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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
  For the quarterly period ended March 30, 2012
 
OR
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
  For the transition period from              to             
 
Commission file number 001-33552

AuthenTec, Inc.
(Exact name of registrant as specified in its charter)
 
  
Delaware
59-3521332
(STATE OR OTHER JURISDICTION OF
INCORPORATION OR ORGANIZATION)
(I.R.S. EMPLOYER
IDENTIFICATION NO.)
 
AuthenTec, Inc.
100 Rialto Place, Suite 100
Melbourne, FL 32901
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
 
(321) 308-1300
(REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE)
 
N/A
(FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR, IF CHANGED SINCE LAST REPORT)
 
  
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨     No  ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer
¨
Accelerated filer
x
       
Non-accelerated filer
¨  (Do not check if a smaller reporting company)
Smaller Reporting Company
¨
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x
 
At May 8, 2012 there were 44,510,647 shares of common stock outstanding.
 
 
 

 
 
AUTHENTEC, INC.
TABLE OF CONTENTS
 
   
Page No.
Part I — Financial Information
 
     
  Item 1.
Consolidated Financial Statements (Unaudited)
3
 
Consolidated Balance Sheets at March 30, 2012 and December 30, 2011
3
 
Consolidated Statements of Operations for the three months ended March 30, 2012 and April 1, 2011
4
  Consolidated Statements of Comprehensive Income (Loss) for the three months ended March 30, 2012 and April 1, 2011   5
 
Consolidated Statements of Cash Flows for the three months ended March 30, 2012 and April 1, 2011
6
 
Notes to Consolidated Financial Statements (Unaudited)
7
  Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operation
18
  Item 3.
Quantitative and Qualitative Disclosure About Market Risks
23
  Item 4.
Controls and Procedures
23
   
PART II — OTHER INFORMATION
 
     
  Item 1.
Legal Proceedings
24
  Item 1A.
Risk Factors
24
  Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
24
  Item 3.
Defaults Upon Senior Securities
24
  Item 4.
Mine Safety Disclosures
24
  Item 5.
Other Information
24
  Item 6.
Exhibits
24
   
Signatures
25
   
   
EX-3.1 Amended and restated certificate of incorporation of AuthenTec, Inc.
 
EX-3.2 Second amended and restated bylaws of AuthenTec, Inc.
 
EX-10.1 Employment Agreement, dated as of January 2, 2012, between AuthenTec Inc. and Scott  
EX-31.1 Section 302 CEO Certification
 
EX-31.2 Section 302 CFO Certification
 
EX-32.1 Section 906 CEO Certification
 
EX-32.2 Section 906 CFO Certification
 
EX-101
The following financial information from the Quarterly Report on Form 10-Q for the fiscal quarter ended March 30, 2012, formatted in XBRL (Extensible Business Reporting Language) and furnished electronically herewith: (i) the Consolidated Balance Sheets at March 30, 2012 and December 30, 2011; (ii) the Consolidated Statements of Operations for the three months ended March 30, 2012 and April 1, 2011; (iii) the Consolidated Statements of Cash Flows for the three months ended March 30, 2012 and April 1, 2011; and (iv) the Notes to the Consolidated Financial Statements – submitted herewith pursuant to Rule 406T.  
 
 
2

 

AuthenTec, Inc. and Subsidiaries
Consolidated Balance Sheets
(In thousands, except per share data)
(Unaudited)
 
   
As of
 
   
March 30,
   
December 30,
 
   
2012
   
2011
 
Assets
           
Current assets
           
Cash and cash equivalents
  $ 18,798     $ 17,200  
Restricted cash
    750       -  
Accounts receivable, net of allowances of $50 and $67, respectively
    9,383       9,444  
Inventory
    7,607       8,111  
Other current assets
    2,068       1,716  
Total current assets
    38,606       36,471  
                 
Long-term investments
    3,229       3,249  
Purchased intangible assets
    19,351       20,287  
Goodwill
    3,501       3,501  
Property and equipment, net
    3,423       3,640  
Total assets
  $ 68,110     $ 67,148  
                 
Liabilities and stockholders’ equity
               
Current liabilities
               
Accounts payable
  $ 5,384     $ 3,539  
Accrued compensation and benefits
    2,458       4,399  
Accrued litigation related legal fees
    -       114  
Other accrued liabilities
    3,341       2,634  
Deferred revenue
    5,778       4,145  
Total current liabilities
    16,961       14,831  
                 
Deferred rent
    353       398  
Other long-term liabilities
    354       768  
Total liabilities
    17,668       15,997  
                 
Commitments and contingencies (see note 9)
               
                 
Stockholders’ equity
               
Common stock, $.01 par value; 100,000 shares authorized; 44,469 and 44,311 issued and outstanding at March 30, 2012 and December 30, 2011
    445       443  
Additional paid-in capital
    193,284       192,694  
Accumulated other comprehensive income
    266       50  
Accumulated deficit
    (143,553 )     (142,036 )
Total stockholders’ equity
    50,442       51,151  
Total liabilities and stockholders’ equity
  $ 68,110     $ 67,148  
 
 See Notes to Consolidated Financial Statements (Unaudited)
 
 
3

 
 
AuthenTec, Inc. and Subsidiaries
Consolidated Statements of Operations
(In thousands, except per share data)
(Unaudited)

   
Three Months Ended
 
   
March 30,
2012
   
April 1,
2011
 
Revenue
  $ 17,460     $ 15,476  
Cost of revenue
    7,421       8,051  
                 
Gross profit
    10,039       7,425  
                 
Operating expenses
               
Research and development
    5,729       5,887  
Selling and marketing
    3,898       3,990  
General and administrative
    1,758       2,457  
Restructuring and impairment related charges
    -       283  
                 
Total operating expenses
    11,385       12,617  
                 
Loss from operations
    (1,346 )     (5,192 )
                 
Other income (expense):
               
Other income (expenses)
    (83 )     (303 )
Interest income
    12       29  
Total other income (expenses), net
    (71 )     (274 )
                 
Net loss before income taxes
  $ (1,417 )   $ (5,466 )
                 
Provision for income taxes
    100       136  
Net loss
  $ (1,517 )   $ (5,602 )
                 
Net loss per common share, basic
  $ (0.03 )   $ (0.13 )
                 
Net loss per common share, diluted
  $ (0.03 )   $ (0.13 )
                 
Shares used in computing basic net loss per common share
    44,401       43,600  
                 
Shares used in computing diluted net loss per common share
    44,401       43,600  
 
See Notes to Consolidated Financial Statements (Unaudited)

 
4

 

AuthenTec, Inc. and Subsidiaries
Consolidated Statements of Comprehensive Income (Loss)
(In thousands)
(Unaudited)

   
Three months ended
 
   
March 30,
   
April 1,
 
   
2012
   
2011
 
             
Net loss
  $ (1,517 )   $ (5,602 )
                 
Other comprehensive income (loss)
         
   Unrealized loss on available for sale investments
    (20 )     (3 )
   Foreign currency translation adjustment
    54       221  
   Net gain on derivative hedging instruments
    186       -  
Total other comprehensive income (loss)
    220       218  
                 
Comprehensive loss
  $ (1,297 )   $ (5,384 )

See Notes to Consolidated Financial Statements (Unaudited)
 
 
5

 
 
 AuthenTec, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
 (In thousands)
(Unaudited)

   
Three months ended
 
   
March 30,
2012
   
April 1,
2011
 
Cash flows from operating activities
           
Net loss
  $ (1,517 )   $ (5,602 )
Adjustments to reconcile net loss to net cash provided by (used in) operating activities                
Depreciation and amortization
    1,377       1,696  
Amortization of deferred rent
    (37 )     29  
Increase (decrease) in bad debt provision
    (17 )     45  
Increase in inventory provision
    64       357  
Stock-based compensation expense
    499       1,144  
Decrease in investment discounts/premiums
    -       204  
Loss on disposal of fixed assets
    11       16  
Decrease (increase) in assets:
               
Accounts receivable
    (321 )     166  
Inventory
    442       (2,518 )
Other assets
    (97 )     182  
Increase (decrease) in liabilities:
               
Accounts payable
    2,301       (115 )
Accrued compensation and benefits and other accrued liabilities
    (1,769 )     (1,726 )
Accrued litigation related legal fees
    (114 )     (99 )
Deferred revenue
    1,633       (803 )
Net cash provided by (used in) operating activities
    2,455       (7,024 )
Cash flows from investing activities
               
Purchase of property and equipment
    (234 )     (298 )
Increases to restricted cash
    (750 )     -  
Redemption of available-for-sale investments
    -       5,100  
Net cash provided by (used in) investing activities
    (984 )     4,802  
Cash flows from financing activities
               
Proceeds from exercise of stock options, net of tax withholdings
    93       68  
Net cash provided by financing activities
    93       68  
Effect of exchange rates on cash and cash equivalents
    34       66  
Net increase (decrease) in cash and cash equivalents
    1,598       (2,088 )
Cash and cash equivalents, beginning of period
    17,200       13,280  
Cash and cash equivalents, end of period
  $ 18,798     $ 11,192  

See Notes to Consolidated Financial Statements (Unaudited)

 
6

 
 
AuthenTec, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)
 
1. Description of Business and Basis of Presentation

AuthenTec, Inc. (“AuthenTec”, “our”, “we”, etc.) is  a leading provider of mobile and network security solutions for enterprise, government and consumer markets.  We provide a series of products including fingerprint sensors, software and intellectual property (IP) that provide security, convenience, personalization and navigation features in such end-use products as PCs, tablets, smartphones, printers, network servers and gateways. During the periods covered by these unaudited interim consolidated financial statements, we operated in two reporting segments: Smart Sensor Solutions (“SSS”) - comprised of smart fingerprint sensors, area sensors (TouchChip sensors), identity management and electronic commerce (e-commerce) solutions – and Embedded Security Solutions (“ESS”) – network and mobile system security solutions.

We primarily sell our products to original equipment manufacturers, or OEMs, original design manufacturers, or ODMs, contract manufacturers, software application vendors, and service providers. We operate a fabless manufacturing model, whereby manufacturing requirements are outsourced to third parties.  
 
The accompanying unaudited consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles for interim financial information pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). They do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The accompanying unaudited consolidated financial statements include the accounts of AuthenTec, Inc and its wholly owned subsidiaries. All significant intercompany transactions are eliminated in consolidation.  In our opinion, all adjustments, consisting primarily of normal recurring accruals, considered necessary for a fair statement of our results of operations for the interim periods reported and of our financial condition as of the date of the interim balance sheet have been included. Operating results for the three months ended March 30, 2012 are not indicative of the results that may be expected for the year ending December 28, 2012 or for any other period.
 
These unaudited interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes for the year ended December 30, 2011 contained in our Annual Report on the Form 10-K, filed with the SEC March 9, 2012.
 
The year end consolidated balance sheet data was derived from audited financial statements set forth in this report, but does not include all disclosures required by accounting principles generally accepted in the United States of America.
 
We utilize a 52/53 week fiscal year. Our current 52 week fiscal year will end on December 28, 2012. References to past or future quarterly or annual periods in our financial statements are to those respective fiscal periods which vary from exact calendar quarters or years.

 
7

 
  
2. Net Income (Loss) Per Share
 
We calculate net income (loss) per share in accordance with Accounting Standards Codification (“ASC”) Topic 260, Earnings per Share. Under ASC 260, basic net income (loss) per common share is calculated by dividing net income (loss) by the weighted-average number of common shares outstanding during the reporting period. Diluted net income (loss) per common share reflects the effects of potentially dilutive securities, which consist of common stock options to purchase common stock and  restricted stock awards. The following table sets forth the computation of basic and diluted loss per common share (in thousands, except per share amounts).
 
   
Three Months Ended
 
   
March 30,
2012
   
April 1,
2011
 
   
(In thousands, except per share data)
 
Numerator:
           
Net loss
  $ (1,517 )   $ (5,602 )
                 
Denominator:
               
Denominator for basic loss per share - weighted average common shares outstanding
    44,401       43,600  
Effect of dilutive securities:
               
Stock options and restricted stock units
    -       -  
                 
Denominator for diluted loss per share -
    44,401       43,600  
weighted average common shares and potential common shares outstanding
    44,401       43,600  
                 
Basic net loss per share
  $ (0.03 )   $ (0.13 )
Diluted net loss per share
  $ (0.03 )   $ (0.13 )
 
Basic and diluted net losses per common share were the same for the three months ended March 30, 2012 and April 1, 2011, respectively. The following table presents the weighted average of potentially dilutive securities outstanding that were excluded from the computation of diluted net loss per common share for the three months ended March 30, 2012 and April 1, 2011, respectively, because their inclusion would have had an anti-dilutive effect:
  
   
Three months ended
 
   
March 30,
2012
 
April 1,
2011
 
   
(In thousands)
 
Options to purchase common stock and non vested restricted stock awards
    7,188       6,143  
      7,188       6,143  
 
3. Cash, Cash Equivalents and Investments
 
Our investments are tailored to appropriately balance the trade-off between the preservation of capital and return. We consider all highly liquid investments with an original maturity of three months or less at the date of purchase to be cash equivalents. Our other investments that include auction rate securities are classified as investments and are accounted for under the provisions of ASC Topic 320, Investments – Debt and Equity Securities. We have classified our auction rate securities as available-for-sale (AFS) and reported at fair value.
 
Unrealized temporary gains and losses, if any, are excluded from earnings and reported in accumulated other comprehensive income (loss), a separate component of stockholders’ equity. Other-than-temporary impairments are recognized through earnings if there is intent to sell the debt security or if it is more likely than not that we will be required to sell the debt security before recovery of its amortized cost basis. In the event of a credit loss, which is determined based on the expected cash flows to be received, only the amount associated with the credit loss is recognized in the statement of earnings. The amount of losses relating to other factors, including those resulting from changes in interest rates, are recorded in accumulated other comprehensive income (loss).
 
 
8

 

The amortized cost, gross unrealized gains and losses, and fair value of investments, by type, were as follows:
 
   
As of
 
   
Amortized cost
   
Unrealized gains/(losses)
   
Fair value
 
   
March 30,
2012
   
December 30,
2011
   
March 30,
2012
   
December 30,
2011
   
March 30,
2012
   
December 30,
2011
 
   
(In thousands)
 
Auction rate securities (AFS)
  $ 3,500     $ 3,500     $ (271 )   $ (251 )   $ 3,229     $ 3,249  
 
The amortized cost and fair value of available-for-sale investments as of March 30, 2012 and December 30, 2011, by contractual maturity, were as follows:
 
   
As of
 
   
Amortized cost
   
Fair value
   
Unrealized gains/(losses)
 
   
March 30,
   
December 30,
   
March 30,
   
December 30,
   
March 30,
   
December 30,
 
   
2012
   
2011
   
2012
   
2011
   
2012
   
2011
 
   
(In thousands)
 
Due after ten years
    1,100       1,100       979       993       (121 )     (107 )
Preferred stock auction rate securities
    2,400       2,400       2,250       2,256       (150 )     (144 )
Total
  $ 3,500     $ 3,500     $ 3,229     $ 3,249     $ (271 )   $ (251 )
 
The fair value of investments with gross unrealized losses by investment type and length of time that individual securities haven been in a continuous loss position were as follows:
 
   
As of March 30, 2012
 
   
Less than 12 months
   
12 months or greater
   
Total
 
   
Fair
   
Gross unrealized
   
Fair
   
Gross unrealized
   
Fair
   
Gross unrealized
 
   
value
   
losses
   
value
   
losses
   
value
   
losses
 
Available-for-sale investments
 
(In thousands)
 
Auction rate securities - student loan
  $     $     $ 979     $ (121 )   $ 979     $ (121 )
Auction rate securities - preferred stock
                2,250       (150 )     2,250       (150 )
Total
  $     $     $ 3,229     $ (271 )   $ 3,229     $ (271 )
 
   
As of December 30, 2011
 
   
Less than 12 months
   
12 months or greater
   
Total
 
   
Fair
   
Gross unrealized
   
Fair
   
Gross unrealized
   
Fair
   
Gross unrealized
 
   
value
   
losses
   
value
   
losses
   
value
   
losses
 
Available-for-sale investments
 
(In thousands)
 
Auction rate securities - student loan
  $     $     $ 993     $ (107 )   $ 993     $ (107 )
Auction rate securities - preferred stock
                2,256       (144 )     2,256       (144 )
Total
  $     $     $ 3,249     $ (251 )   $ 3,249     $ (251 )
 
As of March 30, 2012 and December 30, 2011, all of our long-term investments of approximately $3.2 million were comprised of preferred stock and student loan investments with an auction reset feature (“auction rate securities”). The preferred stock is issued by various closed-end mutual funds that invest primarily in common stock and fixed income securities. The student loan backed auction rate security is a state issued note with its underlying student loans being substantially insured by the U.S. government.
 
Due to auction rate securities markets being disrupted in the beginning of 2008 we experienced auction failures for the first time. An auction failure means that the parties wishing to sell their securities could not be matched with an adequate volume of buyers. In the event that there is a failed auction, the indenture governing the security requires the issuer to pay interest at a contractually defined rate that is generally above market rates for other types of similar short-term instruments and we continue to receive contractual payments. The securities for which auctions have failed will continue to accrue interest at the contractual rate and be auctioned every seven, 28 or 35 days until the auction succeeds, the issuer calls the securities, or they mature.
 
 
9

 
 
All of our auction rate securities held at March 30, 2012 had experienced failed auctions. As a result, our ability to liquidate and fully recover the carrying value of our remaining auction rate securities in the near term may be limited or not exist.
 
We estimated the fair value of our short-term and long-term investments based our own analysis. Our estimates were established on assumptions we believe market participants would use in pricing similar assets in a current transaction, which could change significantly over time based on market conditions. Please refer to Note 4, Fair Value Measurements and Disclosures, for more information.
 
4. Fair Value Measurements and Disclosures
 
We measure certain financial assets and liabilities at fair value on a recurring basis, including cash equivalents, available-for-sale securities and foreign currency forward contracts. Fair value is measured based on a fair value hierarchy following three levels of inputs:
 
Level 1 inputs are defined as quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.
 
Level 2 inputs are defined as inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.
 
Level 3 inputs are defined as unobservable inputs for the asset or liability. Unobservable inputs shall be developed based on the best information available in the circumstances, which might include the reporting entity’s own data.
 
Recurring Fair Value Measurements
 
The fair values of assets based on the level of inputs are summarized below:
 
   
Fair Value Measurements
 
   
As of March 30, 2012
 
As of December 30, 2011
 
 
Description
 
Fair Value
Total
 
Level 1
 
Level 2
 
Level 3
 
Gains (losses)
 
Fair value
total
 
Level 1
 
Level 2
 
Level 3
 
Gains (losses)
 
Available-for-sale investments  
(In Thousands)
 
(In thousands)
 
Money market and treasury funds
  $ 10,650   $ 10,650   $   $   $   $ 10,454   $ 10,454   $   $   $  
Foreign exchange forward contracts
    186         186         186                      
Auction rate securities
    3,229             3,229     (271 )   3,249             3,249     (251 )
Total
  $ 14,065   $ 10,650   $ 186   $ 3,229   $ (85 ) $ 13,703   $ 10,454   $   $ 3,249   $ (251 )
 
The fair values of liabilities based on the level of inputs are summarized below:
 
   
Fair Value Measurements
 
   
As of March 30, 2012
 
As of December 30, 2011
 
Description
 
Fair Value Total
 
Level 1
 
Level 2
 
Level 3
 
Gains (losses)
 
Fair value total
 
Level 1
 
Level 2
 
Level 3
 
Gains (losses)
 
   
(In Thousands)
   
(In Thousands)
   
Contingent consideration liability
  $ 770   $   $   $ 770   $   $ 770   $   $   $ 770   $  
Total
  $ 770   $   $   $ 770   $   $ 770   $   $   $ 770   $  
 
In measuring fair value where Level 1 inputs were available, we used a single valuation technique which valued our securities based on quoted market prices. At March 30, 2012, our money market funds and U.S. Government agency notes were measured using Level 1 inputs and the fair value was based on daily observable trades.

In measuring fair value where Level 2 inputs were available, we used quotations of third parties for our foreign exchange forward contracts. These financial instruments are valued using models or other valuation methodologies. These models are primarily industry-standard models that consider various assumptions, including quoted prices, time value, volatility factors, and current market and contractual prices for the underlying instruments, as well as other relevant economic measures. Substantially all of these assumptions are observable in the marketplace throughout the full term of the instrument, can be derived from observable data or are supported by observable levels at which transactions are executed in the marketplace.

In measuring fair value where Level 3 inputs were available, we used a single valuation technique which valued our securities based on multiple discounted cash flow scenarios with various liquidation time horizons. We believe that this pricing model reflects the assumptions a marketplace participant would use in valuing similar assets, which could change significantly over time based on market conditions. Factors that may impact our valuation include changes to credit ratings of the securities as well as to the underlying assets supporting those securities, rates of default of the underlying assets, underlying collateral value, discount rates, credit risk and ongoing strength and quality of market credit and liquidity.
 
 
10

 

As of March 30, 2012, we held foreign currency forward contracts to hedge Euro and Czech Crown currencies which had a fair value of approximately $5,530,000 based on third party quotations.

At March 30, 2012, our investments in auction rate securities were measured using unobservable inputs with a fair value of approximately $3.2 million which represented approximately 23% of total assets subject to fair value measurements on a recurring basis.  The student loan backed auction rate security with a fair value of approximately $1.0 million and the preferred stock auction rate security with a fair value of approximately $2.2 million remain in Level 3 at March 30, 2012.
   
The table below provides a reconciliation of all assets measured at fair value on a recurring basis which use Level 3 or significant unobservable inputs for the three months ended March 30, 2012:
 
Description
 
Total
   
Auction Rate Securities
 
   
(In Thousands)
 
             
Beginning balance December 30, 2011
  $ 3,249     $ 3,249  
                 
Realized/unrealized gains and losses
               
Included in earnings
           
Included in other comprehensive income (loss)
    (20 )     (20 )
                 
Purchases
           
Issuances
           
Settlements
           
 
               
Transfers in/(out) of Level 3
           
                 
Ending balance March 30, 2012
  $ 3,229     $ 3,229  
 
As of March 30, 2012, we classified $3.2 million of investments in ARS as long-term due to the fact that they had experienced failed auctions. Our money market and treasury funds with a value of $10.7 million have a maturity of ninety days or less and therefore are classified as cash and cash equivalents on our Consolidated Balance Sheet.
 
At March 30, 2012, the estimated fair value of our investments in ARS was $271,000 less than its cost. As we intend to hold on to these securities until the sooner of a recovery in the ARS market or a call of the securities by the issuer and it is more-likely-than-not that we will not be required to sell this ARS prior to recovery, we did not record other-than-temporary impairment charges in the fiscal quarter ended March 30, 2012.

During the fiscal quarter ended March 30, 2012 we recorded $20,000 in unrealized loss on our available-for-sale investments which was recorded in accumulated other comprehensive income on the accompanying Consolidated Balance Sheet at March 30, 2012.
  
We will continue to monitor these securities and may be required to record temporary or other-than-temporary impairment charge in the future.

As a result of our acquisition of PeerSec Networks, a contingent consideration payment may be due by us if certain revenue targets are achieved during the earn-out period. The revenue target calculation requires accumulated annual 2012 product revenue to exceed $600,000 and accumulated annual 2013 product revenue to exceed $900,000, adjusted for certain deferred revenue items. We estimate the fair value of the contingent payment using Level 3 inputs that are based on financial projections of the acquired business and estimated probabilities of achievement. We believe that our estimates and assumptions are reasonable, but there is significant judgment involved. At March 30, 2012 we valued the contingent consideration at approximately $770,000 and have included the current portion in the amount of $416,000 in other current liabilities and the long-term portion in the amount of $354,000 in other long-term liabilities (please see Note 11, Business Acquisitions, for more information).
 
 
11

 

The table below provides a reconciliation of all liabilities measured at fair value on a recurring basis which use Level 3 or significant unobservable inputs for the three months ended March 30, 2012:
 
Description
 
Total
   
Contingent Consideration
 
   
(In Thousands)
 
             
Beginning balance December 30, 2011
  $ 770     $ 770  
                 
Fair value measurements recorded
           
                 
Transfers in/(out) of Level 3
           
                 
Ending balance March 30, 2012
  $ 770     $ 770  
 
We will continue to monitor these liabilities and may be required to record fair value measurement in the future.

Non-recurring Fair Value Measurements

We did not have any non-financial liabilities as of March 30, 2012. Our non-financial assets are reviewed for potential impairment and considered for the need to perform an impairment test pursuant to ASC 360-40, Property Plant and Equipment, Derecognition. 
 
All acquired assets and liabilities as a result of our acquisitions were measured at fair value on a non-recurring basis (please see Note 11, Business Acquisitions, for more information). In measuring assets acquired and liabilities assumed we used Level 3 inputs that included various budget cash flow models, customer attrition rates as well as factors such as general economic and industry outlook. Long-lived assets were reviewed for future use, physical deterioration and technical and economical obsolescence. In order to arrive at our estimates of fair value for purchased intangible assets, we considered a variety of generally accepted valuation approaches and the final fair value was concluded from the reconciliation of the various valuation indications derived from each approach if multiple approaches were used in the analysis.

5. Derivative Instruments
 
Our derivative instruments include forward foreign currency contracts utilized to hedge a portion of our foreign currency subsidiary funding to cover operating expenses in the normal course of business. The derivatives qualifying for hedge accounting are designated as cash flow hedges and valued using observable forward rates (Level 1). The duration of open forward foreign currency contracts range from 1 to 9 months. The associated asset or liability on the open hedges is recorded in other current assets or other current liabilities, as applicable.
 
We enter into derivative instrument contracts with terms that coincide with the underlying exposure being hedged. As such, our derivative instruments are expected to be highly effective. Hedge ineffectiveness, if material to the financial results, is recognized as incurred under the caption of other income (expense) in our Consolidated Statement of Operations. For the three months ended March 30, 2012, we did not recognize any amounts related to hedge ineffectiveness.

Cash flow hedges

In January 2012, we entered into forward foreign currency contracts, which have a current outstanding notional value of approximately $5,344,000, and are designated as cash flow hedges. For cash flow hedges, the effective portion of the gain or loss is reported as a component of other comprehensive income (loss) and reclassified into earnings in the same period or periods during which the hedged transactions affect earnings.

Activity related to cash flow hedges recorded during the three months ended March 30, 2012 was as follows:
 
   
For the three months ended March 30, 2012
 
   
Gain (loss) recognized in other comprehensive income
 
Gain (loss) reclassified into other income (expense)
 
Gain (loss) for ineffectiveness in other Income (expense)
 
Cash flow hedges
                 
                   
Foreign currency contracts
  $ 186     $ 25     $ -  

The net gain recognized in other comprehensive income for foreign currency contracts is expected to be recognized in other income (expense) within the next nine months.  As of March 30, 2012, no contracts originally designated for hedge accounting were re-designated or terminated.

Our foreign currency forward contract includes a collateral requirement to hold 10% of the USD value of the contract in a segregated restricted collateral money market account. The collateral is fixed for the duration of the contract. At March 30, 2012 the restricted cash balance in our collateral money market account was $750,000.
 
 
12

 
 
6. Inventory

   
As of
 
   
March 30,
   
December 30,
 
   
2012
   
2011
 
   
(In thousands)
 
Work-in-process
  $ 5,236     $ 4,877  
Finished goods
    4,488       5,315  
Valuation allowance
    (2,117 )     (2,081 )
    $ 7,607     $ 8,111  
 
7. Property and Equipment
 
         
As of
 
   
Useful Life
   
March 30,
   
December 30,
 
   
(Years)
   
2012
   
2011
 
         
(In thousands)
 
                   
Production and lab equipment
    3 - 8     $ 7,106     $ 6,922  
Computer equipment
    3 - 5       1,646       1,601  
Office furniture and fixtures
    3       630       630  
Computer software
    3 - 5       1,730       1,728  
Leasehold improvements
    3 - 6       1,485       1,492  
              12,597       12,373  
Less: Accumulated depreciation
            (9,174 )     (8,733 )
            $ 3,423     $ 3,640  
 
Depreciation expense was approximately $440,000 and $462,000 for the three months ended March 30, 2012 and April 1, 2011, respectively.

 8. Goodwill and Intangible Assets

The following table summarizes the activity related to the carrying value of our goodwill at March 30, 2012:
 
   
Reportable Segments
       
   
Smart Sensor Solutions
   
Embedded Security Solutions
   
Consolidated
 
    (In thousands)  
                   
Goodwill at December 30, 2011
  $ 265     $ 3,236     $ 3,501  
Impairment
                 
Goodwill at March 30, 2012
  $ 265     $ 3,236     $ 3,501  
 
 
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At March 30, 2012 and December 30, 2011, purchased intangible assets consisted of the following:
 
   
As of
 
   
March 30, 2012
   
December 30, 2011
 
   
Gross carrying value
   
Accumulated amortization
   
Net book value
   
Gross carrying value
   
Accumulated amortization
   
Net book value
 
   
(In thousands)
 
                                     
Patents subject to amortization (6-19 years)
  $ 630       164     $ 466     $ 630     $ 150     $ 480  
Customer relationships (6-10 years)
    13,838       2,900       10,938       13,838       2,453       11,385  
Developed technology (4-9 years)
    10,227       2,721       7,506       10,227       2,299       7,928  
IC distribution agreement (2 years)
    2,020       2,020       -       2,020       2,015       5  
Non-compete agreement (2-5 years)
    700       259       441       700       211       489  
Backlog (1 year)
    829       829       -       829       829       -  
    $ 28,244     $ 8,893     $ 19,351     $ 28,244     $ 7,957     $ 20,287  
 
Amortization expense for intangible assets amounted to approximately $937,000 and $1,234,000 for the three months ended March 30, 2012 and April 1, 2011, respectively. The weighted average amortization period is 7.1 years. The estimated aggregate amortization expense for all amortizable intangibles for each of the succeeding years ending December 30, 2016 is as follows:

Fiscal year
 
Amount
 
   
(In thousands)
 
2012
  $ 2,812  
2013
    3,730  
2014
    3,522  
2015
    3,208  
2016
    2,733  
    $ 16,005  
 
9. Commitments and Contingencies
 
Legal Proceedings
 
There were no material changes in our legal proceedings from the information contained in our Annual Report on the Form 10-K for the year ended December 30, 2011, filed with the SEC March 9, 2012.

In addition, from time to time, we may be involved in various legal proceedings arising from the normal course of business activities.  In our opinion, resolution of these matters is not expected to have a material adverse impact on our consolidated results of operations, cash flows or our financial position.  However, depending on the amount and timing, an unfavorable resolution of a matter could materially affect our future results of operations, cash flows or financial position in a particular period.
 
10. Stock Activity and Stock Plans

2011 Shelf Registration Statement
 
In December 2011, we filed a shelf registration statement on Form S-3 with the Securities and Exchange Commission to, from time to time, sell up to an aggregate of $100 million of our common and preferred stock, warrants or debt securities. On January 6, 2012, the registration statement was declared effective by the SEC, which will allow us to access the capital markets for the three year period following this effective date. Through March 30, 2012, no instruments were issued under this registration statement.
 
 
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Equity Incentive Plans

            A summary of the stock options activity for the three months ended March 30, 2012 is presented below:
 
   
Number of
Shares
(in thousands)
   
Weighted
Average
Exercise
Price
 
Outstanding as of December 30, 2011
    7,226     $ 2.91  
Granted
    118       3.26  
Forfeited
    (69 )     2.72  
Exercised
    (157 )     0.71  
Outstanding as of March 30, 2012
    7,118     $ 2.81  
 
The total intrinsic value of options exercised during the three months ended March 30, 2012 was approximately $435,000.
 
Restricted stock units granted under the 2010 Stock Incentive Plan are either incentive or performance based awards that will result in a payment to a participant in shares of our common stock. The incentive based awards vest as the service conditions are met while the performance based awards also have performance conditions as well as usual service conditions. The plan administrator will determine the number of shares and the conditions that must be satisfied, which typically are based on achievement of performance milestones and service conditions.
 
Restricted stock awards are measured at fair value based on the market price which is determined upon the closing price of our common stock on the NASDAQ Global Market on the date of the grant.
 
A summary of the restricted stock activity for the three months ended March 30, 2012 is presented below:
 
   
Number of
Shares
(in thousands)
   
Weighted
Average
Grant-Date
Fair Value
 
Outstanding as of December 30, 2011
    16     $ 10.39  
Granted
    -       -  
Forfeited
    (1 )     13.74  
Vested/Issued
    (2 )     13.74  
Outstanding as of March 30, 2012
    13     $ 9.80  
 
The total intrinsic value of restricted stock units vested during the three months ended March 30, 2012 was approximately $6,500.

We estimate expected forfeitures based on our historical experience and recognize compensation cost over a four-year vesting period on a straight-line basis. Any performance based awards are recognized in earnings over the requisite service period for each separately vesting portion of the award. We recognize expense over the attribution period beginning when it is determined that meeting the performance condition is probable.

 The total unrecognized stock-based compensation for stock option and restricted stock awards accounted for under ASC 718 was approximately $4,411,000 as of March 30, 2012. These awards had a remaining weighted-average period over which they are expected to be recognized of 2.9 years as of March 30, 2012.

The weighted average estimated values of stock option grants, as well as the weighted average assumptions used in calculating these values were based on estimates at the date of grant as follows:

   
Three Months Ended
 
   
March 30, 2012
   
April 1, 2011
 
Grant Date Fair Value
  $ 2.13     $ 2.09  
Expected life (in years)
    4.9       4.8  
Risk free rate
    1 %     2 %
Volatility
    84 %     76 %
Dividend yield
    0 %     0 %
Estimated forfeiture rate
    10 %     14 %
 
 
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11. Business Acquisitions
 
Proxure, Inc.

On December 20, 2011, we acquired substantially all of the assets and certain liabilities of Proxure, Inc. ("Proxure") in exchange for $0.2 million in cash and 70,975 shares of our common stock (valued at $0.2 million on December 20, 2011). The sellers, which were retained as employees after the acquisition, may earn additional payments of up to $0.5 million in cash based on levels of revenues attributable to the Proxure business between December 31, 2011 and January 3, 2014. The annual earn-out payments, if any, will be estimated on a quarterly basis and paid subsequent to year end. We will record the estimated contractual obligation as compensation expense during each year as it is deemed probable that such amount will be payable. Due to the forfeiture of payments in the case of selling shareholders employment termination, the earn-out payments are not accounted for as additional contingent consideration but rather as compensation for post acquisition services.
 
 PeerSec Networks, Inc.

On November 30, 2011, we acquired substantially all of the assets and certain liabilities of PeerSec Networks ("PeerSec") in exchange for $0.9 million in cash and 161,583 shares of our common stock (valued at $0.5 million on November 30, 2011). The sellers, which were retained as employees after the acquisition, were paid an additional $0.6 million in cash at closing which can be required to be repaid to us in the event that the employment of the sellers is terminated, under certain conditions, before June 30, 2012. This $0.6 million has been recorded as a prepaid asset and is being recognized as compensation expense on a pro rata basis over the 7 month period through June 30, 2012. The sellers may earn additional payments of up to $1.0 million in cash based on levels of revenues attributable to the PeerSec business during fiscal years 2012 and 2013. The annual earn-out payments, if any, are determined based on a percentage of revenues attributable to PeerSec in excess of $0.6 million for 2012 and $0.9 million for 2013. We estimated the fair value of the contingent payment based on financial projections of the acquired business and estimated probabilities of achievement. We believe that our assumptions are reasonable, but there is significant judgment involved. Changes in the fair value of contingent consideration liabilities subsequent to the acquisition date will be recorded in the General and Administrative expense caption of our Consolidated Statement of Operations. The fair value of the contingent consideration at the time of the acquisition of $0.8 million was determined using the income approach with significant inputs that are not observable in the market. Key assumptions include discount rates consistent with the level of risk of achievement and probability-adjusted revenue amounts.
 
Pro forma financial information is not presented as the operating results of the acquired businesses are not material to the consolidated financial statements for the periods presented.
 
12. Segment Information
 
Segment reporting, under the guidance of ASC 280, Segment Reporting, requires disclosures of certain information regarding reportable segments, products and services, geographic areas of operation and major customers. Segment reporting is based upon the “management approach,” which requires management to organize the Company’s reportable segments for which separate financial information is (i) available and (ii) evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance.
 
Historically we operated in one segment.  However, as a result of our acquisition of SafeNet’s Embedded Security Solutions division in February 2010, we have determined that we operate in two reporting segments: Smart Sensor Solutions (“SSS”) and Embedded Security Solutions (“ESS”). Our Chief Executive Officer, who is our chief operating decision maker, reviews financial information at the operating segment level. A description of the types of products and services provided by each business segment follows.
 
 
Smart Sensor Solutions include fingerprint sensors that are used in notebooks, netbooks, tablet PCs, peripherals, cell phones, mobile systems and a wide variety of access control devices. Our sensors offer touch-powered multi-functionality that includes combinations of user navigation, personalization, and convenient security. In addition to smart fingerprint sensors, SSS offers our new identity management software applications, TrueSuite® and TrueSuite Mobile®, which are designed to make fingerprint-enabled PC’s and mobile phones easier to use and more secure, while increasing user convenience and personalization. The TrueSuite family is tailored for consumers who demand simplicity, improved usability, and one-touch access to their digital identity and online social networks.
 
 
Embedded Security Solutions include complete, standards-based, server-side digital rights management (“DRM”) software and toolkits for mobile operators, service providers, platform integrators, as well as client-side DRM solutions for device manufacturers and semiconductors, software application and platform vendors. The Embedded Security Solutions portfolio also includes QuickSec IP security (IPsec) and MAC security (MACsec) toolkits as well as semiconductor intellectual property (IP) and security processors for enterprise and telecom grade security equipment. In addition, Embedded Security Solutions grants licenses, which include certain patent rights of our portfolio, and collects license fees and royalties in partial consideration for such licenses.
 
 
16

 
 
 We evaluate the performance of our segments based on  income (loss) from operations. Our Chief Executive Officer does not review any information regarding total assets on an operating segment basis. The accounting policies for segment reporting are the same as for AuthenTec as a whole. The table below presents revenues and operating loss for reportable segments for the three months ended March 30, 2012 and April 1, 2011:
 
   
Reportable segments
       
   
Smart Sensor Solutions
   
Embedded Security Solutions
   
Consolidated
 
   
(In thousands)
 
Three months ended March 30, 2012
                 
Net revenue
  $ 10,438     $ 7,022     $ 17,460  
Operating income (loss)
    (3,750 )     2,404       (1,346 )
                         
Three months ended April 1, 2011
                       
Net revenue
    10,783       4,693       15,476  
Operating income (loss)
  $ (5,769 )     577     $ (5,192 )
 
The following table is based on the geographic location of OEMs, ODMs and the distributors which purchased our products. For shipments to ODMs, contract manufacturers or distributors, their geographic location may be different from the geographic locations of the ultimate end customers. For the three months ended March 30, 2012 and April 1, 2011, revenue generated from international customers accounted for approximately 70% and 76% of total revenue, respectively.
 
The majority of our revenue is denominated in U.S. dollars, however we do generate revenue that is denominated in other currencies, mostly Euros and Japanese Yen.
 
   
Three months ended
 
   
March 30,
   
April 1,
 
   
2012
   
2011
 
   
Revenue $
   
% of total
   
Revenue $
   
% of total
 
   
(In thousands)
 
                         
Asia/Pacific
  $ 7,464       43 %   $ 8,353       54 %
United States
    5,208       30       3,638       24  
Japan
    2,980       17       2,174       14  
Europe
    1,629       9       1,246       8  
Canada
    179       1       65       0  
    $ 17,460       100 %   $ 15,476       100 %
                                 
% Int'l     70             76%          
 
The following table outlines the geographic location of our net long-lived assets:
 
   
As of
 
   
March 30,
2012
   
December 30,
2011
 
   
(In thousands)
 
Asia/Pacific
  $ 1,783     $ 1,713  
Japan
    44       130  
United States
    1,407       1,246  
Europe
    189       551  
Total
  $ 3,423     $ 3,640  
 
13. Income Taxes
 
During the three months ended March 30, 2012 and April 1, 2011, we recorded an income tax provision of approximately $100,000 and $136,000, respectively.  The income tax provision recorded during the fiscal quarter ended March 30, 2012 and April 1, 2011 resulted from profitable results in our foreign entities.
 
 
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At March 30, 2012 and December 30, 2011, we had unrecognized tax benefits for uncertain tax positions of $1.5 million. None of the balance as of March 30, 2012 would affect our effective tax rate if recognized because it will be offset by the release of a valuation allowance of an equal amount.

We recognize interest and penalties related to uncertain tax positions in income tax expense.  We did not have any interest and penalties related to uncertain tax provisions during the three months ended March 30, 2012.

The tax years 2006 to 2011 remain open to examination by one or more of the major tax jurisdictions in which are subject to taxation on our taxable income.  
 
14. Restructuring and Impairment Related Charges

On November 9, 2010, we announced a global restructuring plan related to our acquisition of UPEK, following an assessment of the combined organization’s operations, global functions, and human resources in view of the Company’s global strategy and cost reduction initiatives. The restructuring plan, which was fully completed during the year 2011, is intended to integrate and streamline operations across the integrated organization.
 
We did not have any restructuring and impairment related charges for the quarter ended March 30, 2012. Below is a listing of the components of the restructuring and impairment related charges for the three months ending April 1, 2011:
 
    (In thousands)  
Severance   $ 318  
Legal fees     72  
Obligation settlement     (107 )
    $ 283  
 
All of the restructuring charges were attributable to the Smart Sensor Solutions segment. There were no amounts in accrued restructuring balances at March 30, 2012.
 
 15. Recent Accounting Pronouncements

In June 2011, the FASB issued guidance, included in ASC 220, Comprehensive Income, to improve the comparability, consistency and transparency of financial reporting and to increase the prominence of items that are recorded in other comprehensive income. The new accounting guidance requires entities to report components of comprehensive income in either one continuous statement of comprehensive income or two separate statements in which the statement of operations is followed consecutively by a statement that presents the components and total of other comprehensive income, and the total of comprehensive income. We adopted this guidance in the first quarter of 2012, and have reported net income and components of comprehensive income in two separate, but consecutive statements, including a Consolidated Statement of Comprehensive Income (Loss), for all periods presented.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
The following discussion should be read in conjunction with, and is qualified in its entirety by reference to our unaudited consolidated financial statements and accompanying notes contained herein and with the audited consolidated financial statements, accompanying notes and Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 30, 2011. Except for the historical information, the discussions in this section contain forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed below.
 
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
 
This Quarterly Report on Form 10-Q contains statements relating to expected future results and business trends that are based upon our current estimate, expectations, and projections about the industry, and upon our beliefs, and certain assumptions we have made that are “forward-looking statements” as defined in the Private Securities Litigation Reform Act of 1995. Words such as “anticipates,” “guidance,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “may,” “will,” “prospects,” “outlook,” “forecast,” and variations of these words or similar expressions are intended to identify “forward-looking statements.” In addition, any statements that refer to expectations, projections, or other characterizations of future events or circumstances, including any underlying assumptions, are “forward-looking statements.” Such statements are not guarantees of future performance and are subject to certain risks, uncertainties, and assumptions that are difficult to predict. Therefore, our actual results may differ materially and adversely from those expressed in any “forward-looking statement” as a result of various factors. These factors include, but are not limited to: the timely introduction of new products, demand for, and market acceptance of, our products, our ability to secure design wins and these design wins leading to future production, our ability to keep pace with ongoing changes in technology, the adoption of our sensors in other applications outside of PC notebooks and wireless devices, the rate at which we increase our activity and opportunities in the wireless market and the growth of the market for mobile and network security solutions, our dependence on a limited number of customers for a significant portion of our revenue and subcontractors for the manufacture of our products, our ability to meet and accurately estimate customer demand for our products, changes in product mix, the actions of existing or future competitors, our ability to successfully integrate acquired businesses in our operations, the ability of our products to meet the exacting specifications of our customers, our ability to become profitable and generate positive cash flow in the future, the impact of litigation, our ability to protect our intellectual property rights, and the impact of the macroeconomic trends on our served markets, as well as other risks detailed from time to time in our SEC filings, including Part I, item 1A of our Annual Report on Form 10-K for the year ended December 30, 2011. These “forward-looking statements” are made only as of the date hereof, and we undertake no obligation to update or revise the “forward-looking statements,” whether as a result of new information, future events or otherwise.
 
 
18

 
 
Overview
 
We are a leading provider of mobile and network and security solutions for enterprise, government and consumer markets.  We provide a series of products including fingerprint sensors, software and intellectual property (IP) that provide security, convenience, personalization and navigation features in such end products as PCs, tablets, smartphones, printers, network servers and gateways and many other products.  Over the past few years, we have evolved from a mixed-signal semiconductor component supplier to a provider of complete solutions focused on mobile and network security solutions, including smart fingerprint sensors, identity management software and embedded hardware and software security products and solutions. Our portfolio of products has significantly expanded during the past two years, and now includes smart fingerprint sensors, area sensors, fingerprint sensor chipsets and modules, USB fingerprint readers, identity management software and embedded hardware and software products and services. Our expansion has been driven by both internal product development efforts and strategic acquisitions, including our acquisitions of SafeNet’s Embedded Security Solution Division, UPEK, Inc., PeerSec Networks and Proxure, Inc.

We primarily sell our products to OEMs, ODMs, contract manufacturers, government agencies, software application vendors, and service providers. Our customers’ products are complex and require significant time to define, design and ramp to volume production. Our sales cycle begins with our selling and marketing staff and application engineers engaging with our customers’ system designers and management, which is typically a multi-month, or even multi-year, process. If we are successful, a customer will decide to incorporate our solution in its product, which we refer to as a design-win.  There is no assurance that a design-win will make it to full production as the product we are designed into could be cancelled for any number of reasons by the customer.  Because the sales cycles for our products are long, we incur expenses to develop and sell our products, regardless of whether we achieve the design-win and well in advance of generating revenue, if any, from those expenditures. We do not have long-term purchase commitments from any of our customers, as sales of our products are generally made under individual purchase orders. However, once one of our products is incorporated into a customer’s design, it is likely to remain designed in for the life cycle of that specific product. We believe this to be the case because a redesign of a product already in production would generally be time consuming and expensive.   
 
We do not own or operate our own semiconductor fabrication, wafer bumping, assembly or test facilities. We depend on independent vendors to manufacture, assemble and test our fingerprint sensor products. By outsourcing manufacturing, we are able to avoid the cost associated with owning and operating our own manufacturing facility and can take advantage of the scale of operations these third parties provide.
 
Critical Accounting Policies
 
Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with United States generally accepted accounting principles. These accounting principles require us to make certain estimates and judgments that can affect the reported amounts of assets and liabilities as of the dates of the consolidated financial statements, the disclosure of contingencies as of the dates of the consolidated financial statements, and the reported amount of revenue and expenses during the periods represented. Although we believe that our judgments and estimates are reasonable under the circumstances, actual results may differ from those estimates.
 
Our critical accounting policies as of March 30, 2012 are consistent with those discussed in our Annual Report on Form 10-K for the year ended December 30, 2011, filed with the SEC March 9, 2012. Please see Note 15 to the Notes to Consolidated Financial Statements for the newly adopted accounting pronouncements.

 
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 Results of Operations
 
The following table sets forth selected statement of operations data for the periods indicated expressed as a percentage of revenue:
 
   
Three Months Ended
 
   
March 30,
2012
   
April 1,
2011
 
             
Revenue
    100 %     100 %
Cost of revenue
    43       52  
                 
Gross margin
    57       48  
                 
Operating expenses
               
Research and development
    33       38  
Selling and marketing
    22       26  
General and administrative
    10       16  
Restructuring and impairment related charges
    -       2  
                 
Total operating expenses
    65       82  
                 
Loss from operations
    (8 )     (34 )
                 
Total other income (expense), net
    -       (2 )
                 
Net loss before income taxes
    (8 )     (36 )
                 
Provision for income taxes
    1       1  
                 
Net loss
    (9% )     (37% )
 
Comparison of the Three Months Ended March 30, 2012 and April 1, 2011
 
Revenue. Our consolidated revenue was $17.5 million for the three months ended March 30, 2012 as compared to $15.5 million for the three months ended April 1, 2011, an increase of $2.0 million or 13%. Revenue in our Embedded Security Solutions segment increased by $2.3 million mainly due to higher royalties in hardware IP and content protection products while revenue in our Smart Sensor Solutions segment declined by $0.3 million primarily due to $1.0 million decreased shipments of our sensors in the PC and wireless markets from anticipated product transitions, which was somewhat offset by $0.6 million revenue increase in the government access market associated with growth in the China identity market.  Overall average selling prices in the Smart Sensor Solutions Segment increased by three percent (3%) as compared to the same period prior year mostly driven by a higher mix of our government and access control touch sensors.

The following table sets forth our revenue by reportable segment for the periods indicated:
 
   
Three Months Ended
 
   
March 30,
2012
 
April 1,
2011
   
% Change
 
   
(In thousands)
       
Smart Sensor Solutions
  $ 10,438     $ 10,783       -3 %
Embedded Security Solutions
    7,022       4,693       50 %
Consolidated
  $ 17,460     $ 15,476       13 %
 
Cost of revenue and gross margin. Our cost of revenue was $7.4 million for the three months ended March 30, 2012 as compared to $8.1 million for the three months ended April 1, 2011, resulting in a gross profit of $10.0 million for the three months ended March 30, 2012 as compared to $7.4 million for the three months ended April 1, 2011, an increase of $2.6 million, or 35%. The decrease in cost of revenue was primarily attributable to higher royalty revenue from a mix of new contracts with no additional costs in the Embedded Security Solutions segment and a change in product mix in the Smart Sensor Solutions segment. Consolidated gross margin was 57% and 48% in the three months ended March 30, 2012 and April 1, 2011, respectively.
 
The Smart Sensor Solutions segment gross margin was 35% in the three months ended March 30, 2012 as compared to 32% in the same time frame last year. The increase in gross margin for the three months ended March 30, 2012 as compared to the same period prior year was primarily attributed to lower amortization of purchased intangible assets associated with sales backlog which was fully amortized during fiscal year 2011 as well as higher margins on our PC products due to improved costs and wireless products due to introduction of new parts.
 
 
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Embedded Security Solutions segment gross margin was 91% in the three months ended March 30, 2012 as compared to 84% the three months ended April 1, 2011. The increase in gross margin was primarily driven by higher royalty revenue with no associated costs. The revenue from software licensing fees and royalties contain no or minimal product costs which yield higher profit margin. Cost of goods in the Embedded Security Solutions segment is mostly comprised of the manufacturing costs associated with the integrated circuit chips, amortization expense as a result of acquired amortizable intangible assets and technical support costs. Depending on the revenue partition between hardware and software, profit margin may vary between periods.

Research and development expenses. Research and development expenses were $5.7 million for the three months ended March 30, 2012 as compared to $5.9 million for the three months ended April 1, 2011, a decrease of $0.2 million, or 3%. Research and development expenses were 33% and 38% of revenue for the three months ended March 30, 2012 and April 1, 2011, respectively. The decrease in the first quarter of 2012 was primarily due to the decreased overall labor related costs. Research and development expenses in the Smart Sensor Solutions segment decreased by $0.4 million mostly due to a decrease in labor related costs of $0.6 million as a result of planned labor reduction that took place in mid 2011 and a decrease in direct materials of $0.1 million due to timing of wafer mask purchases. These decreases were slightly offset by $0.3 million compensation charge recorded during the quarter associated with the Proxure acquisition which will continue into the second quarter at which time will be fully expensed. Research and development expenses associated with Embedded Security Solutions segment increased by $0.2 million for the three months ended March 30, 2012 due to increased engineering labor costs as a result of additional R&D personnel to support anticipated projects.

Selling and marketing expenses. Selling and marketing expenses were $3.9 million for the three months ended March 30, 2012, as compared to $4.0 million for the three months ended April 1, 2011, a decrease of $0.1 million, or 3%. Selling and marketing expenses were 22% and 26% of revenue for the three months ended March 30, 2012 and April 1, 2011, respectively. The selling and marketing expenses in Smart Sensor Solutions segment decreased by $0.4 million primarily associated with a decrease in labor and related costs due to a reduction in headcount of $0.1million, a decrease in sales commissions of $0.1 million as a result of lower revenue and a decrease in acquisition related outside services of $0.1 million. The selling and marketing expenses for the Embedded Security Solutions segment increased by $0.3 million for the three months ended March 30, 2012 mostly associated with higher marketing related expenses for new programs.
 
General and administrative expenses. General and administrative expenses were $1.8 million for the three months ended March 30, 2012 as compared to $2.5 million for the three months ended April 1, 2011, a decrease of $0.7 million or 28%. General and administrative expenses were 10% and 16% of revenue for the three months ended March 30, 2012 and April 1, 2011, respectively. General and administrative expenses decreased by $0.7 million in the Smart Sensor Solutions segment predominately as a result of a decrease in acquisition related legal and accounting costs associated with the UPEK acquisition. The general and administrative expenses in the Embedded Security Solutions segment remained relatively the same as compared to the same period last year.

Restructuring and impairment related charges. There were no restructuring charges for the three months ended March 30, 2012 as compared to $0.3 million for the three months ended April 1, 2011. Restructuring charges were 0% and 2% of revenue for the three months ended March 30, 2012 and April 1, 2011, respectively. As a result of finalization of restructuring activities during the first quarter of 2011, we recorded employment termination benefits of $0.3 million and outside legal and accounting fees of $0.1 million. These costs were slightly offset by $0.1 million credit for an obligation that was settled for less than the contractually obligated amount.
 
Other income (expense), net. Other net expense was $0.1 million for the three months ended March 30, 2012 as compared to $0.3 million net expense for the three months ended April 1, 2011. Other expense, net decreased by $0.2 million mostly attributable to the foreign currency adjustment.
 
 
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Liquidity and Capital Resources
 
Since our inception, we have financed our growth primarily with the issuance and sale of our common and preferred stock, and senior secured convertible debt. Our cash, cash equivalents and investments were $22.8 million as of March 30, 2012, an increase of $2.3 million from December 30, 2011. The increase in our cash, cash equivalents and investments as of March 30, 2012 was primarily attributable to the cash generated from operations.
 
   
Three Months Ended
 
   
March 30,
2012
   
April 1,
2011
 
   
(In thousands)
 
Consolidated statement of cash flows data:
           
Purchase of property and equipment
  $ (234 )   $ (298 )
                 
Cash flows from operating activities
    2,455       (7,024 )
Cash flows from investing activities
    (984 )     4,802  
Cash flows from financing activities
    93       68  
 
Operating activities. Net cash provided by operating activities was $2.5 million in the three months ended March 30, 2012. An increase in trade payables and deferred revenue contributed to $2.1 million of cash provided by operating activities. Results from operations, after adjustments for non-cash items such as stock-based compensation and depreciation and amortization contributed to $0.4 million of cash provided by operating activities.

Net cash used in operating activities was $7.0 million in the three months ended April 1, 2011. Operating loss, excluding stock-based compensation, depreciation and amortization expense and other non cash items contributed to $2.3 million of cash used in operating activities. Inventory purchases and severance payouts contributed to $2.5 million and $1.5 million of cash used and operating activities, respectively. Deferred revenue decrease contributed to $0.8 million of cash used in operating activities due to collections in prior quarter that were partially recognized as revenue during the three months ended April 1, 2011.
 
Investing activities. Net cash used in investing activities was $1.0 million in the three months ended March 30, 2012, primarily due to $0.8 million cash used for a restricted cash account required for the foreign currency forward purchases and $0.2 million used for purchases of property and equipment.

Net cash provided by investing activities was $4.8 million in the three months ended April 1, 2011, mostly related to maturity of our short-term  investments; offset slightly by $0.3 million used for purchases of property and equipment.

Financing activities. Net cash provided by our financing activities is a result of proceeds received from exercise of stock options for the three months ended March 30, 2012 as well as for the three months ended April 1, 2011.
 
Our investment policies are designed to provide liquidity, preserve capital and achieve an acceptable return on invested assets. As of March 30, 2012, our investment portfolio consisted primarily of fixed-income securities. The weighted average maturity is longer than twelve months. We utilize investment vehicles such as auction rate securities.
 
As of March 30, 2012, $3.2 million of our $3.2 million in long-term investments were comprised of preferred stock and student loan investments with an auction reset feature (“auction rate securities”). The preferred stock is issued by various closed-end mutual funds that invest primarily in common stock and fixed income securities. The student loan backed auction rate security is a state issued note with its underlying student loans being substantially insured by the U.S. government.
 
Due to auction rate securities markets being disrupted in the beginning of 2008 we experienced auction failures for the first time. An auction failure means that the parties wishing to sell their securities could not be matched with an adequate volume of buyers. In the event that there is a failed auction, the indenture governing the security requires the issuer to pay interest at a contractually defined rate that is generally above market rates for other types of similar short-term instruments and we continue to receive contractual payments. The securities for which auctions have failed will continue to accrue interest at the contractual rate and be auctioned every seven, 28 or 35 days until the auction succeeds, the issuer calls the securities, or they mature.
 
All of our auction rate securities held at March 30, 2012 had experienced failed auctions. As a result, our ability to liquidate and fully recover the carrying value of our remaining auction rate securities in the near term may be limited or not exist.

We believe that, even if we hold all such securities for an indefinite period of time, our remaining cash and cash equivalents and short-term investments will be sufficient to support our projected operating requirements over the next twelve months. Our long-term future capital requirements will depend on many factors, including our level of revenue, the timing and extent of spending to support our research and development efforts, the expansion of selling and marketing activities, acquisitions, the timing of our introductions of new products, the costs to ensure access to adequate manufacturing capacity and the continuing market acceptance of our products. We could be required, or could elect, to seek additional funding through public or private equity or debt financing. These additional funds may not be available on terms acceptable to us or at all.

We believe that our remaining cash and cash equivalents and short-term investments will be sufficient to support our projected operating requirements over the next twelve months. Our long-term future capital requirements will depend on many factors, including our level of revenue, the timing and extent of spending to support our research and development efforts, the expansion of selling and marketing activities, acquisitions, the timing of our introductions of new products, the costs to ensure access to adequate manufacturing capacity and the continuing market acceptance of our products. We could be required, or could elect, to seek additional funding through public or private equity or debt financing. These additional funds may not be available on terms acceptable to us or at all.
 
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Contractual Obligations
 
There were no material changes during the period covered by this report to the contractual obligations previously disclosed in our Annual Report on Form 10-K for the year ended December 30, 2011.
 
Off-Balance Sheet Arrangements
 
We do not maintain any off-balance sheet arrangements, transactions, obligations or other relationships with unconsolidated entities that would be expected to have a material current or future effect upon our financial condition or results of operations.
 
Recent Accounting Pronouncements
 
See Note 15 of the Notes to Consolidated Financial Statements for recent accounting pronouncements.
 
Item 3.                  Quantitative and Qualitative Disclosure About Market Risks
 
Foreign currency risk. The majority of our revenue is denominated in U.S. dollars, however we do generate revenue that is denominated in other currencies, mostly the Euro and Japanese Yen. We are subject to the risk of our products being more expensive outside the United States if the value of the U.S. dollar increases as compared to the local currency of our customer. This could result in pricing pressure, lower revenue and lower gross margins. Our international sales and research and development operations incur expenses that are denominated in foreign currencies. These expenses increased in fiscal 2011 and 2010 as a result of the acquisitions of SafeNet’s Embedded Security division and UPEK with the main operations of the acquired businesses being located outside the United States. To the extent that we expand our operations into Europe and Asia, the effects of inflation and currency fluctuations could impact our financial condition and results of operations. A ten percent (10%) change in a currency exchange rate could cause an impact to our financial statements of approximately $1.6 million and we could suffer foreign exchange losses associated with such currency fluctuations. From time to time we enter into forward contracts to offset or mitigate the impact of such fluctuations.
 
Interest rate risk. We had cash, cash equivalents and investments of $22.8 million as of March 30, 2012, which were held for working capital and strategic purposes. The primary objectives of our investment activity are to preserve principal, provide liquidity and achieve an acceptable return without significantly increasing our risk. Some of the securities we invest in are subject to market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. To minimize this risk and reduce exposure, we maintain our portfolio of cash equivalents and short-term and long-term investments in investment grade securities that are primarily of a conservative nature. Since our results of operations are not dependent on investments, the risk associated with fluctuating interest rates is limited to our investment portfolio, and we believe that a 10% change in interest rates would not have a material impact on our results from operations.
 
Market risk. Our long term investments consist of auction rate securities that are exposed to certain risks. Although these various investments are managed to a standard designed to avoid principal loss, market forces can have an adverse effect on asset valuations, and it is possible for these investment grade securities to lose a portion of their principal. The ability to determine the risks presented by these investments is limited by, among other things, restrictions on the ability to know the holdings or the collateral backing of the securities.
 
At March 30, 2012, we held $3.2 million in auction rate securities and consider them inactively traded securities. The rate of interest paid on the auction rate securities is determined at auctions held at pre-determined intervals, usually every seven, 28 or 35 days. If sufficient clearing bids are not made in a particular auction, that can result in the inability to liquidate the asset-backed securities in the auction. All of our auction rate securities held as of March 30, 2012 had experienced failed auctions. There can be no assurance that auctions on the auction rate securities in our investment portfolio will succeed. If the issuers are unable to successfully close future auctions and their credit ratings deteriorate, the fair value of those auction rate securities may decline even further and we may record additional temporary or other than temporary impairment charges.
 
Credit ratings and the market for debt securities may continue to worsen which may also require us to record other than temporary impairment charges.  A 10% change in interest rates would not have a material impact in the fair value of our investments.  For more information on fair value assumptions please see Note 4, “Fair Value Measurements and Disclosures”, of the financial statements.
 
Item 4.                  Controls and Procedures.
 
Evaluation of disclosure controls and procedures. Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, performed an evaluation of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), which have been designed to provide reasonable assurance that the information required to be disclosed by us in the reports we file or submit under the Exchange Act is (i) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure and (ii) recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC. They concluded that the controls and procedures were effective as of March 30, 2012 to provide reasonable assurance of the achievement of these objectives.
 
Changes in internal controls. There was no change in our internal control over financial reporting during the quarter ended March 30, 2012 that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
 
 
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PART II — OTHER INFORMATION
 
Item 1.                  Legal Proceedings.
 
There were no material changes in our legal proceedings from the information contained in our Annual Report on the Form 10-K for the year ended December 30, 2011, filed with the SEC March 9, 2012.

In addition, from time to time, we may be involved in various legal proceedings arising from the normal course of business activities.  In our opinion, resolution of these matters is not expected to have a material adverse impact on our consolidated results of operations, cash flows or our financial position.  However, depending on the amount and timing, an unfavorable resolution of a matter could materially affect our future results of operations, cash flows or financial position in a particular period.

Item 1A.               Risk Factors.

In addition to the other information set forth in this Report, you should carefully consider the factors discussed in “Risk Factors” in our Annual Report on Form 10-K for the year ended December 30, 2011, which could materially affect our business, financial position, results of operations, cash flows, or future results. Please be aware that these risks may change over time and other risks may prove to be important in the future. New risks may emerge at any time, and we cannot predict such risks or estimate the extent to which they may affect our business, financial condition or results of operations, or the trading price of our securities.

There were no material changes during the period covered by this report to the risk factors previously disclosed in our Annual Report on Form 10-K for the year ended December 30, 2011.
 
Item 2.                  Unregistered Sales of Equity Securities and Use of Proceeds
 
 
Use of Proceeds from Registered Securities
 
As part of our initial public offering, on July 2, 2007 we registered 7,500,000 shares of our common stock under Form S-1 (File No. 333-141348), which was declared effective by the SEC on June 26, 2007.

Item 3.                  Defaults upon Senior Securities
  
None.

Item 4.                  Mine Safety Disclosures

Not applicable.

Item 5.                   Other Information

None.
 
Item 6.                  Exhibits
 
10.1
Employment Agreement, dated as of January 2, 2012, between AuthenTec, Inc. and Scott Deutsch†
31.1
Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.†
31.2
Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.†
32.1
Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.† †
32.2
Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.† †
101 The following financial information from the Quarterly Report on Form 10-Q for the fiscal quarter ended March 30, 2012, formatted in XBRL (Extensible Business Reporting Language) and furnished electronically herewith: (i) the Consolidated Balance Sheets at March 30, 2012 and December 30, 2011; (ii) the Consolidated Statements of Operations for the three months ended March 30, 2012 and April 1, 2011; (iii) the Consolidated Statements of Cash Flows for the three months ended March 30, 2012 and April 1, 2011; and (iv) the Notes to the Consolidated Financial Statements – submitted herewith pursuant to Rule 406T.
 

Filed herewith.
†† 
Furnished herewith.
 
 
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SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
AUTHENTEC, INC.
 
       
 
By:
/s/ Lawrence Ciaccia
 
   
Lawrence Ciaccia
 
   
Chief Executive Officer
 
   
(on behalf of the Registrant and as the Registrant’s Principal Executive Officer)
 
       
   
/s/ Philip Calamia
 
   
Philip Calamia
 
   
Chief Financial Officer
 
DATE: May 9, 2012
 
(as the Registrant’s Principal Financial Officer)
 
 
 
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