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:

1. Lowering their overall cost structure: reducing headcount further, reducing costs such as travel, what they pay consultants, etc.
2. 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.
3. 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.

So What’s the Bottom Line…

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