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

Good day, and thank you for standing by. Welcome to the Fingerprint Cards AB, Q4 2022 Results Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. I will now like to hand the conference over to your speaker today, Stefan Pettersson. Please go ahead.

Thank you very much, and good morning, everyone. Welcome to Fingerprint Cards earnings call, following the release of our year-end report this morning. We'll start with the presentation by our CEO, Ted Hansson, and thereafter by our CFO, Per Sundqvist. We also have our Chairman on the call today, Christian Lagerling. He will say a few words before we move on to the Q&A session. So if you're following the call on the web, you can post questions throughout the call. And with that, let me now hand over to our CEO, Ted Hansson.

Good morning, everyone, and welcome. So I'm Ted Hansson, and as you may know, I took up the position as acting CEO at the beginning of November in 2022. I have been with Fingerprint Cards for 10 years. Until recently, I was working in China, which is where we generate most of our revenue. My previous role was President of business area Mobile, PC and Access China. And before that, I ran the company's business in the mobile area based in Shanghai, China. Let me first quickly summarize the key figures before moving on to discussing our performance and progress in each of our key product segments. As we expected and previously communicated, our revenue and gross margin in Q4 continue to be negatively affected by the sharp decline in demand for smartphones in China, this because of COVID-19 related restrictions in the country that were there during 2022. While we saw revenue decline by 57% in constant currency compared to Q4 last year, we saw an increase in relation to the preceding quarter by 42% in constant currency. The gross margin was impacted by SEK 22 million inventory write-down this quarter, which Per will give more details about later. Adjusted for this onetime effect, gross margin amounted to 20% in the quarter, which is an improvement compared to the previous quarter, about a 10 percentage point decrease compared to last year, reflecting the increased price competition and lower volumes, factors we expect will affect our sales and margins at least during the first half of this year 2023. We continue to implement cost-saving measures to streamline operations and ensure that we return to profitability. During the fourth quarter, we carried out a set-off issue and a rights issue amounting to SEK 341 million after transaction costs. This strengthened our liquidity and enables us to continue financing customer projects and several important product development initiatives, both within and outside the mobile segment. To consolidate our market-leading position, we continue to focus on developing innovative products, broadening our supplier base and ensuring a competitive cost structure. Our R&D portfolio is strictly focused on projects that are judged to be able to generate significant profitable business. As I mentioned, China accounts for the majority of Fingerprint's revenue, and most of this revenue is generated in the mobile area, more specifically in Fingerprint's sensors for smartphones. We are a market leader in this area, which is our legacy business. So let me first start by discussing the mobile area before we move on to the new areas PC, Access, and Payments, which are continuing to grow in importance in our revenue mix. So please, let's turn to the next slide. So what happened in 2022 was that the mobile phone demand in China fell sharply as lockdown measures were introduced. This happened at a point in time when inventory levels were very high throughout the whole supply chain. The supply chain is complex with many participants and long lead times. Everyone had planned for significantly higher volumes in 2022, and on top of this, additional inventory had been built up in response to the global component shortage that plagued the industry until the beginning of 2022. So sensor suppliers like Fingerprints, distributors, module houses and mobile phone OEMs had to purchase products many months in advance to ensure they had enough products to keep supplying to their customers. As demand fell sharply, everyone stepped on the brakes, focusing on trying to decrease their inventories. This process occurred stepwise for several quarters along the supply chain you can see on the slide. Starting with the mobile phone OEMs on the right-hand side, whose inventory levels are now even lower than usual. As the module houses and distributors have also now begun to place orders again, we could in turn start to bring down our inventory during Q4. You can see this reflected in the revenue increase compared to Q3. We decreased our inventory by over SEK 100 million since Q3, but it is still too high. Our competitors are in a similar situation. Our view is that some of them built even more inventory than what we did. This has led to increased price pressure, which we expect will affect revenue and margins negatively, at least during the first half of 2023. However, recent developments in China are encouraging. In December, authorities began to remove the zero-COVID restrictions that were in place during a significant part of the year. There are actually now signs that the recovery in consumer spending is progressing more quickly than initially expected. There is still, of course, a lot of uncertainty, but we expect a return to the historical demand for mobile phones, even if the recovery will be gradual. This trend will benefit Fingerprint as we generate a significant portion of our sales in China. Next slide, please. At the end of December, we announced Fingerprint's volume order for FPC1632, which is our optical under-display fingerprint recognition solution. As you know, we've been working on this for quite some time, and this order is a significant step for us. It means that we are now expanding our addressable market in mobile area in a very meaningful way. Most smartphones sold today have some form of biometric sensors used on devices, make payments and access applications. The bar chart on this slide shows the estimated market size for fingerprint sensors in volume terms. Phones with under-display sensors are shown in green and the red part is capacitive sensors, where Fingerprint is a well-established market leader. So capacitive accounts for about 2/3 of the market, the rest is under-display. Since average selling prices are higher for under-display, these 2 markets are more comparable in size from a value perspective. So our entry into the under-display means that we are now starting to generate revenue from an entirely new product segment. Our objective is to capture a significant part of the under-display market while remaining a world leader in capacitive sensors. Let's move to the next slide. The PC segment is another important growth area, and we are taking significant steps to strengthen our offerings in this area as well. We are developing a microcontroller unit known as MCU, which will enable Fingerprints to offer PC makers a complete biometric system consisting of a fingerprint sensor and an MCU. This is especially important for us given the changes we are seeing in terms of industry requirements. Today, we still have a situation where PCs intended for private use, the biometric authentication mostly occurs in the computer's CPU, so-called Match-on-Host. In enterprise computers, it's much more common to use Match-on-Chip, which is even more secure since the biometric data is stored on a separate chip. Match-on-Chip solutions for business computers have a higher average selling price and currently accounts for about half of our addressable market in the PC area. However, new requirements from Microsoft are expected to lead to a significant expansion of Match-on-Chip solutions at the expense of Match-on-Host. These new requirements mean that Match-on-Chip will become a prerequisite for suppliers of biometric solutions for Windows Hello Enhanced Sign-in Security. In this new situation, having our own MCU will be critical for our success in this market. Our PC customers support our MCU development project as it will allow for better overall system performance. Other benefits include cost optimization, reduced margin stacking and increased supply chain control. So adding our own MCU will further refine our Match-on-Chip PC solution, which was already added to Microsoft's Approved Vendor List, AVL for Windows Hello Enhanced Sign-in Security in 2022. We expect to start customer engagement with this new solution during the second half of 2023. 4 of the world's 6 largest PC OEMs are already using our technologies in their products, and I'm very confident we will continue to increase our market share in this growing area. Next slide, please. The Access IoT area is a fragmented market and includes such products as access cards, door locks, cars, remote and gaming console controls, smart household appliances and authentication keys. This is a very interesting growth area for us, not at least because of higher ASPs for many of these applications. Also, there are significant synergies with other product segments in terms of product development, one example being the MCU project I just discussed. The primary market for this project is the PC area, but there are other interesting applications in access control and IoT systems. Another example is our biometric software platform for payments, which can be used in a variety of access applications. And of course, our T-Shape sensor module developer payment area can also be used for different types of access cards. During the fourth quarter, we launched FPC1523, which is our latest addition to Fingerprint's access control portfolio. It features an integrated security block, enabling integrity and ciphering functionality, which are important features to meet the increasing demand in the security devices. Door locks is currently the most common application in access control, particularly in Asia, where biometric door locks are more common than in Europe and the U.S. But we're seeing that biometrics is a growing -- it's growing in smart locks outside Asia as well. An example announced in Q4 is the Nuki Keypad 2.0, which is a -- which can open a Nuki Smart Lock with a 6-digit entry code or now as a new feature you can use fingerprint as recognition. The Nuki Keypad is equipped with Fingerprints' sensor FPC1025 and can store up to 20 fingerprints. We are also seeing increased use of biometric access cards and security keys. In many cases, the same key can be used to facilitate uniform secure access to IT system as well as to physical spaces. During the quarter, the ProFICO Bio access card was launched by Valmido. It is equipped with a biometric fingerprint sensor with a typical use case, including password-free Windows log-in and website authentication. Next slide, please. So let me finish by discussing the payment area, which for us constitutes a very large potential market. This market is still in its infancy, but it's clearly the largest long-term market opportunity for us. Our technology is so far being used in 10 commercial launches of biometric payment cards. This number includes 2 additional launches in the Middle East, North Africa region that were announced in Q4. We continuously conduct development work aimed at further sharpening our offering in the payment area, and often this is done in close partnership with key players in payment card manufacturing. The world's 3 largest suppliers of Secure Elements for payments cards, Infineon, NXP and STMicroelectronics have all used some Fingerprints' technology for their reference designs. Already in 2021, we announced that we, together with Infineon have taken a very significant step forward by enabling execution of full biometric authentication in the Secure Element on a payment card with the retained performance in high security. This removed the need for separate [indiscernible] and in November last year, we announced the next step in this cooperation, a joint development and commercialization agreement of a plug-and-play turnkey solution for biometric payment card. The goal of the cooperation is to make a biometric smart card production as simple and easy as producing a standard dual interface payment part. The solution named SECORA Pay Bio will make the overall biometric smart card manufacturing process significantly simpler. It will also reduce the bill of material considerably. This will allow card manufacturers to use already existing card manufacturing equipment for the production of biometric payment cards, enable scalable and efficient volume production. This is a very important prerequisite for this mass market to materialize. In parallel with this, we are seeing that important initiatives by card issuers aiming to drive the adoption of biometric cards. Some banks have begun to simplify the process for enrollment so that you now can do it at home without having to visit a bank branch. This will make the rollout phase much more efficient and cost-effective, which is the key as volumes start to increase beyond the relatively low numbers we have seen so far. Another interesting development is that some banks have now started issuing biometric cards automatically to certain customer segments and not just to those customers who actively order a biometric card. So with that, let me hand over to our CFO, Per Sundqvist.

Okay. Thank you, Ted, and good morning, everyone. So let us now swiftly move over to the first slide of the financial results section. First of all, let me discuss the background and the reason for the quite substantial noncash flow affecting write-downs that we have done this quarter. So then firstly, we have revaluated parts of our wafer inventory. This concerns products that we have purchased at a much higher price at the time when there was a global component shortage, which was not so far long ago. The situation is now very different. And the replacement value of these products are much lower, hence the write-down. Secondly, we have written down the value of a number of our capitalized R&D projects. The main reason here being that the WAC discount rate that we apply in our IP valuation models has increased significantly due to the higher general global market interest rates that we all currently are living through. At the same time, we have also discounted projects, which are no longer deemed financially viable due to the same WAC effect. And we have also assessed that some cash flows may be delayed, primarily due to other macroeconomic factors as well. Thirdly, and the final factor and in this case, a goodwill related impairment is related to our Delta ID acquisition and is twofold. Firstly, also here, the discount rates that we apply has increased due to higher global market interest rates. And secondly, we have also assessed that cash flows may be delayed also here, primarily also in this case due to the macroeconomic factors we mentioned earlier under the IP section. We still, and I have to emphasize, still see a very positive view on the long-term prospect of the iris recognition. If anything, I would say that the long-term prospects in this area actually have improved, not the least in the automotive industry and in the motor sectors. Next slide, please. The impact of the noncash write-downs I just discussed is clearly visible on the operating results on this slide. But the silver lining is that after a few challenging quarters with declining sales, we did see our revenues go up by 42% in constant currencies compared to Q3, a quarter when our sales were very, very low due to the fact that our customers further down the supply chain were focusing on bringing down their inventory levels. Now let us turn to the next slide, and we will have a more closely detailed look at the gross margin. As you can see, the gross margin has been quite volatile in the last year, mostly due to product mix changes from quarter-to-quarter. In the last couple of quarters, gross margins has also been -- have also impacted by the increased customer price pressure we have experienced since our competitors are focusing on lowering their inventories and freeing up cash, much the same manner as we are doing. Note that on this slide, we are showing the gross margin this quarter, excluding the SEK 22 million inventory write-down, which represents an increase on the previous quarter by about 8 percentage points. However, having said that, ours as well as our competitors' inventory levels are still too high, and we thereby expect the continued price pressure, which is likely to put continued pressure on primarily mobile margins, at least for the next couple of quarters in 2023. Next slide, please. This rolling 12 months trend clearly shows the impact on our revenue and margins of the demand drop due to the Chinese lockdowns. The restrictions have now been removed, and we do expect gradual increase towards the historical demand for mobile phones as well as a gradual continued growth in the PC, Access, and Payment segments. However, as mentioned earlier, we do expect continued price pressure in the short term as sensor supplies inventories are still too high in the whole ecosystem. Now then looking ahead, we do expect that our revenue will continue to diversify, thereby lowering our risk level as well as driving our long-term growth in the new segments. Revenues outside of our legacy mobile capacitive business amounted to a bit more than 30% in Q4 and we expect this share to increase to around 45% already by the end of 2023. Next slide please. Operating expenses in Q3 were SEK 111 million versus SEK 108 million in Q4 last year and SEK 77 million last quarter. Development costs of SEK 27.4 million were capitalized during the quarter, which is to be compared with SEK 19.9 million in the same period last year. This corresponds to 46% of the total development costs compared to 34% in the same quarter 2021. We are now, of course, continuously making necessary cost adaptations and reductions to mitigate for a temporary demand drop in the market. We have implemented a number of measures to reduce our costs, mainly staff reductions. Since Q2, we have reduced employees and consultants by roughly 40 people or about 70%. During the quarter, we had some extra onetime costs mainly related to redundancies, and we also see a certain delay in terms of some of the cost reductions. For example, is to be mentioned that we have reduced our office space, which will benefit us fully first from this quarter in 2023. And on an annual basis in 2023, our OpEx will have decreased according to our plan. And we are continuously working to further streamline the operations and OpEx to ensure that we return to profitability as soon as the market so deems. As usual, we will keep maintaining a very strong focus on cash, optimize our costs and make sure that our efficiency improvements are moving us forward and preparing us for the future. Next slide, please. Our core working capital, that is accounts receivables plus our inventory, less our accounts payables was SEK 358 million at the end of the quarter, to be compared to SEK 217 million in the same quarter last year and SEK 355 million last quarter. If you look at the development of core working capital in relation to our rolling 12 months revenue, it increased to 42% from 16% in Q4 last year and from 34% last quarter. However, while we de facto have decreased our inventory by over SEK 100 million since last quarter, this was counterbalanced by a decrease in accounts payable of SEK 116 million. Since we judge our inventory to be still too high, we are still focusing very hard on making further reductions in the quarters to come to further improve and free up more of our cash. Next slide, please. During the fourth quarter, we also carried out a set-off issue and the rights issue amounting to SEK 341 million after transactional costs. And as Ted mentioned earlier, this has strengthened our solvency and our liquidity and, of course, enables us to continue to finance the important customer projects and product development initiatives currently running. Our cash flow from operating activities in the quarter was a negative SEK 104 million compared to negative SEK 17 million in Q4 last year and a negative SEK 112 million last quarter. At the end of the quarter, our cash position stood at SEK 274 million versus SEK 374 million a year ago and SEK 71 million at the end of Q3 2022. Cash flow from investing activities, that is capitalized development expenditures, was in this quarter negative SEK 28 million compared to SEK 24 million last year. And by that, thank you everyone from me. And now let me hand over to our Chairman, Christian Lagerling.

Thank you, Per, and thank you, Ted, and good morning, everyone. Christian Lagerling here, I'm the Chairman of the Board. I wanted to join this call this morning to take the opportunity to give you a brief overview of the Board's proposal for a long-term incentive plan. This was published this morning, and there would be an extra shareholder meeting on February 24 and all the details will be published on the company's website. This is an important proposal for Fingerprint to establish a new strong long-term incentive program to be able to retain and to continue to attract the very best talents in our industry. And at the same time, very importantly, aligning some very clearly defined long-term financial goals that are in the strong mutual interest of investors, employees as well as all stakeholders. The proposed program has been very carefully structured to provide a deeper buy-in in to our corporate performance, encouraging Fingerprint colleagues to invest in Fingerprint and to commit to this long-term ownership, and importantly, profitable growth and performance of the company. As mentioned, details of the program would be outlined and shared near term. But in brief, the proposal is to offer colleagues to make investments in the Fingerprint stock at the launch of the program planned for this spring with the potential of share and option grants that can be awarded after a period of 3 years, subject to the company meeting certain profit and financial performance goals, including strong share price performance. This incentive program represents up to circa 4.3% of our total shares outstanding and subject to the goals as mentioned. And my final comment, I'm very pleased that this program is now put in place, which is very important for us, and it's designed to support company's long-term competitiveness and performance, benefiting all investors and stakeholders. Thank you very much from me, and I believe after this we're now ready to answer some questions.

[Operator Instructions] There are no questions on the phones at this time. Please continue.

Okay. Then I think we will take some questions from the web. So the first one being on the Infineon collaboration. When do you see rollout of pilot or launches from this SECORA Pay Bio that was launched just recently.

Yes. So we have, of course, been working with Infineon now for a while, and we expect to start customer engagement relatively soon. And our target is to have pilots in the second half of this year.

All right. Sounds good. And on the FPC1632, there's a question on this one. Is this a good enough solution to be used for payment and other high security features on Android?

Absolutely. I mean, we are at core a biometric company, and we know biometry, we have been in this for 20 years. And the products that we put on the market, they are good from biometric security point of view. And it's also one of the reasons that we were entering this optical a bit later than some of our competitors, because we wanted to get the security on the right level. So the FPC1632 has passed our internal benchmark testing. It has passed several OEM benchmark testing. It has also passed the Android certification as well as payment schemes like Alipay in China where it has also passed liveness test and so on. So we are very confident about the performance of our 1632 also when it comes to security.

All right. Thank you very much. Also a question on the incentive program proposal. Will there be a lockup period of the shares?

Yes, I can address that. It's a 3-year plan to achieve certain financial goals. And for beneficiaries of the incentive program, you need to stay with the company. There is also a vesting schedule, which will be part of the details that we will share here near term.

All righty. Thank you. And on cash, how confident are you that your cash position is sufficient?

Maybe I should…

Yes, so -- Per, please go ahead.

No, no, I was just saying that at this stage, we feel confident that this will be enough given our current situation.

Okay. All righty. And there is another question for our Chairman, concerning your long-term view or plan for the company, if you can comment anything on long-term plans and what you would like to achieve with the company.