AuthenTec (Nasdaq: AUTH), the world’s leading provider of fingerprint sensors and solutions, released their Q1/2008 earnings and held their analyst conference call Monday, April 28th after the market closed.

As a result of AuthenTec’s latest earnings release as well as rapidly accelerating business trends, which go way above and beyond my expectations, I have upgraded my opinion on AuthenTec from a HOLD to a BUY.

What follows is a summary of AuthenTec’s earnings announcement, conference call highlights, and my reasons for the upgrade.

Click here to read my complete AuthenTec research report and buy recommendation

 

I’ll break down this report into 4 parts:

• Hit Me With The Numbers: Sales, Earnings, Margins: All Up
• Other Business Highlights: Raises Guidance, Cash Flow Positive
• Conference Call Highlights: Litigation Update, Acquisition Impact
• Bottom Line: It’s Time to Revisit Shares of AuthenTec

Hit Me With Some Numbers

AuthenTec Beats Estimates Once Again

Here are some of AuthenTec’s earnings highlights (growth from previous year’s 1Q/analyst’s estimates where applicable):

• Quarterly sales of $15.5 million (up 67% from prior year/vs. $15.16 million projected)
• Non-GAAP quarterly income of $587,000 (up from a -$1.7 million loss in the prior year)
• GAAP quarterly income of $188,000, or $0.01 per diluted share (up from a -$5.7 million, or $7.30 per diluted share, loss in the prior year)
• Non-GAAP $0.02 earnings per share (up from a -$.09 loss in the prior year/ vs. $.02 projected)
• Gross margin improves to 49.6% (up from 46.1% from prior year)

My Take: Once again AuthenTec put its head down and continues to execute as we’ve come to expect from this small but rapidly growing company.

You’ll notice that the $.02 earnings per share this quarter was in-line with analysts estimates, but would have been $.03 per share if it weren’t for the acquisition of EzValidation. Otherwise, AuthenTec also handily beats analysts expectations for earnings per share.

In addition, you can see the continued gross margin improvement from the prior year as AuthenTec gains traction and scale with their business and introduces a better product mix that enables them to get higher margins and better yields.

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Other Business Highlights

Accelerating Business Trends Mark Inflection Point

• For the 2nd quarter of 2008, AuthenTec is projecting sales of between $17.2-17.8 million vs. analysts estimates of $15.5 million.
• The ramp-up of their new sensor, the AES2810, is allowing them to raise their Q2 guidance to $17.2-17.8 million, the midpoint being 42% growth over the prior year, and 13% sequential growth.
• Operating expenses as a percent of revenue declined to 51 percent in the first quarter of 2008 from 65 percent in the year-ago quarter.
• For the 2nd quarter of 2008, AuthenTec expects non-GAAP earnings per share to range between $0.02 to $0.03 per share, compared to a loss of -$0.03 per share in the second quarter of 2007 vs. analysts projections of $.02 per share.
• Margins expected to range from 47-49% for the rest of 2008 because of the ramp-up of new chips with lower yields and inefficiencies typical of new product introductions and scaling.
• $67 million in cash and short term investments, vs. $66.3 million in Q4/2007
• Operating cash flow was $545,000 in the quarter
• CAPEX: $190,000
• Free Cash Flow: $355,000
• 48 days on hand of inventory vs. 59 in Q4/2007

My Take: This is where it gets juicy.

You see, AuthenTec significantly raised their guidance for the second quarter, and thereby their expectations for the full year. It seems they were able to ramp up production of one of their newest sensors, and had higher demand from customers earlier than previously anticipated.

In addition, AuthenTec increased their cash position, had a cash flow, and free cash flow positive quarter, and tightened up other operating efficiencies such as inventory levels.

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Conference Call Highlights

Patent Litigation Continues, Acquisition Strategy Comes Into Focus

The following are the highlights from AuthenTec’s analyst conference call:

• EzValidation Discussion: I had spoken previously about what this deal meant for AuthenTec, but in the conference call, management added more color to the discussion.

First off, the acquisition cost AuthenTec $250,000 in cash which was only for EzValidation’s client based software that resides on the PC, which will allow AuthenTec to enhance the user experience with their current fingerprint sensors.

We will see integration of this software in the 3rd quarter of 2008 as a value-added service to AuthenTec’s customers.

EzValidation’s software uses a Graphical User Interface (GUI) and other feature representation to allow customers using cell phones and PC’s that use AuthenTec sensors, to help them be more aware of the sensor and to also make it easier for them to actually use the sensor and understand it, etc.

From what I gather, AuthenTec will offer this as a value-add, and make some incremental revenue from it.

Current clients either already use their own software to feature AuthenTec’s sensors and its capabilities, or that of a partner or 3rd party.

For the first time, once EzValidation is incorporated into AuthenTec’s client software, the choice of what software to use will include an offering from AuthenTec, rather than clients having to create their own, or use a 3rd party.

This will be a great way for AuthenTec to garner some incremental revenue as things move forward and more customers decide to use AuthenTec’s ready-made software solution.

• Patent Infringement Suit Update (AuthenTec Vs. Atrua Technologies): AuthenTec stated that the suit was initially filed alleging infringement on 3 AuthenTec patents, but has since been expanded to include a total of 5 US patents.

Legal expenses are expected to be about $150k in Q2, and about $500k for the remainder of the year.

I was disappointed that management did not update the other infringement lawsuit with Atmel (Nasdaq: ATML), and no analysts asked them about it either.

I’ll have to do some of my own digging on this and report back when I find out how that suit is progressing.

• Overall Economy’s Affect on Business: Again like last quarter, the CEO talked about how they are not seeing any impact from the overall economy or the credit crisis.

He stated that because they are in the early stages of their growth and are in fact ramping up production and introduction into new products, and are penetrating more already established products, macroeconomic factors are not currently infringing on their business.

• Research and Development Costs (R&D): AuthenTec said they will be using any revenue ramp-ups, like the upcoming one in Q2/2008, for additional R&D spending.

So while their operating margins will come down as a % of revenue over time, they will increase on an absolute basis, and will also increase whenever AuthenTec can take advantage of spikes in revenue or business trends, such as the aforementioned Q2.

• AuthenTec sensors are now integrated into 8 of the 9 leading enterprise and consumer notebook manufacturers, all except Apple (Nasdaq: AAPL).

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Bottom Line

This is exactly what I wanted to see from AuthenTec.

They cleanly executed their last quarter and raised guidance for next quarter, and invariably the full year, and are ramping up sales at a faster and faster clip as time goes on.

Here’s why I am moving AuthenTec to a BUY:

• Well executed quarter with no signs of a slowdown or deterioration of business trends.
• Forward guidance that BLEW away analysts expectations. They’ll be scrambling to raise their numbers today.
• AuthenTec has met or beaten analyst’s expectations every single quarter as a public company, and always raised guidance. I expect this trend to continue in a big way.
• AuthenTec is the leader in their niche. No one comes close or sells as many sensors as AuthenTec does, and this trend is only accelerating.
• The fingerprint biometrics market is rapidly expanding and these sensors will be intertwined into our cell phones and computers, if they aren’t already, sooner than later.
• Insider selling has subsided after my previous trepidations concerning the CEO selling shares on the open market for BELOW the price that he had previously bought shares on the open market. However, this item is still a concern with insiders like Harris Corp. (NYSE: HRS) still dumping shares, albeit for completely different reasons than company execs.
• The patent litigation front is progressing as well as can be expected, and unfortunately for this type of company, is par for the course.
• I’ve come to terms with the fact that valuation will never be “cheap”. Rapidly growing companies that continually exceed and raise guidance are never going to be had for a discount, and if they are, you better pounce! As long as you can purchase shares at a “good” price, you hold your nose and scale in with a long time frame for holding the stock.

My previous reasons for downgrading the stock have been assuaged for the most part, and I’ve concluded that even though AuthenTec’s valuation is not “cheap” it probably will never be cheap.

As such, because of the rapidly accelerating business trends, margin expansion, sales increases, guidance revisions, and flawless execution by management, I am confident that as long term shareholders, we will be handsomely rewarded for our patience and diligence.

If you don’t already own shares of AuthenTec, take a dip, scale in, buy on “weakness”, and then sit tight for a long term story that will become as ubiquitous as cameras are now in cell phones.

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• Click here to read my complete AuthenTec research report and buy recommendation

*Variables You Should Know About AuthenTec (Nasdaq: AUTH)
Current Recommendation:	BUY
The Company:	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.
Why Buy Now:	Proprietary and Patented Technology Low-Cost Advantage Huge Growth In an Expanding and Rapidly Developing Market Strong Relationships With Leading Global PC and Wireless Device Manufacturers Addressable market of over 1 Billion units per year New Company on the Precipice of Fundamental Breakout High Margin Business Multiple Revenue Streams
Market Cap:	$337.90
Revenue (TTM):	$58.60
Cash/Debt:	$67 / $0
Current Price:	$13.00
Risk Rating (?):	7.5 (Moderate-High)
Position Size (?):	1/4 (12-17-07), 1/4 (1-17-08), 1/4 (1-23-08)
Buy Around Price (?):	$13.50 (12-17-07), $13.25 (1-17-08), $12.00 (1-23-08)

*As of 4-28-08. Except share price, all values in millions.