The security issues, cost and inconvenience of passwords and traditional forms of strong authentication have contributed to the increased focus on biometrics in recent years. Biometric technologies use unique behavioral or physiological characteristics to determine or verify an individual’s identity. International Biometrics Group estimates that fingerprint-based biometrics represented 28 percent of overall biometrics market revenue in 2006 and that the overall biometrics market will grow from $2.2 billion in 2006 to $7.4 billion in 2012. Fingerprints have been and are expected to continue to be the most widely used biometric technology because of convenience and ease of use.

Until recently, adoption of biometrics has been driven primarily by homeland security and law enforcement, where biometrics have been used to determine or verify identities at border crossings or in police stations. Today, many of the leading manufacturers of notebook computers are shipping computers incorporating fingerprint biometrics. Of the 82.4 million notebook computers that International Data Corporation, or IDC, an independent research firm, estimates shipped during 2006, UPEK estimates that more than ten percent contained fingerprint biometrics.

In response to the limitations of optical sensor technology, the biometrics industry has embraced silicon sensor technology as the primary enabler for the commercial market, paving the way for an expected high growth commercial biometrics market. According to Frost and Sullivan, an independent research group, the embedded commercial biometrics market is projected to grow from $80 million in 2005 to $1.9 billion in 2011. Silicon sensors are more compact and power efficient than optical sensors, enabling them to be embedded into commercial applications such as notebook computers and other mobile devices. Over the last decade, the continued evolution of semiconductor performance per unit cost has reduced the cost of silicon technology to enable cost-effective deployment of fingerprint sensors to the mass market.

The Company also offers a selection of finished standalone USB peripheral fingerprint readers available with software for original equipments manufacturers, or OEMs, that wish to resell a UPEK branded product or to affix their logos and offer their own branded products to end users.

Protector Suite is a family of software applications that provides identity management and data security capabilities to enterprises and end users. Within the Protector Suite family, the Company offers software for servers, client computers and external USB peripherals, such as keyboards or standalone readers, and portable storage drives, such as USB flashdrives.

The Company is currently developing TrustedLink, its advanced authentication solution, to support the use of fingerprint authentication solutions for online or other remote user authentication services. This solution can be used to support both local user authentication, within client devices at the local host level, as well as centralized user authentication on the application server.

The Company provides software development kits for third-party developers and customers to enable easy integration with both the Company’s embedded and standalone hardware solutions. Developers using these kits include companies addressing the healthcare, financial services, government, enterprise and consumer markets.

Gross profit increased $6.0 million, or 57 percent, from $10.5 million in 2005 to $16.5 million in 2006.

Research and development expense increased in absolute dollars from $6.8 million in 2005 to $8.3 million in 2006.

Sales and marketing expense increased in absolute dollars from $6.5 million in 2005 to $8.9 million in 2006.

Interest income increased from $0.2 million in 2005 to $0.3 million in 2006.

Interest and other expense increased from $64,000 in 2005 to $0.4 million in 2006.