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

Good day, ladies and gentlemen, and welcome to the Q3 2022 Results Conference Call. [Operator Instructions] I would now like to hand the conference over to Stefan Pettersson. Please go ahead, sir.

Thank you, Roberto, and welcome to Fingerprint Cards' earnings call following the release of our Q3 report this morning. So we'll start with the presentation by our CEO, Christian Fredrikson; and thereafter by our CFO, Per Sundqvist. And as Roberto mentioned, we'll have a Q&A session as well. And if you're following the conference call on the web, you can post questions throughout the call. And with that, let me now hand over to our CEO, Christian Fredrikson.

Yes. Thank you, Stefan, and good morning, everyone, and welcome to the call. I will focus now on the third quarter of 2022. And let me start. As you can see from the key numbers on this slide, we went through a very tough quarter, marked by a significant drop in demand. The substantial drop in revenue is due to the destocking measures that are now being implemented along the entire supply chain. I will discuss the background to the situation on the next slide, but the short summary is that we have very quickly gone from a situation where earlier this year we were limited by insufficient access to production capacity due to the global component shortage, 2, a situation where we, our suppliers and all our customers instead have to deal with a very sharp reduction in demand. This demand drop is due to the extensive COVID-19-related restrictions introduced in China during this year, which have led to a significantly decreased demand for smartphones in China. As you know, China is our largest market by far, actually accounting for about 98% of our sales last year. The reduced sales volumes, coupled with increased price competition in mobile China have had a negative effect on our working capital position in 2022, as well as our margins in this quarter. Planned depreciation on customer project is included in our gross margin. And given the significant drop in sales, depreciation as a share of revenues rose to 15% of the third quarter from the normal levels of 6%. Our gross margin can also vary during quarters as we have seen based on our product mix. So with this in this quarter, the comparable gross margin, if we take the depreciation into account as normal levels would be about 10 percentage points better, that gives you a bigger swing actually. Let's turn to the next slide, please. Now in order to improve our working capital position and also to cure the forecasted bridge against the bond covenant, we have issued SEK 75 million in hybrid equity and will carry out a SEK 300 million rights issue, subject to approval at the AGM on November 2. We have already received subscription commitments and underwriting commitments covering this rights issue in full. Actually, the rights issue was oversubscribed by over 2.5x, which shows the trust from investors in our strategy and our opportunities ahead despite the current short-term challenges. The final terms will be determined by the Board of Directors no later than on October 31. The rights issue will allow us to get through these short-term challenges while we can also keep investing in key customer projects for growth and our diversification. We are seeing continued momentum and positive signs outside of our core mobile capacity business, which is in the capacity sensors for the mobile phones as biometrics is increasingly being adopted in new areas as well. Next slide, please. As the COVID-19 crisis hit in 2020 and 2021, we saw an accelerated digitization, which drove the demand for chips. This led to a global semiconductor shortage as we are all well aware of, which limited our growth at the time. In response to the situation, sensor suppliers, such as ourselves, but also other players along the supply chain, distributors, module houses and mobile phone OEMs had to purchase products many months in advance in order to make sure they could keep supplying their customers. This led to an increase in inventories throughout the supply chain. Then came the lockdowns in China, which began at the end of the first quarter and which had a significant negative impact on consumer demand for mobile phones. In response, producers started to scale back their orders for fingerprint sensors to a minimum while focusing on destocking. The same has happened with cameras, displays, memories, et cetera. The earlier components shortage we struggled with is clearly no longer a problem. And this change of scene happened more or less overnight and means, among other things, that we are now in a situation of excessive inventories throughout the whole supply chain, which ties up capital. In our industry, this chain consists of 4 different players and steps, and we are the furthest in this line, and we are the last to get to destocking of our inventory. Manufacturers of mobile phones are at the front of the supply chain, and they plan for significantly higher volumes in 2022. During Q2 and Q3, they have focused on reducing their stocks of phones, pulling back on purchases from module houses to supply OEMs with volumes for assembly into finished products. The OEMs are now at normal inventory levels or actually even lower than normal, as they are pushing their inventories clearly lower than a normal situation given the market uncertainty. This means that module houses and the distributors who supply them with components have started to reduce their inventories, which is happening in Q3 and Q4. And for Fingerprints as a supplier to the distributors and module houses, this means that we can only start reducing our inventory during Q4, which is now happening. Our peak in inventory happened in Q3, and we are now getting our inventory lower in Q4 and onwards. We have tied excess capital into inventory for close to SEK 200 million during Q2 and Q3, which of course is a substantial amount that we are now deploying. Of course, our competitors are in a similar or actually worse situation, which has led to an increased price competition as everybody is destocking. Many Chinese OEMs are facing strong headwinds as demand for phones in China has dropped much more than in the rest of the world. Given our currently high exposure to the Chinese mobile phone industry, the impact is significant, as you can see in the numbers of this quarter. At the same time, our revenue streams are continuing to diversify, and in order to be relevant playing in these segments driving the future growth there we are also building up some inventory there. This buildup and the increased price competition we have seen in capacity sensors have created a short-term strain on our cash flow. So let me just try to describe this and how we see it and the long-term development as well. If we first consider the near-term, this is the next 6 and 12 months, we expect to see the effects of the lockdown in China to start decreasing, including a gradual increase in demand. As I said, we are able to start reducing our inventory now in Q4, which has a positive cash flow effect for us. In addition, our previously announced cost reduction program will have full effect from Q4 with a 20% operating cost reduction. That being said, we do expect that the COVID-19 restrictions in China will continue to have a negative effect on sales and gross margins also for Q4 and Q1 2023. If we take a longer-term view, industry analysts expect the global smartphone shipments will rebound in 2023, even though the consensus is that it will not be until 2024 that we will surpass the levels that we saw in 2021. But certainly, we expect a return to the historical demand for smartphones. While we also see continued solid growth in the PC access and payment areas in terms of biometry. As these new segments continue to increase their weight in our revenue mix, we expect an improved visibility into the production cycle and more predictable cash flows and all cycles are generally longer than in the mobile segment. We will focus on executing on that strategy, and our long-term goals are unchanged. Next slide, please. We continue to introduce innovative new products in the mobile area, and we have increased our market share in capacitive fingerprint sensors during the year, which I find a great sign of strength in our customer channel. During Q3, we announced the first 3 models equipped with our new FPC1553 ultraslim sensors, and they have been launched. This sensor is the latest result of our continuous innovation in this new segment of capacitive fingerprint sensors for smartphones, which we have created a few years ago. It is even smaller than its predecessor, supporting easier integration. Just to give you an idea of how small the sensors is, we have on the right side of this slide illustrated the size of its relative to our FPC1020 sensor from 2014. The FPC1553 has 132x32 pixels, supporting an [ LGA ] size from 2.1 millimeters to 13.2 millimeters. We are using a new foundry production of these sensors with a second source supplier as well. Next slide, please. At the same time, we are now entering a completely new product segment in mobile, as we have said before, optical under-display sensor. As you may know, we secured a design win for our optical under-display solution this summer with a major Asian smartphone OEM following successful qualification test earlier this year. We expect to start shipments and volume shipments now in Q4. As you can see from the bar chart on the right, under-display sensors have around 1/3 of the market for fingerprint sensors for mobile phone. Average selling prices are a bit higher for under-display sensor. So from a values perspective, the markets are more comparable in size. Our entry into this segment is expanding our total addressable market in a strong and meaningful way. We expect that under-display sensors will make a sizable contribution to our revenue from next year. As can be seen in the bar chart on this slide, global shipments of mobile phone are expected to decrease this year, around 8% and some expect even a better decrease, around 10%. The Chinese OEMs are seeing a larger decline because the Chinese market is the one market that is taking by far the biggest hit. Overall, in the mobile market, we expect a slight rebound next year. Let's turn to the next slide, please. We are also expanding into other new areas outside of the mobile phone industry. In fact, the segments outside of capacitive sensors for mobile are expected to account for approximately 30% of Fingerprint revenues by the end of 2022 and 45% by the end of next year. Of course, part of this shift in our revenue mix is due to the fact that our sales in mobile capacitive have decreased, as we can see, so strongly due to all the factors that I just described. However, we are expecting meaningful growth in all of our new segment that is under-display sensor for mobile phone as well as in PC access and payment segments. Since our gross margins are higher in nonmobile segments than in the mobile segment, we expect that this shift in our revenue will continue to improve our gross margin overall. But I've said, there are a few hard quarters ahead because of the inventory depletion that affects the whole industry at the moment. Next slide, please. Going forward, the PC segment accounts for a significant part of this growth in the new areas for us. 4 out of the world top 6 PC OEMs are already using our sensors in their products. And during the quarter, we announced the first PC using our Match-on-Chip solution that has now been launched. The fact that we can now effectively address the whole enterprise segment with this solution is significant. Since Match-on-Chip solutions for business computers have a higher ASP and currently account for about half of our addressable market in the PC segment. On the global market, the global shipments of PCs are expected to decrease by between 10% to 15% this year, and external industry analysts expect slight growth again from next year. Next slide, please. We are also seeing now solid growth in the access area outside of China, where access cards and door locks account for a good part of our business. In China, it has been the same impact as we have had in the mobile phones because the construction business has been taken such a hit. But outside of China, Access business is showing, as I said, solid growth. This area is smaller than the others and quite fragmented, but ASPs are generally significantly higher than in the mobile area. We are seeing that biometrics is being adopted in a growing number of product segment. One example which we announced in Q3 is the logbook or personal notebook or diaries is secured by a touch fingerprint sensor from Fingerprint so that only you have access to its contents. There are many new segments coming up this end of this year and next year as well for us. Let's turn to the next slide. While it is still in the start in terms of volumes, biometric payment card is the largest long-term market opportunity for us. We continue our business development efforts with high intensity. And in the quarter, we announced the collaboration with Tesco with the objective of promoting and supporting the adoption of contactless biometric payment cards in the Middle East. As you know, Fingerprint is supporting 2 recently announced commercial launches in the area. This brings now a total number of commercial launches that we support worldwide so far to 10. Next slide, please. We expect to have 12 banks launched in Q4, altogether 12. Additional banks in Europe are preparing to launch with our technology as far as more banks also in the Middle East. The feedback from consumers who have used the biometric cards is very good. And the ecosystem is now focusing on a very important part of the rollout that is improving the enrollment process so that the consumers do not have to visit a bank branch in order to enroll with their fingerprint. Also, another thing that I believe will accelerate deployment is to start upgrading customer cards to biometric ones automatically. And this is indeed what the banks who have launched biometric cards to their customers in Morocco will start doing. They will start to issue biometric cards to their premium customers automatically at no extra cost. It is not an opt-in anymore. Previously, customers had to actively request a biometric card in order to receive one. Also interesting is to see that our POS bank customer is starting to offer biometric cards as part of their debit segment. This means to all their customer base as an option, so not only to premium customer segments. Overall, we see spreading rollouts in Middle East, in Africa and much more interest now in LatAm beyond Mexico as well. In Europe, also more banks in France will be launching. Next slide, please. Looking ahead, our focus remains on profitable growth and cash flow generation, which obviously has been strained in the last couple of quarters. As mentioned earlier, we have issued SEK 75 million in hybrid equity, and we carry out SEK 300 million rights issue, subject to approval at the AGM on November 2. We have already received subscription commitments and underwriting commitments covering this rights issue in full, and again, the final terms will be determined by the Board of Directors no later than October 31. Our overall strategy remains unchanged, and we focus on strengthening our position, our market position, both in the mobile market and in the new fast-growing segments despite all the short-term challenges. Fingerprint's revenue streams will continue to diversify at a rapid pace for the remainder of this year and going into 2023. Our business model is highly scalable. So when we get back to volumes, we will again focus on cash flow generation while maintaining a high level of R&D activity to capitalize on the growing market for biometric solutions and our strong customer channel in all our key markets that we have now built up. And with that, let me hand over to our CFO, Per Sundqvist, please.

Thank you, Christian, and good morning to you all. Let's now move to the first slide of the financial results section. So this slide clearly shows the effect of the very significant drop in demand that we experienced in the third quarter. Our revenue decreased by 60% in relation to Q3 last year and by 37% compared to last quarter. At the same time, the previous inventory buildup throughout the supply chain, combined with a sharp drop in sales of mobile phones in China have led to increased price competition, which you can clearly see the effects of in our gross margin, which decreased to 12% this quarter from 31% in Q2. The significant drop in revenue also means that the planned depreciation as a share of sales increased sharply in the quarter with significant relative impact on the gross margin, as Christian mentioned before. Next slide, please. The rolling 12-month trend this quarter tells the same story, showing the impact of the Chinese lockdowns on our revenue. We expect these effects to start decreasing with a gradual increase towards the historical demand for mobile phones, while we, at the same time, see continued growth in the PC, access and payment segments, albeit from a lower level in those cases. However, we also expect a lag effect for us due to the inventory cleaning by module houses and distributors that are further down the supply chain. We expect that our revenue will continue to diversify, thereby continuing to lower our risk level as well as driving our long-term growth and improve our margins. Next slide, please. Operating expenses in Q3 were SEK 77 million versus SEK 90 million in Q3 last year and SEK 83 million last quarter. Around SEK 3 million in restructuring costs in the quarter are included in OpEx this quarter due to the cost savings program currently running. Other operating income and expenses increased a positive SEK 15.8 million versus actually a negative SEK 1 million last year. Most of that attributable to positive operating exchange rate effects. It should also be mentioned that the significant movements in currency have had an impact also on the line's other comprehensive income and parent company shareholders at the recalculation effects on our USD-related assets takes its effect. Development costs of SEK 27.8 million were capitalized during the quarter, which is to be compared with SEK 25.7 million in the same period last year. This corresponds to 52% of total development costs, which is roughly the same level as in the same quarter of 2021. As we communicated in our Q2 report, we are making necessary cost adaptations and reductions to mitigate for the short temporary demand drop in the market. This cost reduction program will reduce our annual operating expense run rate by approximately SEK 80 million, with full effect from the fourth quarter of 2022. We will keep maintaining a strong focus on cash, cost and efficiency improvements going forward. Next slide, please. Our core working capital, that is accounts receivables plus inventory less our accounts payable, was SEK 355 million at the end of the quarter to be compared with SEK 170 million in the same quarter last year and SEK 251 million last quarter. If you look at the development of core working capital in relation to our rolling 12 months revenue, it increased to 34% from 13% in Q3 last year and from 20% last quarter. The increasing trend in working capital is due to several sales and operational factors earlier mentioned by Christian. First, earlier in the year, we built our inventory to meet expected sales growth and also to mitigate and minimize any potential supply chain disruptions. We have, of course, quickly changed our stance on this in response to the sharp drop in demand that we have seen. However, as Christian described earlier, there is a built-in lag effect in the whole supply chain structure. And due to the inventory cleaning further down in the supply chain currently running, this means that we see that mobile phone OEMs are now starting to approach more normal inventory levels, which in turn means that the module houses and the distributors who supply them with components are not only now starting to reduce their inventories, that is in Q3 and Q4. Meaning that we being at the end of the chain can only start reducing our inventory in a meaningful way during Q4. Next slide, please. Given the earlier-mentioned factors, this, of course, has meant that our cash flow from operating activities was a negative SEK 112 million compared to negative SEK 46 million in Q3 last year and a negative SEK 28 million last quarter. At the end of the quarter, our cash position stood at SEK 71 million versus SEK 121 million a year ago and SEK 213 million at the end of Q2 2022. The SEK 75 million in additional short-term financing from the issue of the hybrid equity is, however, not included in our cash balance at the end of Q3 as we only received those funds at the end -- sorry, at the beginning of October. Cash flow from investing activities, capitalized development expenditures, was negative SEK 28 million compared to SEK 26 million last year. Thank you, everyone, and we are now ready to take questions.

[Operator Instructions] And the first question from Markus Almerud from Penser.

Markus Almerud here from Penser Bank. So I'd like to dig in a little bit to the situation, demand situation that you're seeing. If I talk through the value chain and I start talking about the end-user demand, you can start there. So we know that the lockdowns are less -- we have less lockdowns now than we have in than we had in Q2. So Q2 was the worst and we've seen people started moving again. And the mobility numbers are up. But what are you seeing on the ground and how are consumers acting right now? That is what is the end-user purchases of mobile phones at the moment? Just to get an idea of where we are.

Yes. I think roughly, it is so that of course the total lockdown that happened in Q2, we have nothing of the kind now going on in Q3 or in the Q4. And even in China, they now call it instead of 0 COVID policy, they call it dynamic 0 COVID policy, which, in a way, as we understand it, that they are -- what they do is it goes up and down, the lockdown barriers are shorter. They test and trace and isolate in a very fast manner, but it goes on all the time. So that means that there are -- we have -- the best view that we can say is that there is probably between 100 million and 200 million people in some kind of lockdowns at least right now, roughly, right? But we don't know exact figures, I suppose nobody knows. But it is not of the same magnitude as Q2, but it still continues. So it has a dampening effect on demand and it continues to have it. But of course, nothing like in Q2. So overall, we see roughly -- and in global perspective, about 10% decline in mobile phone industry, mobile phones this year, roughly. That seems to be what the analysts says are as well. And then in China, about minus 20% decline. So what that means is that of course China is the biggest decliner and that's where, of course, our customers have a large share. So that's why I said that the Chinese OEMs are paying the biggest hit of course of all the other players namely at Apple and Samsung, right? So -- and we see that continuing, and that's the way we plan it from now onwards. We don't know when they're going to use it, but we don't see them making it harder anymore. I mean it seems to be that they are not going for a full lockdown, not even they can drive that anymore, it is so negative in terms of economy for people.

But in terms of, if I look at number of mobile phones sold and if you look at Q3 versus Q2, the Q3 was higher than Q2. The absolute bulk of the mobile phones sold was Q2.

Yes. Exactly. Absolutely. And Q3 was much better than Q2. And what we also see is that the OEMs -- we talked about this chain. So the OEMs are -- they have taken their inventories down. Actually they have gone below the normal levels that we have pre the -- prelockdown. So they are going in between 30% and 50% down on their inventory from what it was before in the Q1. So basically, they are taking safety measures, right, to -- for themselves. So in a way that we are now in Q4, we are going down on our inventory. And we built over SEK 200 million in our inventory, has been tied, additional and excess capacity which is now going down from Q4 for us.

Okay. So if we then move up and if we say that the destocking in the OEMs is kind of done and then the module house and distributors are starting to draw their inventory down now, meaning that you also don't have any sales to these guys because they will use their inventories. How long do you expect that to go on? So that starts now in Q3? Will it go on through Q4 and then they're done? Or how long does -- how long is such a process usually?

Yes. I mean I have to say that this is of course first time in, I suppose, at least in my life and even in the mobile phone industry, which has a lot of different swingers when it is so dramatic as it is now. So nobody knows 100%. But clearly OEMs are down below the levels they were even before. A module -- the rest of the chain above us is, in Q4 is going to be probably below the levels they were before. So it's getting kind of -- at some point, it will be very empty in the channel, actually, of course. So you will have -- there will be a kind of rebound at some point of time when you only have very, very little well below the normal levels. And we are then starting to destock now from Q4, we are going down, which, of course, helps us in the cash flow and then we start [Audio Gap] take this SEK 200 million that has been additionally tied in inventory for us is starting to go down.

But in terms of sales, I guess, what will decide sales when sales will trough for you is going to be when the distributors and module houses are done with their destocking, then they will start buying from you again, so to speak. So that would be the point when sales for you will kind of turn up again to kind of meet demand.

Exactly. And then it will step-by-step improve for us again as this whole pretty crazy break has been passed and has been taken down inventory across the chain. And we don't want to give forecast, but we can say that it's not going to get any -- on any numbers. It's not going to get worse any more than what we saw in Q3.

Okay. Okay. So sales-wise also you would say that we are at the top for you. It's not going to get worse than we are right now.

No, it's not going to get worse anymore. I think that we -- because we are now -- now we are -- I mean, Q2 and Q3, we have built inventory, as you can see, as I said, and that has been a huge break, and now we can -- we are kind of getting down on our inventory levels here. So we don't see it getting worsening.

And we should expect a couple of quarters something like that magnitude. It took a couple of quarters for the OEMs to destock. And that is kind of the normal change. A couple of quarters is also what should take for you to kind of destock the inventory that you've built.

Exactly. And so it will take us a couple of quarters to get our numbers down as well now.

Okay. And then on pricing, if I look at -- you're talking about price competition throughout the value chain. Can you talk a little bit to give us some more color on the ASPs of your products, not just across the value chain, but what are we talking about? And I guess prices are falling, but is it dramatic, et cetera? So just some more color.

Yes. I think in especially mobile capacity and also in mobile optical, so I think those 2 areas, mobile optical is still having a higher ASP. But of course in those when we are probably the one with least, the smallest amount of inventory, we broke -- we kind of stopped everything we could very fast and already in start of April actually. And then you have the 6 months of -- that we had bought beforehand because of the chip situation, right? So in a way that means that all across the chain, everybody is -- you have inventory, it is stuff that you want to get out. So then what happens is that people just want to get it out. It doesn't matter so much what ASP they have as long as they get it out right. So we have focused on maintaining and improving our market share. And then there will be a time when you destock when prices are lower. That's how it goes. It seems to go every time when you have even if it smaller, every case has been smaller before.