Fingerprint Cards AB (publ) (FINGB) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Fingerprint Cards Q3 2020 Results. [Operator Instructions] I must advise you the conference is being recorded. I would now like to hand to your first speaker today, Stefan Pettersson. Please go ahead.

Thank you, and good morning, everyone, and welcome to our earnings call following the release of our third quarter 2020 results this morning. We'll begin today's call with a presentation of the report by our CEO, Christian Fredrikson, and thereafter by our CFO, Per Sundqvist. And following this, we'll have a Q&A session. If you're following the call on the web, you can post questions throughout the call. And for those of you participating in the phone conference, instructions on how to ask questions will be given by the operator before we get into the session. And with that, I'll now hand over to our CEO, Christian Fredrikson.

Yes. Thank you, and good morning, everyone, and welcome to the call, which will focus on Fingerprints' progress and performance in the third quarter. Let me start by discussing the status when it comes to the supply chain constraints, and we can go to the first slide, which we also talked about in our previous report. Demand for our products remained strong in the third quarter, but our sales suffered due to the current production capacity deficit in our supply chain. The current high market demand for silicon wafer production capacity also resulted in further purchase price increases this quarter, which is basically the clear reason for our -- that our gross margin declined. We continue to focus on working capital and effective cost control as well, which contributed to strong cash flow for the quarter. I am pleased with that. We expect that the situation with insufficient capacity to production will persist in the short term. But at the same time, we anticipate that the changes in our product mix will, over time, contribute to improved profitability, which is clearly also a must for us and a target. As previously communicated, we plan for significant volume growth in the coming years. Broadening our supplier base is, therefore, very important priority for us and as it has been during this couple of quarters. And we have intensified our efforts to secure additional suppliers of important components both within and outside mainland China. While we expect that the coronavirus outbreak will dampen the demand for smartphones for the remainder of the year, we have seen a clear upswing in the market for capacitive sensors for smartphones. So far this year, about 60% of launched smartphones from the 10 largest OEMs have a capacitive fingerprint sensor, while about 35% have an under-display sensor. Both capacitive sensors and under-display sensors are increasing, while the proportion of phones without any biometric sensor continues to decrease. Thus far, biometrics for PCs has been quite a narrow market, but this is now changing rapidly. We have seen a clear increase in interest from PC makers, and we foresee good growth in this segment in the quarters and years ahead. As we have previously stated -- and let me come back to this discussing PC segment a bit more. Next slide, please. Approximately 460 smartphones have now launched with our sensors, including the new customers such as CAT Phones, Transsion and Vinsmart. Our side-mounted FPC1540 sensor is doing particularly well in the market, and we expect that its importance in our capacitive product portfolio will continue to grow. We also saw a lot of activity during the quarter in the payments area. It was announced that Visa has certified payment cards from Thales which includes fingerprint technology. This biometric card is the first in the world to be certified by both Visa and Mastercard, enabling card issuers to conduct major commercial launches. The lack of certification has been a major obstacle to commercial launches, and this has now been removed. Another important prerequisite for this new mass market for biometrics to gain momentum is a reasonable cost level. Also in this respect, we took a significant step forward during the quarter with the launch of the latest generation T-Shape sensor module for contactless biometric payment cards. The new T-Shape offers better performance than its predecessor while also being the world-leading in terms of cost effectiveness, with an indicated price below $3 at volume production. We will continue to lower the cost and improve the security in the years ahead, but it is already now an excellent product, and it will enable mass market rollouts. Next slide, please. As I said, another very interesting market and a growth market for us is the PC segment, which is why we launched a new solution specifically for this segment this August. This solution is tailored for use across a growing number of different form factors and use cases, including notebooks, 2-in-1 convertibles and PC accessories, such as keyboards, for example. As you may know, we recently announced a design win with a major PC maker with a planned product launch in Q1 next year, and we have received a number of wins with smaller makers as well, also with planned launches in Q1. This market is finally starting to move after having been quite a narrow market for biometrics so far. Around 260 million PCs are shipped every year, so we see great potential in the coming quarters and years. Our positioning is very strong in PCs. And so far, products from Acer, ASUS, Google, HP, Huawei, Microsoft and Samsung have launched with sensors from us. Other circumstances that I believe will benefit us include the fact that our smartphone customers are also gaining PC market share and the traditional smartphone module houses that we partner with are now significant players in PCs as well. Next slide, please. We continue to make good progress against our strategic priorities. In the mobile area, I would like to especially highlight the success we have garnered with our FPC1540 sensor, despite the short-term challenges in production capacity. This product has done extremely well in the market, and I would even say this is a key reason for the resurgence of the capacitive sensor in the mobile sector. This sensor is very thin, so it can be mounted on the side or the front, even doubling as the power button or volume control button. While we are continuing our work to enter the under-display market, we are also investing in continued innovation in capacitive sensors, and that road map also continues to evolve. We are, of course, very well positioned now in the strong trend towards side-mounted sensors. And we will be more -- launching more exciting news in this area, so please stay tuned. If we look at segments outside of mobile, I have already talked about the good progress made in the payment area in the quarter. Let me just reiterate the fact that we saw an important certification by Visa, which means that Fingerprints' technology is now the only contactless biometric payment card that has thus far been certified by both Mastercard and Visa. This finally makes it possible for card issuers to plan for larger-scale launches. As previously communicated by BNP Paribas, they are doing a commercial launch this fall in France. As far as we know, the first cards are being rolled out to customers. Obviously, the current situation with the COVID-19 outbreak makes it a bit more complicated, but this is moving ahead now. The launch of our latest T-Shape sensor module further strengthens Fingerprints' position in this emerging market, mass market for biometrics. Let me also mention our partnership with Sentry Enterprises to enable a first-of-its-kind converged biometric credential for physical and logical access. The Sentry card replaces stand-alone biometric solutions while leveraging the existing infrastructure for physical access control, supporting multiple industry standard protocols. More secure and seamless access and authentication methods are now in high demand and on the agendas of large multinational enterprises in order to keep the workplace safe, both for physical access and to log-in for corporate systems and applications. Partners like Sentry card and others that we are working in are well positioned now to meet these requirements. And the access industry is also showing good trend for us. Next slide, please. Let me quickly summarize before handing over to our CFO, Per Sundqvist. Market demand for our sensor was strong in the quarter, including in the PC segment, which is now finally moving. But also, clearly, we are not pleased with the results of the supply constraints that I discussed earlier. And we have not been able to satisfy clearly, at all, the demand in this area. We do expect these supply chain issues to persist in the short term. But at the same time, our product mix is shifting in a way which we will expect to contribute to improved profitability, and we are getting into new segments outside of mobile, which also improve the profitability. And we will obviously work very hard on extending our supply chain. The prerequisites for large-scale commercial launches of biometric payments cards are now coming into place and have made things happen. We passed recently the world's first contactless biometric cards certified by both Mastercard and Visa, so this means that an important obstacle to commercial launching has been finally removed. The cost level is, of course, also important, and I believe we took a huge step forward with the launch of our new chip T-Shape sensor module in Q3. Our recently announced partnership with semiconductor companies, Infineon and STMicroelectronics, are also important in strengthening our position in this market. We also have partnership with NXP. So we, at the moment, are working with all top 3 global secure element providers that have a combined 85% market share in the payment card industry. With that, let me hand over to Per Sundqvist.

Thank you, Christian, and good morning, everyone. Let's move to the first slide in the financial results section, please. Starting with our revenue, we reported a 17% drop in relation to the corresponding quarter last year. We experienced continued strong demand for our sensors, but our revenue as well as our margins was negatively impacted by the supply constraints like last quarter. In constant currency terms, revenue declined by 9%, currency having an 8% negative impact as the U.S. dollar has weakened against the SEK. If we then look further into our gross margin, it decreased by 5 percentage points compared to last year. This is due to the continued upward pressure on our purchase prices due to the tight supply situation. We have, of course, as Christian mentioned, intensified our efforts to secure more suppliers of key components within as well as outside of Mainland China. And as Christian also mentioned, we expect the shift in our product mix will contribute to improved margins over time. Our operating profit was negative SEK 5 million versus the negative SEK 3 million in the same quarter last year and a negative SEK 17 million in Q2 2020. Our net income was negative SEK 2 million, which could be compared to SEK 6 million in Q3 last year. Next slide, please. This slide shows the development of revenue and gross margin on a 12-month rolling basis. The decrease in revenue in this period is due to the factors discussed and mentioned earlier, that is the continued impact of our supply chain disruptions. The decrease in gross margin is also a consequence of these supply chain issues as our purchase prices have been pushed up as competition for production capacity further has intensified this quarter. We are, of course, not happy with this gross margin level and are continuing our efforts to improve profitability, both by continuously increasing our efficiency and by diversifying our business into new customer segments and application areas. And as mentioned earlier, we expect the shift in our product mix going forward will contribute to improved margins over time. Next slide, please. Excluding other operating income and expenses, our operating expenses for the first quarter were SEK 59 million versus SEK 78 million in Q3 last year and SEK 80 million last quarter. Development cost of SEK 32 million were capitalized during the second quarter, compared to SEK 24 million in Q3 last year and SEK 26 million last quarter. We will maintain a strong focus on cost and efficiency improvements going forward. Next slide, please. Our core working capital, that is accounts receivables plus the inventory less the accounts payable was SEK 161 million at the end of the quarter, which should be compared to SEK 257 million in the same quarter last year and SEK 208 million last quarter. We continue to work very actively and efficiently to manage our working capital. Next slide, please. As the conclusion, our cash flow from operating activities was a positive SEK 68 million, which is to be compared to SEK 60 million in Q3 last year. And our cash position stood at SEK 453 million versus SEK 537 million in the same quarter last year and SEK 429 million at the end of Q2 2020. And I must reiterate that we continue our focus on working capital and effective cost control during this quarter, which contributed to the strong cash flow. And cash flow from investing activities, less capitalized development expenditures, was SEK 33 million, compared to SEK 26 million last year. Thank you, everyone. And we are now ready to take questions.

[Operator Instructions] And your first question comes from Francois Bouvignies.

I have a couple of questions. The first one is on the current geopolitical situation. So when we look at Huawei that has been banned or restricted from September, I just wanted to have your view on how it impacts you, especially in Q4 and beyond given this restriction? Maybe it's a big customer of yours, I mean, based on your design wins with them. So I just wanted to have a view of if you are still shipping to them in Q4. Are we going to see an impact on that? And the other thing which is very active in the industry in terms of conversation is the fact that the other Chinese OEMs, so the competitors of Huawei, Xiaomi, Oppo, Vivo are quite aggressive at the moment to capture the potential of share gain of Huawei. I just wanted to have your view of what you think about this situation of aggressive non-Huawei Chinese local and Huawei that have -- that can fully produce at the moment? That's the first question. And I have a couple of others, if I may, after.

Yes, Francois. And yes, I think it's very clear that Huawei is being impacted, and we have -- Huawei is obviously a big customer of ours. And it has been impacted, obviously, by all the actions and the geopolitical situation when it comes to Huawei itself. Now I cannot comment anymore on the deliveries as such to Huawei. But obviously, there has been a large impact. And we are, of course, following all of the rules of the international sector, if you may. But I can say that when it comes to our capacity situation, that doesn't impact us. I mean, we have -- there is so much more demand that it just overshadows that the issue is really about supply. And so that doesn't -- and I don't see that impacting us either, actually. So it is clearly this one single issue that we need to fix. And even that customer is not impacting us in terms of the revenues. And then...

Just Christian, sorry, can I follow up first on that? I mean, many -- some of your peers, they assume 0 revenues from Huawei, for example, from Q4 onwards. Do you -- are you going to still have revenues from Huawei in Q4? Or we assume 0? And did you have any revenues from Huawei in Q3? Just to clarify.

No, I don't want to get into any customer revenues, right, but we're following the international rules. And when there is a blockage, we, of course, follow the blockages according to the rules, right? So -- and we will not go against any of that, right? So -- and as long as that is on, that is all right for us. So clearly, there is an impact, right? But not -- I don't want to talk anymore of our specific customers. Obviously, there is an impact, and we follow the rules and the restrictions that are there. And then on the Chinese OEMs, I think you're very right, Francois, and there is obviously, the dust will settle when we get into next year and go through this. I think there is a -- there are many big changes happening. Mobile industry always has many big changes in market shares and shifts. And obviously, the other Chinese OEMs have geared up to take that share in the market, right? So there is a big battle coming in that one as well. And that, obviously, we will see the impact when we go into the next year. I think that's a very correct analysis from you, Francois.

Okay. And the other question I had is on your gross margin. It seems in your wording that you say that the product mix will improve over time, and I think it was smartly used, this over time. So I just wanted to know if you're going to see it from Q4 or it's going to be beyond Q4, just in terms of improvement of product mix.

Yes. Thanks for asking, Francois. And I knew, of course, that you would notice the wording. Because we don't want to give a forecast in the short term, but we see, of course, over time, that both the new -- I think there is 3 elements, right? The new sectors, such as the PC, for example, also in access, there are -- there is growth for us. We're also growing actually back in mobile, but we cannot just deliver at the moment. So we will -- we are getting new products also into mobile, growing in other segments. And then, of course, we need to do all the actions when it comes to getting the supply situation improved for us. And there is a lot going on for us there. So we see that, clearly, these actions will improve the gross margin. So this is obviously not the gross margin level that we can -- we want to have and accept ourselves even to have as a company, right? So it will improve. And we took a knock now clearly from just the -- just an unbelievable, very high demand that is hitting the whole supply chain right now. So it has helped us, of course, on the other side, but not enough. I do realize that a good question is that why haven't we raised prices? Actually, the ASP declined for the first time in my time this company has started. So clearly, there is -- and in the new product areas, there is even increase in price levels, but they are coming out, of course, now as we go into the side-mount. So that is happening, but there is just so much demand, so overwhelming demand at the moment on the whole foundry industry, right? That -- and you can see it from their results as well. So there is almost an auction for product at the moment in the supply chain. That's maybe why I'd say that we will improve the gross margin, but we don't give any time schedule for it.

Okay. That's very clear, Christian. The other one is on smart cards. I mean, obviously, a lot of announcement in the last few months, especially with your long-term targets with SEK 3 billion by way of payments by 2026. What are the next milestone? What are you looking forward now? Just to get an idea of the shape of these strong markets. Obviously, payment is a very big market, but also slower than mobile, so to which SEK 3 billion in 2026, I guess, is not going to be in 1 or 2 years. So should we see a strong pickup from next year, basically? And what are you looking for if you don't want to give any volume indication about the milestone, like orders from customers that you expect soon or anything around that would be very helpful.

Yes, I think a very good point again, Francois. And as a basis, because we don't sell the products to the consumer, so that's why I have understood that and given up on trying to give an exact forecast in the short term. And the timing, we know that it takes longer. That's why we have posted a long-term view on this one because we also need to work -- already looking at the situation of today, we clearly need to work on production capacity over the years, right, to have that capacity when this happens. So in a way, this has triggered very important actions on our side, actually, which were must-do for us as a company. And I think that the trigger point that we are looking for now on is, of course, bank launches now. I think there is no need to do pilots anymore. We know this works. There is just -- there is -- we have the certification. We have the technology, it works. And now it is more about basically just getting the banks going out. It's starting now in France and have started, as I said, with BNP Paribas going out. Obviously, the pandemic with the lockdown happening right now in the very next few months, maybe -- it's not making it easier, of course, to do all this. But obviously, it's still moving ahead. So I expect the bank launches to continue, and that is kind of the trigger point where you get -- and it's a gradual growth, but it's obviously going to be good growth, very good growth for us over the years, right, in the payment industry now. And so more and more launches. And one thing, as I said earlier, obviously we see, from all our research and all the discussions with the banks, is that the consumers are valuing a lot because that's important at the end of it. At the end of it, this has to bring a lot of value to the consumers and the banks to go out there. And it does, and it seems to be from all the discussions, all the pilots, all the research, all the work being done with the consumers that there is a huge demand. And it's obviously been helped by this horrible pandemic when people do -- absolutely do not want to touch the device -- the terminal, the payment terminal. So clearly, the contactless and taking the capital, finally, so that you can pay without cash securely is very important. So I think that, that demand is only increasing right now. So banks, I would say, Francois, it's a summary, bank launches. That's what we expect.

Okay. That's very clear. And the last one for me is on your OpEx and D&A. The D&A decreased significantly this quarter, and I was wondering why it decreased so much, like 4% of your revenues when your CapEx -- total CapEx, including intangibles are increasing a lot as well. So I just wanted to understand what happened this quarter to have D&A so much down. And on your OpEx, obviously, you did a strong work on the cost control. So what should we think about your OpEx run rate at the moment? Because it's moving a lot. And I -- just to -- for model purposes to see how we should forecast in the future.

Yes. Francois, this is Per Sundqvist here. Well, the OpEx level that you see now is affected by the fact that we have higher activity actually in the portfolio right now, in the R&D portfolio. That's the reason why that part has increased. And going forward in time, when you look, we don't give any forecast on that one. But you have -- you know that we have worked hard and diligently with the OpEx in the past over this year, and we will continue to monitor this in relation to free cash flow and, of course, in relation to revenue as well.

Yes, Francois...

But your R&D decreased a lot this quarter in expenses, I mean, in Q3?

Yes. But they are lower -- the whole cost base is lower right now outside the capitalization, as well.

Okay. Okay. Just surprised by the magnitude. That's...

Yes, yes. I understand, Francois. And -- but yes, it's been -- I mean, we've been running this, I would say, I mean, the teams here have run this very well. And -- but obviously, we're not going to -- we can't cut ourselves into victory. So we are running this well. We're cash flow positive. I'm pleased with that. The teams are doing this very well. And then we're investing heavily still in terms of -- into the new segments and the new products that we are doing, right? So we continue doing that. And of course growth is what we will drive for now and when we have so strong demand for the products as well.

Okay. Makes sense. And the D&A?

Sorry. Come again?

The D&A, depreciation and amortization?

Yes. The D&A.

The depreciation and amortization came down from SEK 26 million to SEK 13 million.

Yes. And that's just because of the fact that we have had very significant depreciation lowering due to the fact that we've had large projects actually running out of that depreciation, old projects that have been activated and been running for several years now, they have come to an end.

Okay. But -- but your D&A is 4% of revenues and your CapEx is 11%?

Yes.

Should we expect the D&A to come back up?

Well, it's a forecast. And as we said earlier, I don't give that. It depends on what we see in terms of R&D projects going forward and what kind of business case we can create based on that. And then I just reiterate what Christian just said in regards to what we do on efforts there.

Okay. That's very clear.

And your next question comes from Viktor Westman.

I was wondering about the price of $3 for the new sensor in cards. Is that the total cost for the sensor, including your margin? And when can you reach the $3 cost? How many million sensors do you need to sell to reach this level?

Viktor, we don't give that -- any of those breakpoints. But of course, this is all built for volume rollouts and in volume when we are in volumes, right? And basically, this is the price -- this is the price that close to -- that we do it right in. And then, of course, you have in all the other costs, and that's why we said that the total cost will be below $10 per card.

Okay. And can you compare the total system cost to TrustedBio from IDEX now? You -- with your software, there is no need for an MCU anymore. So what's the total system cost?

Yes, I think the whole card cost is clearly below $10. And obviously, we are working -- and yes, the answer is there's no MCU needed in our system, and we will continue working on this one, right? I think we aim to be, of course, the security, the performance as well as the cost leader in this industry.

Okay. But you don't want to compare the total system cost, I guess?

No. I think we -- as I said, I -- there's no point for me to talk about what everybody else does. We want to be the leader. We've said that we want 50% in the long term of this market. So obviously, we need to be the leader in performance, in security and in cost. And that is on system level. We, of course, understand that we need to drive the system cost of the card together with our partners when it comes to the whole ecosystem, right? The SE suppliers. That's why we work with all the 3 big ones that have in the security element area, for example, that have 85% of the market. We work very closely with them and jointly with them the way we will develop this product going forward as well, so that the efficiency, the security and the cost and the volume production capability will be best in the world.

Yes. And one question on your -- on the targets that you announced earlier. You -- I think you mentioned 800 million capacitive units and 600 million for in-display. Can you discuss why you don't think that in-display will not outgrow capacitive?

Yes. I think we've seen a bounce back actually quite strongly now with -- that's why, right? So of course, this is a high-tech industry that moves fast. But clearly, we see that the performance is so good and the side button that we have and we're launching on is taking off very well. And of course, we're glad to see that even Apple launched that one on one of the iPads, right? So I think that the very nice sensor on the side, that's the reason why -- which actually has been our innovation that we've been driving for this industry. So it's shifting. And it is very comfortable. It's a very good position, right? So it's -- that's why. So we see that in the models coming out that is actually a bounce back in the capacity. And on the top of it, of course, this is going also low tier. So it goes actually lower and lower into phones that have the feature phones or have had no biometrics, so we see both that. So expansion also in the lower tier, right? That's what we think.

Yes. Last question on the capacity issues here. You mentioned in your last -- in the Q2 report that there is a lot of other products that want to have capacity in the fabs, you mentioned 5G, IoT, et cetera. Can you discuss this a little bit more this issue? Is this some -- is this domestic demand related to the trade war? Or how should we think about this?