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 September 30, 2011

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  x     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 November 9, 2011 there were 43,912,474 shares of common stock outstanding.

AUTHENTEC, INC.

TABLE OF CONTENTS

			Page No.
Part I — Financial Information
Item 1.		Consolidated Financial Statements	3
		Consolidated Balance Sheets at September 30, 2011 and December 31, 2010	3
		Consolidated Statements of Operations for the three and nine months ended September 30, 2011 and October 1, 2010	4
		Consolidated Statements of Cash Flows for the nine months ended September 30, 2011 and October 1, 2010	5
		Notes to Consolidated Financial Statements	6
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operation	19
Item 3.		Quantitative and Qualitative Disclosure About Market Risks	27
Item 4.		Controls and Procedures	28
PART II — OTHER INFORMATION
Item 1.		Legal Proceedings	28
Item 1A.		Risk Factors	28
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds	28
Item 6.		Exhibits	29
Signatures			30
Exhibit Index
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 September 30, 2011, formatted in XBRL (Extensible Business Reporting Language) and furnished electronically herewith: (i) the Consolidated Balance Sheets at September 30, 2011 and December 31, 2010; (ii) the Consolidated Statements of Operations for the three and nine month periods ended September 30, 2011 and October 1, 2010; (iii) the Consolidated Statements of Cash Flows for the nine months ended September 30, 2011 and October 1, 2010; 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
	September 30,			December 31,
	2011			2010
Assets
Current assets
Cash and cash equivalents	$	17,365		$	13,280
Short-term investments		-			15,176
Accounts receivable, net of allowances of $262 and $150, respectively		11,284			9,678
Inventory		7,731			5,460
Other current assets		2,450			1,993
Total current assets		38,830			45,587
Long-term investments		3,256			3,323
Purchased intangible assets		19,620			24,033
Goodwill		2,729			2,729
Property and equipment, net		3,782			4,430
Total assets	$	68,217		$	80,102
Liabilities and stockholders’ equity
Current liabilities
Accounts payable	$	6,847		$	6,907
Accrued compensation and benefits		3,392			3,640
Accrued litigation related legal fees		353			1,802
Other accrued liabilities		3,169			4,002
Deferred revenue		3,381			4,678
Total current liabilities		17,142			21,029
Deferred rent		435			546
Total liabilities		17,577			21,575
Commitments and contingencies (see note 9)
Stockholders’ equity
Common stock, $.01 par value; 100,000 shares authorized; 43,859 and 43,581 issued and outstanding at September 30, 2011 and December 31, 2010		438			436
Additional paid-in capital		191,317			189,205
Accumulated other comprehensive income		297			54
Accumulated deficit		(141,412	)		(131,168	)
Total stockholders’ equity		50,640			58,527
Total liabilities and stockholders’ equity	$	68,217		$	80,102

 See Notes to Consolidated Financial Statements

3

AuthenTec, Inc. and Subsidiaries

Consolidated Statements of Operations

(In thousands, except per share data)

(Unaudited)

	Three Months Ended						Nine Months Ended
	September 30, 2011			October 1, 2010			September 30, 2011			October 1, 2010
Revenue	$	19,316		$	10,232		$	51,003		$	30,129
Cost of revenue		8,789			5,068			25,303			15,006
Gross profit		10,527			5,164			25,700			15,123
Operating expenses
Research and development		5,136			5,314			17,500			14,042
Selling and marketing		3,876			3,324			11,943			8,896
General and administrative		1,423			4,039			5,621			9,065
Restructuring and impairment related charges		(46	)		-			275			-
Litigation dismissal		-			4,141			-			4,141
Total operating expenses		10,389			16,818			35,339			36,144
Income (loss) from operations		138			(11,654	)		(9,639	)		(21,021	)
Other income (expense):
Earnout adjustment		-						-			729
Interest income		19			40			42			124
Other income (expense)		170			(190	)		(245	)		(190	)
Total other income (expense), net		189			(150	)		(203	)		663
Income (loss) before provision for income taxes		327			(11,804	)		(9,842	)		(20,358	)
Provision for income taxes		126			(286	)		402			(223	)
Net income (loss)	$	201		$	(11,518	)	$	(10,244	)	$	(20,135	)
Net income (loss) per common share, basic	$	0.00		$	(0.37	)	$	(0.23	)	$	(0.67	)
Net income (loss) per common share, diluted	$	0.00		$	(0.37	)	$	(0.23	)	$	(0.67	)
Shares used in computing basic net income (loss) per common share		43,816			31,503			43,723			30,189
Shares used in computing diluted net income (loss) per common share		45,406			31,503			43,723			30,189

See Notes to Consolidated Financial Statements

4

AuthenTec, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

 (In thousands)

(Unaudited)

	Nine Months Ended
	September 30, 2011			October 1, 2010
Cash flows from operating activities
Net loss		(10,244	)		(20,135	)
Adjustments to reconcile net loss to net cash used in operating activities
Depreciation and amortization		5,456			2,496
Amortization of deferred rent		(88	)		65
Increase in bad debt provision		110			78
Increase in inventory provision		930			389
Stock-based compensation expense		1,998			2,503
Decrease in investment discounts/premiums		370			169
Impairment of fixed assets		16			—
Loss on sale of intangible assets		6
Litigation dismissal charge		—			4,141
Earnout adjustment		—			(729	)
Decrease (increase) in assets, net of effects of acquisitions:
Accounts receivable		(1,369	)		(2,060	)
Inventory		(3,204	)		(199	)
Other assets		(661	)		66
Increase (decrease) in liabilities, net of effects of acquisitions:
Accounts payable		(393	)		(226	)
Accrued compensation and benefits and other accrued liabilities		(807	)		418
Accrued litigation related legal fees		(1,449	)		—
Deferred revenue		(1,297	)		1,732
Net cash used in operating activities		(10,626	)		(11,292	)
Cash flows from investing activities
Purchase of property and equipment		(752	)		(547	)
Acquisitions, net of cash acquired		—			(7,620	)
Purchase of available-for-sale investments		—			(15,165	)
Redemption of available-for-sale investments		15,000			24,700
Sale of intangible assets		340			—
Net cash provided by investing activities		14,588			1,368
Cash flows from financing activities
Proceeds from exercise of stock options, net of tax withholdings		121			11
Net cash provided by financing activities		121			11
Effect of exchange rates on cash and cash equivalents		2			34
Net increase (decrease) in cash and cash equivalents		4,085			(9,879	)
Cash and cash equivalents, beginning of period		13,280			27,482
Cash and cash equivalents, end of period	$	17,365		$	17,603
Supplemental non-cash disclosures
Accrued purchase of property and equipment	$	-		$	151
Stock issuance in connection with the SafeNet acquisition (see Note 11)	$	-		$	13,342
Working capital adjustment in connection with the SafeNet acquisition (see Note 11)	$	-		$	(1,173	)
Accrued earnout in connection with the SafeNet acquisition (see Note 11)	$	-		$	729
Fair value of the promissory note issued in connection with the UPEK acquisition (see Note 11)	$	-		$	13,606

See Notes to Consolidated Financial Statements

5

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.  AuthenTec brings a broad range of features including security, convenience, personalization and navigation to PCs, tablets, smartphones and many other products. AuthenTec has 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. Complementing our sensors is our TrueSuite® identity management software, providing PC and mobile users secure, one-touch access to their digital identity and online social networks. TrueSuite was introduced in 2009 and is currently being integrated in AuthenTec-enabled notebook PCs being offered by the world’s leading PC Original Equipment Manufacturers, or OEMs. Our latest offering, TrueSuite Mobile®, for AuthenTec-enabled mobile phones, was introduced in October 2010 and is targeted for AuthenTec-enabled mobile phones.

We primarily sell our products to OEMs, Original Design Manufacturers, or ODMs or contract manufacturers, government agencies, 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 in the United States (“GAAP”) for annual 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 and nine months ended September 30, 2011 are not necessarily indicative of the results that may be expected for the year ending December 30, 2011 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 31, 2010 contained in our Annual Report on Form 10-K, filed with the SEC on March 17, 2011.

The year end consolidated balance sheet data was derived from audited financial statements set forth in our Annual Report on Form 10-K, but does not include all disclosures required by GAAP in the United States of America.

We utilize a 52/53 week fiscal year. Our current 52 week fiscal year will end on December 30, 2011. 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. The fiscal quarter ended September 30, 2011 as well as the comparable fiscal quarter ended October 1, 2010 included results for 13 weeks.

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, restricted stock awards and warrants to purchase common stock. The following table sets forth the computation of basic and diluted loss per common share (in thousands, except per share amounts).

6

	Three Months Ended					Nine Months Ended
	September 30, 2011		October 1, 2010			September 30, 2011			October 1, 2010
	(In thousands, except per share data)
Numerator:
Net income (loss)	$	201	$	(11,518	)	$	(10,244	)	$	(20,135	)
Denominator:
Denominator for basic income (loss) per share -
weighted average common shares outstanding		43,816		31,503			43,723			30,189
Effect of dilutive securities:
Stock options and restricted stock units		1,590		-			-			-
Denominator for diluted income (loss) per share -
weighted average common shares and potential
common shares outstanding		45,406		31,503			43,723			30,189
Basic net income (loss) per share	$	0.00	$	(0.37	)	$	(0.23	)	$	(0.67	)
Diluted net income (loss) per share	$	0.00	$	(0.37	)	$	(0.23	)	$	(0.67	)

Basic net loss per common share for the nine months ended September 30, 2011 and for the three and nine months ended October 1, 2010 were the same as diluted net loss per common share for the same periods due to the net losses for such periods. As of September 30, 2011, 5.4 million shares were attributable to outstanding stock options, which were excluded from the calculation of diluted earnings per share because the exercise prices of the stock options were greater than or equal to the average price of the common shares. Therefore, inclusion of these amounts would have been anti-dilutive.

The following table presents the potentially dilutive securities outstanding that were excluded from the computation of diluted net loss per common share for the three and nine months ended September 30, 2011 and October 1, 2010, respectively, because their inclusion would have had an anti-dilutive effect:

	Three months ended				Nine months ended
	September 30, 2 011		October 1, 2010		September 30, 2011		October 1, 2010
	(In thousands)
Options to purchase common stock and
non-vested restricted stock awards		5,396		6,005		6,357		5,694
Warrants to purchase common or preferred stock		-		-		-		18
Shares issuable under convertible promissory note		-		2,106		-		702
		5,396		8,111		6,357		6,141

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 U.S. treasury and U.S. government agency funds and 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 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 amounts relating to other factors, including those resulting from changes in interest rates, are recorded in accumulated other comprehensive income (loss).

The amortized cost, gross unrealized gains and losses, and fair value of investments, by type, were as follows:

7

	As of
	Amortized cost				Unrealized gains/(losses)						Fair value
	September 30,		December 31,		September 30,			December 31,			September 30,		December 31,
	2011		2010		2011			2010			2011		2010
	(In thousands)
U.S. Government agency notes (AFS)	$	-	$	15,168	$	-		$	8			-	$	15,176
Auction rate securities (AFS)		3,500		3,700		(244	)		(377	)		3,256		3,323
Total	$	3,500	$	18,868	$	(244	)	$	(369	)		3,256	$	18,499

The amortized cost and fair value of available-for-sale investments as of September 30, 2011 and December 31, 2010, by contractual maturity, were as follows:

	As of
	Amortized cost				Unrealized gains/(losses)						Fair value
	September 30,		December 31,		September 30,			December 31,			September 30,		December 31,
	2011		2010		2011			2010			2011		2010
	(In thousands)
Due in one year or less	$	-	$	15,168	$	-		$	8		$	-	$	15,176
Due after ten years		1,100		1,300		(96	)		(198	)		1,004		1,102
Preferred stock auction rate securities		2,400		2,400		(148	)		(179	)		2,252		2,221
Total	$	3,500	$	18,868	$	(244	)	$	(369	)	$	3,256	$	18,499

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 September 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	$	—	$	—	$	1,004	$	(96	)	$	1,004	$	(96	)
Auction rate securities - preferred stock		—		—		2,252		(148	)		2,252		(148	)
Total	$	-	$	-	$	3,256	$	(244	)	$	3,256	$	(244	)

	As of December 31, 2010
	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	$	—	$	—	$	1,102	$	(198	)	$	1,102	$	(198	)
Auction rate securities - preferred stock		—		—		2,221		(179	)		2,221		(179	)
Total	$	-	$	-	$	3,323	$	(377	)	$	3,323	$	(377	)

As of September 30, 2011 and December 31, 2010, approximately $3.3 million of our $3.3 million and $18.5 million in investments, respectively, 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.

8

All of our auction rate securities held at September 30, 2011 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 nonexistent.

We estimated the fair value of our short-term and long-term investments based on 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 and available-for-sale securities. 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

At September 30, 2011, we had $13.7 million in cash equivalents and long-term investments that were subject to fair value measurements in accordance with ASC 820.

The fair values of our investments based on the level of inputs are summarized below:

		Fair Value Measurements
		September 30, 2011											As of December 31, 2010
Description		Fair Value Total		Level 1		Level 2		Level 3		Gains (losses)			Fair Value Total		Level 1		Level 2		Level 3		Gains (losses)
Cash and cash equivalents	(In Thousands)												(In Thousands)
Money market and treasury funds		$	10,442	$	10,442	$	—	$	—	$	—		$	4,004	$	4,004	$	—	$	—	$	—
Available-for-sale investments
U.S. Government agency notes			—		—		—		—		—			15,176		15,176		—				8
Auction rate securities			3,256		—		—		3,256		(244	)		3,323		—		—		3,323		(377	)
Total		$	13,698	$	10,442	$	-	$	3,256	$	(244	)	$	22,503	$	19,180	$	-	$	3,323	$	(369	)

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 September 30, 2011, our money market funds were measured using Level 1 inputs and the fair value was based on daily observable trades.

None of our investments were measured using Level 2 inputs. 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.

At September 30, 2011 our investments in auction rate securities were measured using unobservable inputs with a fair value of approximately $3.3 million which represented approximately 24% 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 $2.3 million remain in Level 3 at September 30, 2011. 

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 nine months ended September 30, 2011:

9

Description	Total			Auction Rate Securities
	(In Thousands)
Beginning balance December 31, 2010	$	3,323		$	3,323
Realized/unrealized gains (losses)
Included in earnings		—			—
Included in other comprehensive income (loss)		(8	)		(8	)
Ending balance April 1, 2011	$	3,315		$	3,315
Realized/unrealized gains (losses)
Included in earnings		—			—
Included in other comprehensive income (loss)		78			78
Ending balance July 1, 2011	$	3,393		$	3,393
Realized/unrealized gains (losses)
Included in earnings		—			—
Included in other comprehensive income (loss)		63			63
Settlements		(200	)		(200	)
Ending balance September 30, 2011	$	3,256		$	3,256

As of September 30, 2011, we classified $3.3 million of investments in auction rate securities as long-term due to the fact that they had experienced failed auctions. Our money market and treasury funds with a value of $10.4 million have a maturity of ninety days or less from the date of acquisition and therefore are classified as cash and cash equivalents on our consolidated balance sheet.

At September 30, 2011, the estimated fair value of our investments in auction rate securities was approximately $244,000 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 auction rate securities prior to recovery, we did not record other-than-temporary impairment charges in the fiscal quarter ended September 30, 2011.

During the fiscal quarter ended September 30, 2011 we recorded approximately $63,000 in unrealized gains on our available-for-sale investments which was recorded in accumulated other comprehensive income on the accompanying consolidated balance sheet at September 30, 2011.

We will continue to monitor these securities and may be required to record temporary or other-than-temporary impairment charge in the future.

Non-recurring Fair Value Measurements

Our non-financial assets are reviewed for potential impairment and considered for the need to perform an impairment test pursuant to ASC 360, Property Plant and Equipment and ASC 350, Intangibles – Goodwill and Other.

All acquired assets and liabilities as a result of our acquisitions are measured at fair value on a non-recurring basis.

We review our long-lived assets for future use, physical deterioration, and technical and economical obsolescence. We recorded an impairment of zero and $16,000 related to our long-lived assets for the three and nine months ended September 30, 2011, respectively.

5. Comprehensive Income (Loss)

Comprehensive income (loss) is defined as a change in equity resulting from non-owner sources. The components of our comprehensive loss are as follows:

10

	Three months ended						Nine months ended
	September 30,			October 1,			September 30,			October 1,
	2011			2010			2011			2010
	(In thousands)
Net income (loss)	$	201		$	(11,518	)	$	(10,244	)	$	(20,135	)
Unrealized gain on AFS investments		63			111			125			169
Currency translation adjustment		(212	)		230			118			218
Comprehensive income (loss)	$	52		$	(11,177	)	$	(10,001	)	$	(19,748	)

6. Inventory

	As of
	September 30,			December 31,
	2011			2010
	(In thousands)
Work-in-process	$	5,706		$	4,402
Finished goods		4,172			2,793
Valuation allowance		(2,147	)		(1,735	)
	$	7,731		$	5,460

7. Property and Equipment

			As of
	Useful Life		September 30,			December 31,
	(Years)		2011			2010
			(In thousands)
Production and lab equipment		3 - 8	$	6,722		$	6,169
Computer equipment		3 - 5		1,622			1,426
Office furniture and fixtures		3		642			588
Computer software		3 - 5		1,715			1,768
Leasehold improvements		3 - 6		1,340			1,361
				12,041			11,312
Less:  Accumulated depreciation				(8,259	)		(6,882	)
			$	3,782		$	4,430

Depreciation expense was approximately $459,000 and $1,389,000 for the three and nine months ended September 30, 2011, respectively, and $461,000 and $1,140,000 for the three and nine months ended October 1, 2010, respectively.

 8. Goodwill and Intangible Assets

The following table summarizes the activity related to the carrying value of our goodwill at September 30, 2011:

	Reportable Segments
	Smart Sensor Solutions		Embedded Security Solutions		Consolidated
	(In thousands)
Goodwill at December 31, 2010	$	—	$	2,729	$	2,729
Impairment		—		—		—
Goodwill at September 30, 2011	$	—	$	2,729	$	2,729

At September 30, 2011 and December 31, 2010, purchased intangible assets consisted of the following:

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	As of
	September 30, 2011						December 31, 2010
	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		136	$	494	$	1,050	$	144	$	906
Customer relationships subject to amortization (6-9 years)		13,575		2,008		11,567		13,575		692		12,883
Developed technology subject to amortization (5-7 years)		8,692		1,922		6,770		8,692		876		7,816
Integrated circuit distribution agreement subject to amortization (2 years)		2,020		1,586		434		2,020		526		1,494
Non-compete agreement subject to amortization (5 years)		533		178		355		533		97		436
Backlog (less than 1 year)		829		829		-		829		331		498
	$	26,279	$	6,659	$	19,620	$	26,699	$	2,666	$	24,033

 During the three months ended July 1, 2011, we have revised the remaining useful life of the integrated circuit distribution agreement from 5 years to 2 years due to the anticipated end of life for this product being shorter than originally estimated. We expect to cease manufacturing of the integrated circuit chips by the end of our fiscal 2011.  As a result of the change, net income for the three and the nine months ended September 30, 2011 decreased by approximately $0.3 million and $0.6 million, or $0.01 and $0.01 per diluted share, respectively.

Amortization expense for intangible assets amounted to approximately $1,279,000 and $4,067,000 for the three and nine months ended September 30, 2011, respectively, and $774,000 and $1,355,000 for the three and nine months ended October 1, 2010, respectively. The weighted average amortization period is 6.8 years. The estimated aggregate amortization expense for all amortizable intangibles for each of the succeeding years ending January 1, 2016 is as follows:

Fiscal year	Amount
	(In thousands)
2011	$	1,264
2012		3,311
2013		3,311
2014		3,176
2015		2,862
	$	13,924

During the three months ended September 30, 2011, we sold some of our patents for the total price of $340,000 and realized approximately $6,000 loss on the sale which was recorded in the general and administrative caption of our consolidated statement of operations.

9. Commitments and contingencies

Legal Proceedings

AuthenTec is an intervening party in a federal patent infringement lawsuit brought by Innovative Biometric Technology, LLC (“IBT”), against Lenovo, Fujitsu, ASUS, Toshiba, and others.  The case is captioned Innovative Biometric Technology, LLC v. Lenovo (United States), Inc., et al., Case No. 9:09-cv-81046-KLR, and was filed by IBT on July 19, 2009 in the U.S. District Court for the Southern District of Florida (the “Court”).  IBT asserted that the use of certain of the defendant’s products shipped into the United States infringe U.S. Patent No. 7,134,016, which is entitled Software System with a Biometric Dongle (the “‘016 patent”) and relates generally to a method of protecting software program access.   AuthenTec intervened in the case, in November 2010, because IBT’s allegations relate, in part, to the use of biometric software or hardware supplied by us and UPEK, Inc. (“UPEK”) to certain of the defendants that has been integrated into laptop computers by our and UPEK’s customers. In view of IBT’s formal claim construction arguments, on March 25, 2011, AuthenTec filed a Motion for Summary Judgment of Noninfringement, or in the Alternative, Invalidity of the ‘016 patent.  Following a July 2011 hearing on AuthenTec’s Motion for Summary Judgment, on September 27, 2011, IBT conceded that its infringement contentions lacked merit by filing a “covenant not to sue” and a unilateral Motion to Dismiss Toshiba and AuthenTec (the other remaining parties).  The Court issued an Order dismissing the case on October 3, 2011 with prejudice.  On October 7, 2011, AuthenTec and Toshiba filed a Motion to Vacate or Set Aside the Court’s Order of Dismissal asking the Court for permission to file a formal response to IBT’s motion and requesting that the Court impose conditions the Court deems just in exchange for the grant of dismissal.  In particular, we believe the covenant not to sue should be modified in order to better protect the Defendants.  In addition, we maintain that certain attorney’s fees and costs should be paid by IBT to AuthenTec and Toshiba as a condition of the dismissal with prejudice. 

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We accrue litigation related legal expenses if these costs are reasonably estimable, regardless of whether a liability can be estimated for the loss contingency, itself. If actual and forecasted legal expenses differ from these estimates, adjustments to the accrual account may be required in future periods.  In fiscal year 2010 we accrued approximately $1.9 million in estimated future costs associated with defending the IBT litigation. We recorded the expense for the accrual of the legal fees during the quarter ended December 31, 2010 in the General and Administrative caption of our Statement of Operations.  During the three months ended September 30, 2011, we released $0.4 million of the remaining litigation fee accrual due to the fact that the merits of the IBT litigation are resolved. However, due to further actions initiated by AuthenTec, we believe that we will continue to incur some legal costs in the future until the case is fully closed and we estimated those costs to be approximately $0.2 million which remain accrued at September 30, 2011, along with $0.2 million in IBT legal costs incurred but not paid at the period end. 

In addition to these legal actions, 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-Based Compensation

A summary of the stock options activity for the nine months ended September 30, 2011 is presented below:

				Weighted
	Number of			Average
	Shares			Exercise
	(in thousands)			Price
Outstanding as of December 31, 2010		6,167		$	3.31
Granted		2,004			3.24
Forfeited		(523	)		9.91
Exercised		(217	)		1.03
Outstanding as of September 30, 2011		7,431		$	2.89

The total intrinsic value of options exercised during the nine months ended September 30, 2011 was approximately $434,000.

           A summary of the restricted stock activity for the nine months ended September 30, 2011 is presented below:

				Weighted
	Number of			Average
	Shares			Grant-Date
	(in thousands)			Fair Value
Outstanding as of December 31, 2010		131		$	4.09
Granted		6			3.46
Forfeited		(9	)		5.03
Vested/Issued		(112	)		3.10
Outstanding as of September 30, 2011		16		$	10.45

The total intrinsic value of restricted stock units vested during the nine months ended September 30, 2011 was approximately $347,000.

The total unrecognized stock-based compensation for stock option and restricted stock awards accounted for under ASC 718 was approximately $5,089,000 as of September 30, 2011. These awards had a remaining weighted-average period over which they are expected to be recognized of 3.1 years as of September 30, 2011.

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:

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	Three Months Ended						Nine Months Ended
	September 30, 2011			October 1, 2010			September 30, 2011			October 1, 2010
Grant Date Fair Value	$	1.62		$	1.07		$	1.60		$	1.11
Expected life (in years)		4.8			3.9			4.5			4.0
Risk free rate		1.2	%		1.2	%		1.3	%		1.2	%
Volatility		80	%		82	%		78	%		81	%
Dividend yield		0	%		0	%		0	%		0	%
Estimated forfeiture rate		12	%		12	%		12	%		12	%

11. Business Acquisitions

On February 26, 2010, we acquired substantially all of the assets and certain liabilities related to SafeNet's Embedded Security Solutions division in exchange for approximately $8.5 million in cash and 1,211,482 shares of our common stock (which was later reduced by 385,982 shares for a total share consideration of 825,500 in connection with the opening balance sheet working capital adjustment pursuant to the agreement). A contingent consideration payment could have been due by us if certain revenue targets were achieved by our Embedded Security Solutions segment during the earn out period. The revenue target calculation required accumulated Embedded Security Solutions annual revenue to reach $20 million, adjusted for certain deferred revenue items and pro-rated for the length of the earn out period. We recorded $0.7 million in estimated earnout liability during the quarter ended April 2, 2010 and subsequently determined that the minimum required revenue target could not be achieved during the earn out period and therefore no contingent consideration would be due. As a result of this determination, we reversed the earn out liability of $0.7 million and recorded the change in Other Income (Expense) caption of our consolidated statement of operations during the quarter ended October 1, 2010.

On September 7, 2010, we closed on the acquisition of UPEK in which we acquired all of the outstanding shares of capital stock of UPEK in exchange for 5,956,540 shares of our common stock and a non-interest bearing promissory note which was recorded at a fair value of approximately $13,606,000 at the time of acquisition. On December 22, 2010, we issued 7,984,281 shares of our common stock in settlement of the promissory note and recorded a note settlement charge of $7.1 million.  These acquisitions were accounted for under the acquisition method, in accordance with ASC 805, "Business Combinations", with the assets and liabilities acquired recorded at their fair values at the date of acquisition. The results of operations of the acquired businesses have been included in our operating results beginning as of the effective dates of these acquisitions.

Supplemental Pro Forma Data

The following unaudited pro forma financial information for the three and nine months ended October 1, 2010 represent the combined results of our operations as if the SafeNet’s Embedded Security Solutions division and the UPEK acquisitions had occurred on January 1, 2010. The unaudited pro forma results reflect certain adjustments related to these acquisitions such as increased amortization expense on acquired intangible assets resulting from the fair valuation of assets acquired. The unaudited pro forma financial information does not necessarily reflect the results of operations that would have occurred had we operated as a single entity during such period.

	Three Months Ended			Nine Months Ended
	October 1, 2010			October 1, 2010
Revenue	$	13,640		$	48,282
Net loss		(13,164	)		(27,020	)
Net loss per common share, basic and diluted	$	(0.42	)	$	(0.90	)

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.

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            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 reporting 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.

We evaluate the performance of our segments based on income (loss) from operations. The accounting policies for segment reporting are the same as for AuthenTec as a whole. There are no intersegment revenues. We allocate the costs of shared resources between segments based on each segment's estimated usage of the shared resources. Our assets are managed centrally and are not being reviewed at a segment level by our chief operating decision maker.

The table below presents revenues and operating loss for reportable segments:

	Reportable segments
	Smart Sensor Solutions			Embedded Security Solutions			Consolidated
	(In thousands)
Three months ended September 30, 2011
Net revenue	$	12,025		$	7,291		$	19,316
Operating income (loss)		(2,326	)		2,464			138
Three months ended October 1, 2010
Net revenue		6,071			4,161			10,232
Operating income (loss)		(12,413	)		759			(11,654	)
Nine months ended Septmber 30, 2011
Net revenue		34,122			16,881			51,003
Operating income (loss)		(12,462	)		2,823			(9,639	)
Nine months ended October 1, 2010
Net revenue		22,249			7,880			30,129
Operating loss	$	(20,770	)	$	(251	)	$	(21,021	)

13. Information about Geographic Areas

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 September 30, 2011 and October 1, 2010, revenue generated from international customers accounted for approximately 71% and 79% of total revenue, respectively. For the nine months ended September 30, 2011 and October 1, 2010, revenue generated from international customers accounted for approximately 75% and 86% of total revenue, respectively.

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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										Nine months ended
	September 30,					October 1,					September 30,					October 1,
	2011					2010					2011					2010
	Revenue $		% of total			Revenue $		% of total			Revenue $		% of total			Revenue $		% of total
	(In thousands)										(In thousands)
Asia/Pacific	$	7,098		36	%	$	2,711		26	%	$	23,575		46	%		13,337		44	%
Japan		4,350		23			4,475		44			9,107		18			10,798		36
United States		5,608		29			2,137		21			12,774		25			4,083		14
Europe		1,303		7			717		7			4,419		9			1,387		5
Canada		957		5			192		2			1,128		2			524		2
	$	19,316		100	%	$	10,232		100	%	$	51,003		100	%	$	30,129		100	%

The following table is based on the geographic location of our net long-lived assets:

	As of
	September 30,		December 31,
	2011		2010
	(In thousands)
Asia Pacific	$	1,684	$	2,118
Japan		6		4
United States		1,378		1,418
Europe		714		890
Total	$	3,782	$	4,430

14. Income Taxes

For the three and the nine months ended September 30, 2011, we recorded an income tax provision of approximately $126,000 and $402,000, respectively. For the three and the nine months ended October 1, 2010, we recorded an income tax benefit of approximately $286,000 and $223,000, respectively.  The income tax provision recorded during the three and nine months ended September 30, 2011 resulted from profitable results in certain of our foreign entities.

Following our acquisition of UPEK on September 7, 2010, a portion of the purchase price for UPEK was allocated to deferred tax assets, related valuation allowance and accruals for uncertain tax positions. UPEK’s deferred tax asset as of September 7, 2010 was approximately $3.9 million, net of valuation allowances of $3.3 million. UPEK’s total amount of unrecognized tax benefits and related accrued interest as of September 7, 2010 was $4.3 million.

Due to the expiration of the federal statute of limitations, the $4.2 million calculated as uncertain tax positions for the 2006 tax year and recorded in connection with the UPEK acquisition have been reversed as of September 15, 2010. The reversals of these liabilities for uncertain tax positions were almost entirely offset by the reversals of related deferred tax assets. Included in this reversal is federal AMT and accrued interest of approximately $348,000 attributable to the 2006 tax year, which was recorded in theProvision (benefit) for income taxescaption in our consolidated statements of operations for the three months ended October 1, 2010. This reserve for uncertain tax positions reverses at September 13, 2010, which was the date that the 2009 federal tax return was filed. 

            At September 30, 2011 and December 31, 2010, we had unrecognized tax benefits for uncertain tax positions of $1.5 million. None of the balance as of September 30, 2011 would affect our effective tax rate if recognized because it would be offset by the release of a valuation allowance of an equal amount. We do not expect to utilize any portion of our uncertain tax positions during the remainder of 2011.

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 and nine months ended September 30, 2011.

The tax years 2006 to 2010 remain open to examination by one or more of the major tax jurisdictions in which are subject to taxation on our taxable income.  Currently, tax years 2006 to 2009 are under examination by the Internal Revenue Service.

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 15. 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 three months ended September 30, 2011, is intended to integrate and streamline operations across the integrated organization.

            Action plans necessary to carry out the restructuring plan have been identified and the majority was implemented during the first half of 2011 with its final completion during the three months ended September 30, 2011. These action plans included the closure of UPEK’s Singapore operations, which was substantially completed by the end of 2010.

Costs incurred with restructuring activities generally consist of voluntary and involuntary severance-related expenses, asset impairments and other costs to exit activities. We recognize involuntary severance-related expenses depending on whether the termination benefits are provided under an ongoing benefit arrangement or under a one-time benefit arrangement. We recognize involuntary severance-related expenses associated with an ongoing benefit arrangement once they are probable and the amounts are estimable. We recognize involuntary severance-related expenses associated with a one-time benefit arrangement once the benefits have been communicated to employees.

Restructuring activities have also resulted in asset impairments, which were included in restructuring expense and were recorded as an adjustment to the basis of the asset.

Below is a listing of the components of the restructuring and impairment related charges for the three and the nine months ended September 30, 2011:

	Three Months Ended			Nine Months Ended
Severance	$	(46	)	$	310
Legal fees		-			79
Obligation settlement		-			(114	)
	$	(46	)	$	275

All of the restructuring charges were attributable to the Smart Sensor Solutions segment. The table below reflects the changes in accrued restructuring balances associated with these actions:

	Severance and Benefits			Legal and Other
	(In thousands)
Accrual at December 31, 2010	$	717		$	259
Restructuring expense		318			(35	)
Payments		(684	)		(157	)
Accrual at April 1, 2011	$	351		$	67
Restructuring expense		39			-
Payments		(343	)		(67	)
Accrual at July 1, 2011	$	47		$	-
Restructuring expense		(46	)		-
Payments		(1	)		-
Accrual at September 30, 2011	$	-		$	-

The accrual balances above are components of Accrued compensation and benefits and Other accrued liabilities on our consolidated balance sheets, depending on the expected timing of payment.

16. Recent Accounting Pronouncements

In October 2009, the FASB issued Accounting Standards Update (“ASU”) No. 2009-13, which updates the guidance currently included under topic ASC 605-25, Multiple Element Arrangements. ASU 2009-13 relates to the final consensus reached by FASB on a new revenue recognition guidance regarding revenue arrangements with multiple deliverables. The new accounting guidance addresses how to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting, and how the arrangement consideration should be allocated among the separate units of accounting. The new accounting guidance is effective for fiscal years beginning after June 15, 2010 and may be applied retrospectively or prospectively for new or materially modified arrangements. We adopted ASU 2009-13 on January 1, 2011 and the adoption did not have a material impact on our consolidated financial statements.

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            In October 2009, FASB issued ASU No. 2009-14, Topic 985: Certain Revenue Arrangements That Include Software Elements (a Consensus of the FASB Emerging Issues Task Force Issue (EITF)). ASU No. 2009-14 modifies ASC 985-605, Software Revenue, to exclude tangible products that include software and non-software components that function together to deliver the product's functionality. This updated guidance will be applied on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. We adopted ASU 2009-14 on January 1, 2011 and the adoption did not have a material impact on our consolidated financial statements.

            In April 2010, the FASB issued ASU No. 2010-17, Topic 650: Revenue Recognition – Milestone Method. This update provides guidance on defining a milestone as well as the criteria that should be met for determining whether the milestone method of revenue recognition is appropriate. The amendments in this update are effective on a prospective basis for milestones achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2010. We adopted ASU 2010-17 on January 1, 2011 and the adoption did not have a material impact on our consolidated financial statements.

We adopted the above new revenue recognition accounting standards on the first day of our fiscal 2011 for revenue arrangements that include both hardware and software elements. These new standards require companies to account for product or service deliverables separately rather than as one combined unit in a multiple element arrangement. Under these new standards, hardware products containing software components and non software components that function together to deliver the hardware product’s essential functionality are excluded from the pre-existing software revenue standards. In addition, hardware components of a tangible product containing software components are always excluded from the pre-existing software revenue standards. The residual method is no longer allowed when allocating consideration for arrangements under these new accounting standards.

A multiple element arrangement is any arrangement that includes or contemplates rights to a combination of software or hardware products, software license types, services, training or maintenance in a single arrangement. From time to time, we may include individual deliverables in separately priced and separately executed contracts with the same customer. We evaluate all relevant facts and circumstances in determining whether the separate contracts should be accounted for individually as distinct arrangements or whether the separate contracts are, in substance, a multiple element arrangement. Significant judgment can be involved in determining whether a group of contracts might be so closely related that they are, in effect, part of a single arrangement.

For a single transaction or multiple element arrangement that includes software and non software elements, we allocate consideration to all deliverables based on their relative standalone selling prices. In these circumstances, the new accounting standards establish a hierarchy to determine the standalone selling price to be used for allocating consideration to deliverables as follows:

• Vendor-specific objective evidence of fair value, or VSOE;

• Third-party evidence of selling price, or TPE; and

• Best estimate of the selling price, or BESP.

The new accounting standards do not generally change the separate elements identified in our revenue transactions. For multiple element arrangements that contain software and non software elements, we allocate the consideration to software or software-related elements as a group, and to any non software element separately based on the standalone selling price hierarchy. The consideration allocated to each element is then recognized as revenue when the basic revenue recognition criteria are met for each element. Once the consideration is allocated to the group of software and software-related elements, we then follow the recognition principles of pre-existing software accounting guidance.

TPE is determined based on competitor prices for similar deliverables when sold separately. Generally, our offerings contain significant differentiation such that comparable pricing of products with similar functionality cannot be obtained. Furthermore, we are unable to reliably determine what similar competitor products’ selling prices are sold on a stand-alone basis. Therefore, we typically are not able to obtain TPE and it is not used to determine any standalone selling prices.

We calculate the BESP of our hardware products based on our pricing practices, including the historical average prices charged for comparable hardware products. Our process for determining BESP for our software deliverables without VSOE or TPE takes into account multiple factors that vary depending upon the unique facts and circumstances related to each deliverable. Key external and internal factors considered in developing the BESPs include, but are not limited to, prices charged by us for similar arrangements, historical pricing practices and the nature of the product. In addition, when developing BESPs, we may consider other factors as appropriate including the pricing of competitive alternatives, if they exist, and product-specific business objectives.

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We adopted these new accounting standards on a prospective basis. Therefore, revenue will continue to be recognized in future periods under the pre-existing accounting standards for arrangements that were entered into on or prior to December 31, 2010. We began applying the new accounting standards for arrangements entered into or materially modified on or after January 1, 2011. The adoption of the new standards did not have a material impact on our consolidated financial statements.

In May 2011, the FASB issued ASU No. 2011-04, Topic 820, Fair Value Measurements and Disclosures, an amendment to the accounting standards related to fair value measurements and disclosure requirements that result in a consistent definition of fair value and common requirements for the measurement and disclosure of fair value between “GAAP” and International Financial Reporting Standards. This standard provides certain amendments to the existing guidance on the use and application of fair value measurements and maintains a definition of fair value that is based on the notion of exit price. This standard will become effective for us on December 31, 2011, which is the first day of our next fiscal year, and is not expected to have a material impact on our consolidated financial statements.

In June 2011, the FASB issued ASU No. 2011-05, Topic 220, Comprehensive Income, an amendment to the accounting standards related to the presentation of comprehensive income. This standard revises the manner in which entities present comprehensive income in their financial statements and removes the option to present items of other comprehensive income in the statement of changes in equity. This standard requires an entity to report components of comprehensive income in either (1) a continuous statement of comprehensive income or (2) two separate but consecutive statements of net income and other comprehensive income. This standard will become effective retrospectively for us on December 31, 2011, which is the first day of our next fiscal year, and is not expected to have a material impact on our consolidated financial statements.

In September 2011, the FASB issued ASU No. 2011-08, Topic 350, Intangibles—Goodwill and Other, an amendment to testing goodwill for impairment. This standard permits an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. This standard is effective for interim and annual goodwill impairment tests performed for fiscal years beginning after December 15, 2011, with early adoption permitted, and is not expected to have a material impact on our consolidated financial statements. We anticipate to early adopt this standard in the fourth quarter of fiscal 2011.

 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 31, 2010. 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, new and existing fingerprint sensors and related software in the PC and wireless markets, our ability to secure design wins and these design wins leading to future production, the adoption of our sensors and related software in other applications outside of PC notebooks and wireless devices, the rate at which we increase our activity and opportunities in the wireless market, the acceptance of our Embedded Security products in the mobile and network security markets and the continued integrity of our products’ data privacy protections, changes in product mix, the actions of existing or future competitors, our ability to successfully integrate acquired businesses in our operations, the impact of litigation 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. Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2010. 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.

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 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, smartphone, 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 security and identity management solutions, including smart fingerprint sensors, identity management software and IP products and services. We believe our smart fingerprint sensors products, which are based on our patented technologies, are the most accurate, reliable, cost-effective, easy to use and versatile products commercially available today. They offer multiple functions to users of PCs, smart phones, tablets and other products. Since our inception in 1998, and excluding shipments from our UPEK acquisition, we have shipped over 54 million sensors which have been integrated into over 250 different models of laptops, desktops and PC peripherals as well as over 15 million mobile phones. Complementing our smart sensors is our TrueSuite® identity management family of software, providing PC and mobile users secure, one-touch access to their digital identity and online social networks. TrueSuite was introduced in 2009, and is currently being integrated in AuthenTec-enabled notebook PCs being offered by the world’s leading PC OEMs. TrueSuite Mobile® for AuthenTec-enabled mobile phones was introduced in October 2010. Our revenue in the past was highly concentrated in the markets outside the U.S. Following the acquisition of our Embedded Security Solutions Division segment, currently we are experiencing revenue growth in the U.S. market and our revenue by geographic location may vary from quarter to quarter depending on the customer base in our Embedded Security Solutions division. Financial information with respect to our operations outside the United States is contained in the Note 13 to the consolidated financial statements captioned “Information about Geographic Areas”.

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.

In February 2010, we acquired SafeNet’s Embedded Security Solutions division, further enhancing our offering of security and identity management solutions.  The Embedded Security Solution products are used in hundreds of millions of communication and network products to ensure data privacy for businesses and individuals, and are sold to a variety of brand name customers including Hewlett Packard, HBO, Motorola, Samsung, LG, Ericsson, Advanced Micro Devices, Cisco, Alcatel-Lucent, Juniper Networks, Nokia-Siemens and Texas Instruments among others.  

In September 2010, we acquired privately-held UPEK, a leading supplier of fingerprint solutions for consumer, business and government applications. We have benefitted and will continue to benefit from UPEK’s software expertise, presence in the PC markets and leadership in silicon based biometrics for government and ID uses.  

As a result of these acquisitions, we now offer a broad portfolio of smart sensors for the PC, wireless, access control and government markets, multiple USB fingerprint readers, PC identity management software (TrueSuite® and TrueSuite Mobile®), and a comprehensive embedded security IP portfolio. With the addition of UPEK patents, we expanded our intellectual property portfolio to nearly 200 issued and filed U.S. patents.

Furthermore, the acquisitions of Safenet’s Embedded Security Division and UPEK contributed to our growth in revenue to $44.7 million in 2010 from $34.1 million in 2009 and to $51.0 million for the nine months ended September 30, 2011 from $30.1 million for the nine months ended October 1, 2010.

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 Challenges and Risks

Our future profitability and rate of growth, if any, will be directly affected by the continued acceptance of our products in the marketplace, the timing and size of product orders, our product mix, the average selling prices and costs of our products, the timely introduction of new products and the generation of IP license fees and royalties from our prodcuts, as well as general economic conditions in the markets that we serve. Our ability to achieve profitability will also be affected by the extent to which we must incur additional expenses to expand our sales, marketing, development, and general and administrative capabilities to expand our business. The largest component of our operating expenses is personnel costs. Personnel costs consist of salaries, benefits and incentive compensation, including bonuses and stock-based compensation, for our employees. The following are material trends that are creating opportunities and risks to our business, and a discussion of how we are responding to such trends.

● The global macroeconomic downturn accelerated the growth in sales of consumer lower cost PCs. We also believe the broad acceptance of tablets has negatively impacted the growth rate of  PC’s. The fingerprint sensor attach rate in lower-cost PCs is lower relative to more expensive, feature rich models. To increase penetration of the lower-cost PC market, we are focusing development efforts on lower-cost fingerprint sensors and client application software tailored for use in this growing portion of the PC market. We have introduced lower-cost fingerprint sensors as well as added consumer friendly features such as LED based feedback for the PC market. We launched and our TrueSuite identity management software in 2009 and today it is in use by some of the leading PC OEM’s. In 2011 we launched our AuthenTec webstore and jointly launched a HP-AuthenTec webstore specifically targeted to the consumer market, offering additional software applications and the newest versions of our TrueSuite software. We have also developed complete solutions combining fingerprint sensors with a version of our TrueSuite identity management software specifically tailored to the tablet market.

● Outside of Japan, adoption of fingerprint sensors by US wireless network carriers for inclusion in smartphones has been limited. We have seen some adoption for the US market as the LG Expo with our fingerprint sensor was launched in 2010 by ATT and the Motorola Atrix was launched in 2011 also by ATT.  We expect eventual widespread integration of fingerprint sensors into wireless devices; however, the timing of such adoption by wireless network carriers, if at all, will have a significant impact on our future revenues. In response, we are working with wireless device manufacturers to accelerate adoption of fingerprint sensors by highlighting features such as personalization, navigation, our application software and integration into NFC based mobile wallet transaction architectures.  We are starting to see results of our efforts and we are focused on improving the durability and aesthetics of our sensors for wireless devices through continued development of our new TouchStone packaging technology. In February 2010, we introduced the AES1750, first smart sensor for the mobile systems market, which takes full advantage of AuthenTec’s new TouchStone packaging technology. In October 2010, we introduced our AES850 as a cost competitive alternative to navigation only devices in mobile phones.  The AES850 is the smallest sensor we have developed to date and combines advanced navigation with biometrically enabled touch based features. In 2011 we offered mobile applications that can be downloaded for use on smartphones with our fingerprint sensors.

Results of Operations

The following table sets forth selected statement of operations data for the periods indicated expressed as a percentage of revenue:

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	Three Months Ended						Nine Months Ended
	September 30, 2011			October 1, 2010			September 30, 2011			October 1, 2010
Revenue		100	%		100	%		100	%		100	%
Cost of revenue		46			50			50			50
Gross margin		54			50			50			50
Operating expenses
Research and development		27			52			34			47
Selling and marketing		20			32			23			30
General and administrative		7			39			12			30
Restructuring and impairment related charges		-			-			-			-
Litigation dismissal		-			40						14
Total operating expenses		54			163			69			121
Income (loss) from operations		-			(113	)		(19	)		(71	)
Total other income (expense), net		1			(1	)		-			2
Provision for income taxes		(1	)		(3	)		1			(1	)
Net income (loss)		0	%		(112	%)		(20	%)		(68	%)

Comparison of the Three and Nine months Ended September 30, 2011 and October 1, 2010

Following is an analysis of revenue by reportable segment:

	Three Months Ended							Nine Months Ended
	September 30, 2011		October 1, 2010		% Change			September 30, 2011		October 1, 2010		% Change
	(In thousands)							(In thousands)
Smart Sensor Solutions	$	12,025	$	6,071		98	%	$	34,122	$	22,249		53	%
Embedded Security Solutions		7,291		4,161		75	%		16,881		7,880		114	%
Consolidated	$	19,316	$	10,232		89	%	$	51,003	$	30,129		69	%

Revenue. Our consolidated revenue was $19.3 million for the three months ended September 30, 2011 as compared to $10.2 million for the three months ended October 1, 2010, an increase of $9.1 million, or 89%.  The increase in revenue was partially attributable to the incremental revenue gained from the acquisition of UPEK, which is included in our Smart Sensor Solutions segment, as well as revenue growth in our Embedded Security Solutions segment.  The UPEK acquisition was completed on September 7, 2010 and, therefore, only one month of revenue from UPEK is included in the results for the three months ended October 1, 2010. Our revenue in the Smart Sensor Solutions segment increased by $6.0 million, or 98%, for the three months ended September 30, 2011, and our revenue in Embedded Security Solutions segment grew by $3.1 million, or 75%, as compared to the same period last year. The increase in Smart Sensor revenue was primarily driven by the growth in the government and access control market of $4.0 million and the PC market of $2.0 million primarily a result of the UPEK acquisition. Our growth in Embedded Security Solutions revenue was attributable to increased licensing and royalty revenue of $2.0 million which mainly consisted of licensing our IP and DRM products and royalties for our Toolkits, as well as an increase of $1.2 million in shipments of legacy integrated circuit chips resulting from accelerated purchases by customers as we ceased manufacturing this product.

Our consolidated revenue was $51.0 million for the nine months ended September 30, 2011 as compared to $30.1 million for the nine months ended October 1, 2010, an increase of $20.9 million, or 69%. The increase in revenue was mostly attributable to the incremental revenue gained from the acquisition of UPEK and higher revenue in our Embedded Security Solutions segment. Our Smart Sensor Solutions revenue increased by $11.9 million, or 53%, for the nine months ended September 30, 2011 as compared to the nine months ended October 1, 2010. The increase in Smart Sensor revenue was primarily attributable to the increase in the government and access control market of $10.1 million and increased shipments in our PC, software and eCommerce markets of $1.8 million. This growth was mostly a result of the UPEK acquisition. Revenues in Embedded Security Solutions segment increased by $9.0 million, or 114%, for the nine months ended September 30, 2011 as compared to the nine months ended October 1, 2010. Licensing and royalty revenue increased by $7.7 million and integrated chips revenue increased by $1.3 million as a result of increased shipments due to end of life of these products which is anticipated by the end of our fiscal 2011. In addition to the organic growth in the Embedded Security Solutions segment, our results for the nine months ended October 1, 2010 only include revenues from our acquisition of SafeNet’s Embedded Security Solutions division from February 26, 2010 and amounted to $7.9 million.

Cost of revenue and gross margin. Our cost of revenue was $8.8 million for the three months ended September 30, 2011 as compared to $5.1 million for the three months ended October 1, 2010, resulting in a gross profit of $10.5 million for the three months ended September 30, 2011 as compared to $5.2 million for the three months ended October 1, 2010, an increase of $5.4 million, or 104%. Consolidated gross margin was 54% in the three months ended September 30, 2011 as compared to 50% in the three months ended October 1, 2010.

The Smart Sensor Solutions segment gross margin was 38% in the three months ended September 30, 2011 as compared to 29% in the same period last year. The increase in gross margin is primarily attributable to higher revenue in the government and access control market which has a higher margin product offering. During the three months ended October 1, 2010, we incurred some additional one-time inventory related costs associated with the legacy UPEK products. The overall decline in average selling prices (“ASP”) was two percent (2%) for the three months ended September 30, 2011 as compared to a three percent (3%) decline for the three months ended October 1, 2010.

Embedded Security Solutions segment gross margin was consistent at 81% in the three months ended September 30, 2011 and in the three months ended October 1, 2010. The revenue from software licensing fees and royalties contains no or minimal product costs which result in 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. During the three months ended September 30, 2011, we recorded additional $0.3 million in amortization expense as a result of a change in the estimated remaining useful life of the integrated circuit chips distribution agreement due to anticipated end of life of this product by the end of our fiscal 2011. Depending on the revenue mix between hardware and software, profit margin may vary between periods.

Our cost of revenue was $25.3 million for the nine months ended September 30, 2011 as compared to $15.0 million for the nine months ended October 1, 2010, resulting in a gross profit of $25.7 million for the nine months ended September 30, 2011 as compared to $15.1 million for the nine months ended October 1, 2010, an increase of $10.6 million, or 70%. The increase in the gross profit was primarily related to the acquisition of UPEK and the addition of Embedded Security Solutions segment for the entire nine month period. Consolidated gross margin was consistent at 50% in the nine months ended September 30, 2011 and in the nine months ended October 1, 2010.

The Smart Sensor Solutions segment gross margin was 35% in the nine months ended September 30, 2011 as compared to 41% in the same time frame last year. The decrease in the gross margin was mostly attributable to the acquisition of UPEK driven by increased amortization of purchased intangible assets and lower margins associated with the legacy UPEK products being sold to PC OEMs along with an overall decline in ASPs which resulted in two percent (2%) reduction of revenue.   

The Embedded Security Solutions segment gross margin was 81% in the nine months ended September 30, 2011 as compared to 76% in the same period last year. The increase in gross margin was primarily driven by the mix of higher licensing and royalty revenue as compared to lower margin revenue from hardware shipments which was partially offset by the increased amortization of integrated circuit chips distribution agreement which amounted to $0.6 million for the nine months ended September 30, 2011

Research and development expenses. Research and development expenses were $5.1 million for the three months ended September 30, 2011 as compared to $5.3 million for the three months ended October 1, 2010, a decrease of $0.2 million, or 3%. Research and development expenses were 27% and 52% of revenue for the three months ended September 30, 2011 and October 1, 2010, respectively. Research and development expenses in the Smart Sensor Solutions segment decreased by $0.3 million mostly due to decrease in labor and personnel related costs driven by reduction in headcount. Research and development expenses associated with Embedded Security Solutions segment increased by $0.2 million for the three months ended September 30, 2011 due to increased labor and personnel related costs as well as higher Euro exchange rate. Our research and development facilities for the Embedded Security Solutions segment are located in Europe.

Research and development expenses were $17.5 million for the nine months ended September 30, 2011 as compared to $14.0 million for the nine months ended October 1, 2010, an increase of $3.5 million, or 25%. Research and development expenses were 34% and 47% of revenue for the nine months ended September 30, 2011 and October 1, 2010, respectively. The increase was mostly attributable to the incremental costs of our acquired businesses, UPEK and SafeNet’s Embedded Security Solutions division. Research and development expenses attributable to the Smart Sensor Solutions segment increased by $1.4 million, or 13%, mostly due to an increase in labor and personnel related costs and an increase in amortization of purchased intangible assets, all primarily attributable to the UPEK acquisition. The nine months ended October 1, 2010 included only one month of activity after the completion of the UPEK acquisition on September 7, 2010. Research and development expenses associated with Embedded Security Solutions segment increased by $2.1 million, or 68% due to increased labor and personnel related costs and amortization of purchased intangible assets. The nine months ended October 1, 2010 included only seven months of activity after the acquisition of such division on February 26, 2010.

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Selling and marketing expenses. Selling and marketing expenses were $3.9 million for the three months ended September 30, 2011, as compared to $3.3 million for the three months ended October 1, 2010, an increase of $0.6 million, or 17%. Selling and marketing expenses were 20% and 32% of revenue for the three months ended September 30, 2011 and October 1, 2010, respectively. The selling and marketing expenses for the Smart Sensor Solutions segment remained relatively flat for both periods presented. The selling and marketing expenses for the Embedded Security Solutions segment increased by $0.6 million or 67%, mainly due to an increase in sales commissions as a result of higher revenue.

Selling and marketing expenses were $11.9 million for the nine months ended September 30, 2011, as compared to $8.9 million for the nine months ended October 1, 2010, an increase of $3.0 million, or 34%. Selling and marketing expenses were 23% and 30% of revenue for the nine months ended September 30, 2011 and October 1, 2010, respectively. The selling and marketing expenses for the Smart Sensor Solutions segment increased by $1.4 million, or 23%, primarily due to an increase in personnel costs of $0.6 million and an increase in amortization of purchased intangible assets of $0.8 million mostly related to the UPEK acquisition. The selling and marketing expenses for the Embedded Security Solutions segment increased by $1.6 million, or 61%, and were mostly associated with higher labor and personnel related costs and sales commissions as well as amortization of purchased intangible assets. The nine months ended October 1, 2010 included only seven months of activity of the Embedded Security Solutions division after the acquisition of such division on February 26, 2010.

General and administrative expenses. General and administrative expenses were $1.4 million for the three months ended September 30, 2011 as compared to $4.0 million for the three months ended October 1, 2010, a decrease of $2.6 million, or 65%. General and administrative expenses were 7% and 39% of revenue for the three months ended September 30, 2011 and October 1, 2010, respectively. General and administrative expenses decreased by $3.3 million, or 81%, in the Smart Sensor Solutions segment predominately driven by a decrease in labor related costs of $1.4 million as a result of severance charges incurred during three months ended October 1, 2010 due to management transition, decrease in acquisition related fees of $0.8 million, and a decrease in legal fees of $0.4 million mostly related to the reversal of accrued IBT litigation related fees. 

General and administrative expenses were $5.6 million for the nine months ended September 30, 2011 as compared to $9.1 million for the nine months ended October 1, 2010, a decrease of $3.4 million, or 38%. General and administrative expenses were 12% and 30% of revenue for the nine months ended September 30, 2011 and October 1, 2010, respectively. General and administrative expenses decreased by $4.9 million, or 54%, in the Smart Sensor Solutions segment primarily as a result of a decrease in acquisition related fees of $1.9 million, a decrease in labor and personnel related costs of $1.8 million and a decrease in outside legal fees of $1.2 million, which included release of the accrued IBT litigation related fees of $0.4 million during the nine months ended September 30, 2011. The general and administrative expenses for the Embedded Security Solutions segment increased by $0.9 million primarily due to increased outside legal and audit related fees. The nine months ended October 1, 2010 included only seven months of activity of the Embedded Security Solutions division after the acquisition of such division on February 26, 2010.

Restructuring and impairment related charges. Restructuring charges were $(46,000) for the three months ended September 30, 2011 as compared to none for the three months ended October 1, 2010. The amount recorded in the three months ended September 30, 2011 represents a release of the remaining accrual of employment termination benefits.

Restructuring and impairment related charges were $0.3 million for the nine months ended September 30, 2011 as compared to none for the same time last year. As a result of restructuring activities, 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.

Litigation dismissal.There were no litigation dismissal expenses for the three and the nine months ended September 30, 2011 as compared to $4.1 million for the three and the nine months ended October 1, 2010. During the three months ended October 1, 2010, we recorded $4.1 million in estimated legal fees as a result of a patent lawsuit dismissal in connection with the UPEK acquisition.

Other income (expense), net. Other income (expense), net increased by $0.4 million to a net other income of $0.2 million for the three months ended September 30, 2011 mostly attributable to the foreign currency gains due to lower Euro exchange rates.

Other income (expense), net decreased by $0.9 million to a net other expense of $0.2 million for the nine months ended September 30, 2011 mostly attributable to the reversal of the earnout liability of $0.7 million during the nine months ended October 1, 2010 associated with the contingent consideration related to the acquisition of SafeNet’s Embedded Security Solutions division as well as foreign currency losses due to higher Euro exchange rates in the beginning of the year.

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A contingent consideration payment could have been due by us if certain revenue targets were achieved by our Embedded Security Solutions segment during the earnout period. The revenue target calculation required accumulated Embedded Security Solutions annual revenue to reach $20 million, adjusted for certain deferred revenue items and pro-rated for the length of the earn out period. We recorded $0.7 million in estimated earnout liability during the quarter ended April 2, 2010 and subsequently determined that the minimum required revenue target could not be achieved during the earn out period and therefore no contingent consideration would be due. As a result of this determination, we reversed the earn out liability of $0.7 million and recorded the change in Other Income (Expense) caption of our consolidated statement of operations during the nine months ended October 1, 2010.

Liquidity and Capital Resources

Since our inception, we have financed our growth primarily with funds generated from operations, the issuance and sale of our common and preferred stock and senior secured convertible debt. Our cash, cash equivalents and investments were $20.6 million as of September 30, 2011, a decrease of $11.2 million from December 31, 2010. The decrease in our cash, cash equivalents and investments as of September 30, 2011 was primarily attributable to the net operating loss, purchases of inventory parts and severance payments associated with restructuring activities.

	Nine Months Ended
	September 30, 2011			October 1, 2010
	(In thousands)
Consolidated statement of cash flows data:
Purchase of property and equipment	$	(752	)	$	(547	)
Cash flows from operating activities		(10,626	)		(11,292	)
Cash flows from investing activities		14,588			1,368
Cash flows from financing activities		121			11

Operating activities. Net cash used in operating activities was $10.6 million in the nine months ended September 30, 2011, primarily due to net operating loss for the period as well as an increase in accounts receivable, purchases of inventory and payments of severance and legal invoices. Operating loss, excluding stock-based compensation, depreciation and amortization expense contributed to $2.8 million of cash used in operating activities, increase in accounts receivable contributed to $1.3 million decrease in cash, payments for inventory, severance and legal fees contributed to $5.4 million of cash used and increase in deferred revenue contributed to $1.4 million decrease in cash in the operating activities.

During the three months ended September 30, 2011 we were in a cash flow positive position with $0.4 million in cash generated from operations.

Investing activities. Net cash provided by investing activities was $14.6 million in the nine months ended September 30, 2011, mostly attributable to redemption of our short-term investments of $15.0 million and cash received from the sale of certain patents of $0.4 million; partially offset by $0.8 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.

We believe our $17.4 million of cash and cash equivalents at September 30, 2011 as well as expected cash flow from operations will be sufficient to fund our projected operating requirements for at least the next twelve months.

Our investment policies are designed to provide liquidity, preserve capital and achieve an acceptable return on invested assets. As of September 30, 2011, our investment portfolio consisted primarily of U.S. treasury and U.S. government agency funds and fixed-income securities. The weighted average maturity is less than twelve months. We utilize investment vehicles such as treasuries, U.S. government agency funds and auction rate securities.

As of September 30, 2011, all of our $3.3 million in short-term and 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.

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All of our auction rate securities held at September 30, 2011 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.

In the ordinary course of business, our written supply agreements include intellectual property indemnification clauses which, under certain limited circumstances, may require us to defend and/or indemnify certain customers for damages resulting from the infringement of intellectual property rights of third parties. In addition, UPEK has entered into similar indemnification arrangements with its customers. Because UPEK remains an existing wholly owned subsidiary, certain such indemnity obligations survived the merger and may require AuthenTec to assume those obligations for UPEK. To date, our indemnification obligations under such contracts have had an insignificant impact on our financial condition and results of operations and, as a result, we have not accrued for any such indemnity obligations on our financial statements. However, in the future we may be required to indemnify and defend our customers against such claims.

These indemnification obligations may result in material expense to us, including legal and other costs incurred to defend any claims. We may settle or compromise such matters or be subjected to an adverse outcome which could result in material financial or other costs to us. There is no guarantee that our indemnification obligations will not have a material adverse impact on our financial condition and results of operations in the future.

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 GAAP. 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 September 30, 2011 are consistent with those discussed in our Annual Report on Form 10-K for the year ended December 31, 2010, except for our adoption of new accounting standards related to revenue recognition and described below.

Accounting Standards Adopted

In October 2009, the Financial Accounting Standards Board (FASB) concurrently issued the following Accounting Standards Updates (ASUs):

●  ASU No. 2009 – 14 - Software (Topic 985): Certain Revenue Arrangements That Include Software Elements. This standard removes tangible products from the scope of software revenue recognition guidance and also provides guidance on determining whether software deliverables in an arrangement that includes a tangible product, such as embedded software, are within the scope of the software revenue guidance.

● ASU No. 2009 – 13 - Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements. This standard modifies the revenue recognition guidance for arrangements that involve the delivery of multiple elements, such as product, software, services and support, to a customer at different times as part of a single revenue generating transaction. This standard provides principles and application guidance to determine whether multiple deliverables exist, how the individual deliverables should be separated and how to allocate the revenue in the arrangement among those separate deliverables.

We adopted these standards in the first quarter of 2011 by applying them on a prospective basis to revenue arrangements entered into or materially modified beginning January 1, 2011. The adoption of these standards did not have a significant impact on our financial position or results of operations.

Contractual Obligations

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There were no material changes during the period covered by this report to the contractual obligations previously disclosed in our 2010 Annual Report on Form10-K filed with the SEC on March 17, 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 16 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 Euros and Japanese Yen. We do have 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 have and may continue to increase in fiscal 2011 as a result of the acquisitions of SafeNet’s Embedded Security division and UPEK whose main operations are 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 consolidated financial statements of approximately $1.7 million.

Interest rate risk. We had cash, cash equivalents and investments of $20.6 million as of September 30, 2011, 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 significant impact on our results from operations.

Market risk. Our short term and long term investments consist of U.S. Treasury and U.S. Government agency funds and 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 September 30, 2011, we held $3.3 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 September 30, 2011 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 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) , 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 September 30, 2011 to provide reasonable assurance of the achievement of these objectives.

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Changes in internal controls. There was no change in our internal control over financial reporting during the quarter ended September 30, 2011, that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II — OTHER INFORMATION

Item 1. Legal Proceedings.

AuthenTec is an intervening party in a federal patent infringement lawsuit brought by Innovative Biometric Technology, LLC (“IBT”), against Lenovo, Fujitsu, ASUS, Toshiba, and others.  The case is captioned Innovative Biometric Technology, LLC v. Lenovo (United States), Inc., et al., Case No. 9:09-cv-81046-KLR, and was filed by IBT on July 19, 2009 in the U.S. District Court for the Southern District of Florida (the “Court”).  IBT asserted that the use of certain of the defendant’s products shipped into the United States infringe U.S. Patent No. 7,134,016, which is entitled Software System with a Biometric Dongle (the “‘016 patent”) and relates generally to a method of protecting software program access.   AuthenTec intervened in the case, in November 2010, because IBT’s allegations relate, in part, to the use of biometric software or hardware supplied by us and UPEK, Inc. (“UPEK”) to certain of the defendants that has been integrated into laptop computers by our and UPEK’s customers. In view of IBT’s formal claim construction arguments, on March 25, 2011, AuthenTec filed a Motion for Summary Judgment of Noninfringement, or in the Alternative, Invalidity of the ‘016 patent.  Following a July 2011 hearing on AuthenTec’s Motion for Summary Judgment, on September 27, 2011, IBT conceded that its infringement contentions lacked merit by filing a “covenant not to sue” and a unilateral Motion to Dismiss Toshiba and AuthenTec (the other remaining parties).  The Court issued an Order dismissing the case on October 3, 2011 with prejudice.  On October 7, 2011, AuthenTec and Toshiba filed a Motion to Vacate or Set Aside the Court’s Order of Dismissal asking the Court for permission to file a formal response to IBT’s motion and requesting that the Court impose conditions the Court deems just in exchange for the grant of dismissal.  In particular, we believe the covenant not to sue should be modified in order to better protect the Defendants.  In addition, we maintain that certain attorney’s fees and costs should be paid by IBT to AuthenTec and Toshiba as a condition of the dismissal with prejudice. 

We accrue litigation related legal expenses if these costs are reasonably estimable, regardless of whether a liability can be estimated for the loss contingency, itself. If actual and forecasted legal expenses differ from these estimates, adjustments to the accrual account may be required in future periods.  In fiscal year 2010 we accrued approximately $1.9 million in estimated future costs associated with defending the IBT litigation. We recorded the expense for the accrual of the legal fees during the quarter ended December 31, 2010 in the General and Administrative caption of our Statement of Operations.  During the three months ended September 30, 2011, we released $0.4 million of the remaining litigation fee accrual due to the fact that the merits of the IBT litigation are resolved. However, due to further actions initiated by AuthenTec, we believe that we will continue to incur some legal costs in the future until the case is fully closed and we estimated those costs to be approximately $0.2 million which remain accrued at September 30, 2011, along with $0.2 million in IBT legal costs incurred but not paid at the period end..

In addition to these legal actions, 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

There have been no material changes from the risk factors previously disclosed in our Annual Report on the Form 10-K for the fiscal year ended December 31, 2010.

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 Securities and Exchange Commission on June 26, 2007, at an offering price to the public of $11.00 per share. We registered 5,625,000 of these shares on our behalf and 1,875,000 of these shares on behalf of certain of our selling stockholders.

The offering of the common stock resulted in net proceeds of approximately $56 million to us after deducting underwriting discounts and commissions of approximately $5.8 million and offering costs of approximately $1.6 million. The net proceeds from our initial public offering will be used for working capital and general corporate purposes, including potential acquisitions such as the acquisition of SafeNet’s Embedded Security Solutions division. We currently have no agreements or commitments with respect to any material acquisitions.

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This expected use of the net proceeds represents our current intentions based upon our present plans and business condition. The amounts and timing of our actual expenditures will depend upon numerous factors, including cash flows from operations and the anticipated growth of our business. We will retain broad discretion in the allocation and use of our net proceeds.

Item 6. Exhibits

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 September 30, 2011, formatted in XBRL (Extensible Business Reporting Language) and furnished electronically herewith: (i) the Consolidated Balance Sheets at September 30, 2011 and December 31, 2010; (ii) the Consolidated Statements of Operations for the three and nine month periods ended September 30, 2011 and October 1, 2010; (iii) the Consolidated Statements of Cash Flows for the nine months ended September 30, 2011 and October 1, 2010; and (iv) the Notes to the Consolidated Financial Statements – submitted herewith pursuant to Rule 406T.

†	Filed herewith.
††	Furnished herewith.

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: November 9, 2011		(as the Registrant’s Principal Financial Officer)