after deducting for certain purchase accounting adjustments.
I’m pleased to note that even at this revenue level Embedded was slightly accretive during the quarter with operating income just above the breakeven point. Our Smart Sensor Solutions business generated revenues of 7.9 million, down roughly 5% from the prior quarter and the same quarter a year ago. However, of particular note, in our Smart Sensor business is that our wireless revenues were up over 100% from the same quarter last year and 28% sequentially.
Staying in our Sensor business for a few minutes, you’ll remember that wireless has been one of our focused investment areas and growth opportunities. In fact, over the last couple of earnings calls I’ve mentioned a few design win that we’re hopeful would go into production by the end of this year.
To that end two new customers recently announced phones that incorporate AuthenTec’s Smart Sensors. The first of these is a new enterprise digital assistance from mobile professionals introduced by Motorola that utilizes our TruePrint AES 711 Sensor for both security and personalization. Already announced the Motorola ES400 will soon be available to the Sprint network here in the United States.
The new phone can store two sets of fingerprints to ensure access to the phone by both the authorized user and their network administrator. It can also be programmed to launch to cure applications and Website be it their different fingers.
This is our first win at Motorola on a production phone and we look forward to working with both Motorola and Sprint in the future.
We also recently won our first mobile phone design with Toshiba, which also uses our AES1711 Sensor in a new enterprise smartphone for KDDI in Japan.
According to a recent article in Nikkei business the new phone will be used in enterprise markets including transportation, medicine and finance. The article went on to note that the first appointment was Yamato Transport, one of Japan’s largest delivery services to authenticate home delivery transaction.
This is our first phone for both Toshiba and KDDI and further expands mobile phone opportunities for AuthenTec in Japan into new enterprise market.
During the quarter we also introduced several new mobile phone design wins including two phones from NTT DOCOMO that incorporate our new AES1750 Sensor.
These Fujitsu built phones includes the new PRIME series F-06 and the STYLE series F-O7, which incorporates the 1750 for one type security, personalization and our new TrueNav navigation features. The 1750 is our first smart sensor designed for our new TouchStone packaging technology, which is one of the key product developments completed in the last year.
Of noting this announcement is a fact that DOCOMO has extended the reach of our sensors from just their high end PRIME series to their style, smart and PRO series feature phones. Moreover, the focus on security and convenience has propelled Fujitsu to be the largest supplier to DOCOMO over the last few years.
We also announced a new mobile phone design win with Radar Technology in China for their new matrix M5 cell phone. This is a low cost quad band phone that it incorporates the ATW310 Sensor that we acquired through a purchase of Atrua. This expands our reach beyond smartphones and feature phones to include low cost phones and broadens our mobile phone user base to new geographic market.
The Atrua acquisition is proving to be quite positive for us in several ways and we continue to see an increase in our mobile and PC business in China where Atrua was the strongest.
We have several other design wins in the mobile market that should they go to production will roll out starting late this year and into the first half of 2011. Some of these phones represent significant volume opportunities include some of today’s largest OEM accounts.
Last week with regards to our mobile market we continue on schedule for our new Saturn product which we believe will be a true game changer given its very small size, aesthetic appearance, low cost and its combined navigation and identity management functionality.
In the smart sensor PC space our lower revenue forecast simply represent design win decisions that were made some two years ago and are only coming to full realization now.
Looking back, we initially forecast its revenue reduction for the end of 2009. But the slip in the new Intel Calpella platform move that out almost a year. Thus consistent with our previous communication new design wins for the next Intel platform Huron River were also pushed out and thus will not be ramping until early next year.
The good news is that based on the investments we made to focus on lower cost laptops and ease-of-use with our new TrueSuite software, we have secured several design wins in these last few months on both Calpella and Huron River notebooks, that will begin initial small volume shipments late this year and move to full production volume production as we move through the 2011 fiscal year.
While we do not discuss specific design wins or losses until such time as the customer announces we start shipping. I will note that we presently expect to ship our TruePrint centers to nine of the top ten OEM PC accounts in 2011.
Moreover, our TrueSuite identity management software has been designed into seven different PCO end including five of those top ten. We believe these design wins together with our opportunities in wireless will represent growth opportunities starting in the fourth quarter and continuing throughout the next year.
With respect to new PC products we will soon be introducing a new sensor, which like a wireless AES1750 will use our TouchStone packaging technology. This new flat center with LED lighting has received very positive comments from customers and has already been designed into one leading PC OEM.
So let me finish my comments by touching on our Embedded business which we acquired late in the first quarter. This is turning out to be a very positive acquisition for us in a number of ways.
First, the deal has already proven accretive and we expect this process to go as our embedded revenues for us. Together with its high margins and growth projections this business will have a long-term benefit to our company and its own right.
The second, I would say that we are seeing a great many more opportunities for revenue synergies than we initially contemplated. This is particularly true in the wireless market where we can combine and sell our client-oriented embedded capabilities in mobile VPN and digital rights management together with our TruePrint centers and TrueSuite identity management software.
While we are not at liberty to disclose the customers’ name, we recently secured a deal with the top cell phone OEM to use our mobile VPN on all their new android phones. Moreover, the same OEM presently plans to use our TruePrint and TrueSuite offerings on an android phone plan for introduction early next year. We are seeing these kinds of opportunities across multiple wireless accounts.
As another example, the synergies between our two product lines, I would note that we are in design of a new TruePrint PC product. And although I’ll not go into detail here we’re using the encryption and security codes from our Embedded product line instead of licensing these from others. This will save us upwards of a million dollars in licensing fees and royalty.
Lastly, albeit a longer-term, we are expanding the reach of our TrueSuite offering beyond the consumer PC and wireless market and into the enterprise, made possible through the capabilities and sales channels that come with the Embedded acquisition.
With our Embedded acquisition we’ve also managed to diversify our revenues as part of our strategy to become a more of a solution provider in both security and identity management. We have now opportunities in exciting new market such as the Smart Grid, Center Cell [ph], DRM or Digital Rights Management, and even multifunction printer.
As examples of these opportunities this last quarter we announced the signing of a deal with SmartSynch, one of the largest in the burgeoning Smart Grid market. SmartSynch selected AuthenTec’s carrier grade network security solutions to provide standards compliant authentication, confidentiality and data integrity for its smart grid solutions.
In another deal we are providing DRM capabilities for the online store of one of the world’s largest cell phone manufacturers. This ensures that again downloaded to one person’s phone is not then distributed to cluster web to anyone that might want that same game. Of course, longer-term, it is not hard to envision that downloading game being tied to the person to the individual by way of their TruePrint Sensor versus just the user’s one machine. This way the user can play the game on their phone, their PC, or even their TV.
Before turning it over to Gary and as I noted on our press release I see Q3 as the book end of a rather challenging time in our corporate history. This started in Q3 of 2008. Although we’ve cut costs our focus has been on how do we make this market and our company to once again drive the revenue growth that we and of course our investors expect. Although we have a long way to go we expect to once again achieve that revenue growth as we move into 2011. Gary?
Gary Larsen
Thanks, Scott. Revenue for the Q2 of 2010 was $10.7 million which includes approximately $2.8 million from our first full quarter of Embedded Security Solutions and $7.0 million of Smart Sensor revenue. The consolidated revenue represents an increase of 27% compared to the year ago quarter.
Smart Sensor revenue decreased from the $8.4 million in the year ago quarter and $8.2 million in the Q1 of 2010. This decrease was primarily to previously announced PC OEM transitions of notebook models on the Intel Calpella platform offset by increased sales of wireless products during the quarter to support the ramp up of new AuthenTec-enabled smartphone models in Japan and China.
The wireless market comprised 29% of our Smart Sensor revenues in Q2, up from 16% in fiscal year 2009.
Embedded Security revenue was $2.8 million, an increase from the $900,000 recorded during one month of post acquisition sales in the Q1 2010. On a GAAP basis consolidated net loss during the Q2 was $3.9 million or $0.13 per share. This compares to a GAAP net loss of $5.8 million or $0.20 per share in the Q2 of 2009 and a GAAP net loss of $4.7 million or $0.16 per share in the Q1 of 2010.
Turning to the non-GAAP results I would first highlight that the Q2 exclude $600,000 for legal and acquisition-related cost to completing the ESS acquisition along with other M&A activity and $400,000 for costs related to reduction in workforce, primarily in Europe. These items are partially offset by the exclusion of $700,000 of other income related to reduction of liability for potential earn-out payment related to the ESS purchase.
Non-GAAP gross margin in the Q2 was 54.6% compared to 46.9% in the Q2 2009 and 50.2% in the Q1 2010. The increase in gross margin was due primarily to the revenue contribution from Embedded Security which has a substantially higher margin in the Smart Sensors, partially offset by higher inventory provisions in the Smart Sensor business during the quarter related to a product transition.
On a non-GAAP basis total operating expenses were $8.3 million during the quarter compared to $6.2 million in the Q2 of 2009 and $7.1 million in the Q1 2010.
Operating expenses in Embedded Security were $2.2 million, an increase from the $900,000 recorded in the one month post acquisition in the Q1of 2010. Operating expenses in Smart Sensors were $6.1 million, down from the $6.4 million in the Q1 of 2010 due to lower mass spending and lower expenses related to the financial audit. Q2 2010 Smart Sensor operating expenses were also below the $6.3 million recorded in the Q2 of 2009.
On a non-GAAP basis consolidated net loss for the Q2 of 2010 was $2.5 million or $0.08 per share. This compares to a non-GAAP net loss of $2.2 million or $0.08 cents in the Q2 of 2009 and a non-GAAP net loss of $2.4 million, also $0.08 per share in the Q1 of 2010. Non-GAAP net loss per share for the Q2 of 2010 was computed using 29.9 million outstanding shares.
AuthenTec ended the Q2 of 2010 with $43.2 million in cash and investments. This compares to $45.3 million in cash and investments at the end of the Q1 of 2010. As of July 2, 2010 accounts receivables were $5.6 million or flat with the amount at the end of the Q1.
Days sales outstanding for the Q2 were calculated at 48 days down from 52 days during the Q1 of 2010. The decrease in DSO versus the Q1 is due primarily to collection by the accounts receivable acquired through the Embedded Security acquisition.
At the end of the Q2 inventory was $1.7 million which represent 30 days on hand. This reflects a decline of $400,000 as compared to $2.1 million or 41 days on hand at the end of the Q1 2010. Inventory decrease mainly due to active management to keep inventory levels above and in line with current sales volume.
Capital expenditures for the Q2 were $193,000. Depreciation was $343,000 and amortization was $486,000. Looking ahead to the Q3 2010 we expect revenue to range between $8.2 million and $9.2 million. The sequential decline in revenue reflects the effect of previously discussed design decisions on notebook using Intel Calpella platform that will be fully realized for the first time in our Q3 Smart Sensor revenue projections.
We expect the Q3 non-GAAP net loss per share between $0.10 per share and $0.12 per share. Further clarify our EPS guidance I walk through the various P&L lines.
First, we expect on non-GAAP gross margins to be approximately 60% in the Q3 due to a higher proportion of Embedded Security revenue. Regarding non-GAAP operating expenses, we expect our Q3 expenses to be approximately $8.5 million relatively flat with the Q2.
Finally, earnings on our investments continue to be impacted by lower interest rates. We expect our interest income earned in the Q3 to be approximately $40,000.
Let me turn the call back over to Scott to say a few words.
Scott Moody
So, as most of you likely saw in the press release this afternoon just after 4 O’ clock, Gary will be leaving us mid next month to pursue another CFO position at a larger company. Frankly, I am very sorry to see Gary leaving and I say that on both the professional and a personal level. However, at the same time I am happy for Gary as this is a good career opportunity for him and I certainly wish him and his family well. Gary leaves behind a very good team and excellent systems.
We also announce the promotion of Larry Ciaccia to the newly created position of President and COO. Larry has been our President for the last four years responsible for marketing and sales and has played an instrumental part in our recent design wins and ESS integration. In this new role Larry will be responsible for the overall day-to-date operations of the company leaving the more opportunity to focus on customers and strategies including M&A.
With that, let me turn it over to the operator who can facilitate any question.
Question-and-Answer Session
Operator
(Operator instructions) Your first question comes from the line of Steve Dyer representing Craig-Hallum. Please proceed.
Steve Dyer – Craig-Hallum
Thanks, good afternoon.
Scott Moody
Hi, Steve.
Steve Dyer – Craig-Hallum
So given that it’s taken almost two years now for Calpella to completely roll-off, are you still confident that Huron River rolls on in Q1 to the same extent that you thought it would, or do you see any possibility of push out on that?
Scott Moody
I don’t necessarily we see push out, but I think that some of the ramps will be slower than we had hoped. I mentioned that we are on a couple of actual Calpella, they are still releasing some PCs, new PCs with Calpella and we’ve got designed into them with some of our new products on 1660s and 2616 and even TrueSuite. So those who stored a little bit in Q4 and then I would expect Huron River to ramp during the course of the year but nothing like the slip that is we also on in Calpella.
Steve Dyer – Craig-Hallum
So with respect to the large customer who you’ve indicated that you won back, do you still think that that ramp starts pretty materially in Q1, or is that slipped as well?
Scott Moody
That’s a good question. I think we are still estimating that, but the fact of the matter is we do still see it ramping in the Q1 and then ramping throughout the rest of the year.
Steve Dyer – Craig-Hallum
So I think last call we have kind of triangulated non-GAAP profitability in Q1 just based on that ramping pretty meaningfully in Q1. Is that still in the cards do you think or is that not as likely now?
Scott Moody
So again a good question I guess all the good questions right off Steve I mean I do think most of the analysts are not sure about yours had looked at really Q2, that’s our objective at this point not only because what you talked about in terms of the revenues, which are going up, but not as fast as we had hoped. And again that my guidance, but in terms of looking at our own internal forecast we’re ramping back starting in Q4 and then we expect each of the next four quarters, but in terms of profitability we’re probably looking at pushing that out, about a quarter because of that and of course we then looking at our expenses that we were tying to that in fact increasing so that will push out as well.
Steve Dyer – Craig-Hallum
Okay. I will hop back in the queue. Thanks.
Scott Moody
Thanks, Steve.
Operator
(Operator instructions) Your next question comes from the line of Steve Smigie representing Raymond James
Steve Smigie – Raymond James
Can you guys touch on ASPs in the quarter perhaps? And maybe what you’d be expecting there given some of the push-outs here, what kind of declines you guys may have expected in 2010?
Scott Moody
Yes, so just to talk about the actual quarter that just was completed. So Q2 the average ASP was $2.64, so that was about a 19% decline from the prior year. So that does reflect price erosion along with some makeshift facilitate between enterprise and consumer within that the PC space. So it is a very competitive pricing environment there. So we would expect that near-term at least at that level of price erosion will continue.
Steve Smigie – Raymond James
And looking at the PC market a little bit closer, you guys have any sense about how a mix there will trend now, enterprise versus more consumer-oriented PCs?
Gary Larsen
We think with our focus on the consumer segment we actually think will be trending more towards the consumer side of things we have seen some rebound on the enterprise side of the business as well.
Steve Smigie – Raymond James
Okay. All right, thanks very much.
Scott Moody
Thanks, Steve.
Operator
(Operator instructions) We have a follow-up question from the line of Steve Dyer representing Craig-Hallum. Please proceed.
Steve Dyer – Craig-Hallum
Thanks. Just looking at expenses next year and how profitability may ramp and when, would you expect kind of an absolute basis operating expenses would be up, down or flat next year compared to this year? I know there was kind of some one-off things this year, but how would you view that sort of big picture directionally?
Gary Larsen
Well, there will be some, the fact that we didn’t have Embedded the first two months, Steve that would create some growth going into next year. I mean I think our intent, obviously, in this will be predicated on the revenue ramp occurring. We still though to keep expenses relatively in line for next year with where we are this year. I think we have a lot of the infrastructure in place. We are already spending a lot in some of these areas like wireless, which we’re just now starting to see the impact we don’t expect that we’re going to have that much more in the way of incremental resources as those revenues come on. And again I mean we will be managing those expenses relative to the revenue ramps as we get better visibility on those.
Scott Moody
Yes, I think following up on that, point I mean for example most of all of the PC OEMs, so now it’s a matter of what volume they buy. So to Gary’s point I think that we will be able to continue with the revenue ramp with basically at the same level of resources; just more efficient.
Steve Dyer – Craig-Hallum
Okay. So I guess kind of looking at that and the margin kind of the way you’ve talked about margins in the new structure, it implies a pretty aggressive revenue ramp next year to reach profitability at all level on Q2. I mean something that you have every reason to believe.
Scott Moody
Yes, I mean I think of course it does depend a little bit on the revenue and particularly some of these mobile phones. We’re going to be locking expenses and it’s not a matter of just obviously not adding, but we’ll take the necessary expense actions as necessary really associated with to some of these phones ramp as we expect we’re not. We’ll continue as we’ve been before, watching our expenses and take the action if necessary.
Steve Dyer – Craig-Hallum
And then with respect to your cash, any thoughts there as to what you may or may not do with it or is it held tightly right now?
Scott Moody
Well, we do still want to pursue M&A opportunities, obviously, we want to use little cash as possible on those opportunities, but we’re going to play it to the chest, and use it to fund our own internal developments as well as the opportunities for acquisitions. Otherwise, we will try to keep as much in the bank as possible.
Steve Dyer – Craig-Hallum
Okay, thanks.
Operator
Ladies and gentlemen, that concludes the conference call. We thank you for your participation. You may now disconnect your lines.
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