Fingercard Cards AB (OTCPK:FGRRF) Q2 2022 Earnings Conference Call July 18, 2022 3:00 AM ET
Company Participants
Stefan Pettersson – Head of IR
Christian Fredrikson – CEO
Per Sundqvist – CFO
Conference Call Participants
Markus Almerud – Penser Bank
Stefan Pettersson
Thank you, and good morning, everyone, and welcome to Fingerprints Cards’ Earnings Call following the release of our Q2 Report this morning. We’ll start with a presentation of the report by our CEO, Christian Fredrikson; and thereafter by our CFO, Per Sundqvist, we’ll also have a Q&A session.
And if you’re following this conference call on the web, you can post questions throughout the call. And for those of you participating on 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 now hand over to our CEO, Christian Fredrikson.
Christian Fredrikson
Thank you, Stefan. Good morning, everyone, and welcome to this call, focusing on Fingerprints’ progress and performance in the second quarter of 2022, which was a quarter for us impacted clearly by the COVID-related lockdowns in China. I did mention that already in connection with our Q1 reports as it then had just started. Now these lockdowns continued mostly through second quarter and led to a sharp reduction in the sales of smartphones and PCs in the country. According to the China Academy of Information and Communications Technology, mobile phone shipments in China were down by about 27% in the first 5 months of this year, compared to the same period in 2021.
And as a result of this, the whole ecosystem has been impacted and mobile manufacturers have reduced their orders for all components, including — now obviously, for fingerprint sensors to a minimum, while at the same time focusing on drawing down their inventories. Obviously, this had a significant impact on our sales, given our exposure to the Chinese smartphone market. This is reflected in our revenue, which decreased by 21% and by 33% in constant currency terms. Although lockdown policies in China have eased, there is still some uncertainty for the country. And given this situation, we are withdrawing our revenue forecast for 2022 as well as our EBITDA margin forecast for Q4 2022.
In response to these market developments, we are taking swift action to lower our cost base to protect our financials and to keep ourself the freedom to invest in — according to our strategy. We are reducing our annual operating cost run rate by approximately 20% or SEK 80 million as a result of these measures with full effect from the fourth quarter.
We will hence also reduce our global workforce by around 10%, while we are also delaying some of our development projects. These cost reductions are necessary to safeguard our financials and to maintain our strategy doing this, which we believe temporary but still strong lockdowns that have happened in China.
At the same time, we also saw positively our gross margin improved to 31% as the PC and access areas continued the growth and diversification, which is expanding their share of our total revenue. Let me come back to this point as well.
Let’s turn to the next slide.
This data shows the fairly dramatic drop in mobile phone shipments in China with a 27% drop in the first 5 months of this year. Even though the numbers are now improving somewhat, we still expect and Gartner also expects an 18% decrease in 2022 versus 2021, which is, of course, fairly significant still. In response, mobile OEMs have slashed their orders for components all across the mobile phone industry and now focusing on decreasing their inventories.
We expect the situation to gradually improved as we can see now, the ecosystem inventories deplete and OEMs will need to start ordering components again. Nobody, of course, knows exactly when that normalization will happen and we hope now that the worst of the lockdowns are over, which were quite dramatic in the second quarter.
For us, there are many things we can do and we have done. We have accelerated our business development work. And as a result, Fingerprints has actually been gaining market share in capacitive sensors for mobile phones. At the same time, we are now entering a completely new product segment under display sensors, which means that our addressable market in the mobile segment is now considerably bigger.
Let’s look at this in more detail in a while, but let me first describe the cost measures we are implementing to mitigate the effects of the downturn in the mobile phone market in China. Let’s look at this on the next slide, please.
As I said, we are reducing our global workforce by approximately 10%, and we are also making other reduction, including postponing some of our projects. All in all, once again, these measures will reduce our annual operating cost run rate by around SEK 80 million or 20% with full effect from the fourth quarter.
As you know, our industry is fast moving and dynamic to say the least, and Fingerprints continuously, we need to review and adapt fast our cost structure to current conditions. Given the temporary market situation, these cost reductions are necessary. However, our strategy and long-term growth plans are unchanged. As we said in the report this morning, we assess and continue to believe that these challenges are of temporary nature and that the situation is gradually normalized.
Our strategy remains unchanged, and we focus on strengthening our position, both in the mobile market and then in the new fast-growing segment. That clearly helped lift our gross margin in the second quarter.
Our revenue streams will continue to diversify at a rapid pace for the remainder of this year and in 2023. While we are postponing some projects, all of our short-term growth-oriented projects will continue as planned. Let’s look at the different business areas and start with the mobile area first now.
Let’s turn to the next slide. Thank you.
So in June, we secured a design win for our optical under-display solution, the FPC 1632 product with a major Asian smartphone OEM, following successful qualification test earlier this year. We expect to commence shipments during the fourth quarter of 2022. This is significant for us as it marks our entry into a new market segment, which will open up attractive new growth opportunities going forward.
Our goal is to capture a significant share of this market and we will get back to more design win during this year still. So how big is this opportunity? From a volume perspective, the market for capacitive sensors is bigger, accounting for about two-thirds of the market, while under-display has about one-third.
Average selling prices are a bit higher for under-display sensors. So from a value perspective, the markets are more comparable in size. So clearly, our entry into this market segment is expanding our total addressable market in an extremely meaningful way. We expect further design wins already this year and anticipate that under-display sensors will make a sizable contribution to our revenue from next year and starting in Q4.
Next slide, please. If we consider the Android phones launched by the top 10 brands, which cover most of the market, around two-thirds had a capacitive fingerprint sensor, while the third had an under-display sensor. As you know, we are a leading player in the capacitive sensors while we have — not had any share of the market for under-display sensor. I’m very pleased to see this now changing.
Now OEMs phone inventories have been going down as they sell their stock to customers. So we expect purchase orders for components to start picking up and things normalizing. Our product and business development work continues during the downturn, and it means that we are in a favorable position once again when the mobile capacitive market normalizes.
Now next slide, please. We are also diversifying our revenue to new application areas outside of the mobile industry. As you know, the PC market has emerged as an important new area for us. In fact, four out of the world’s top six PC OEMs are already using our sensors in their products. And during the quarter, we announced another two models launched by a new customer, a top-tier Taiwan-based OEM.
We are also seeing solid growth in the access area where access cards and door locks account for a good part of our business.
Looking at our revenue mix, mobile has, as you know, accounted for around 90% of our sales in the past few years. During the first half of this how — of this year, however, we saw a significant increase in the proportion of our sales accounted by new areas with the growth, particularly now in PC and access. And we expect this share to continue to increase rapidly during this and next year. This is expected to drive growth and improve margins at the same time as our risk level decreases when we get more length to standard.
Our operations within payments made a positive contribution, and it is also clearly growing, but of course, from a smaller number. We expect still strong growth in access and PC areas during this and next year. This year, we expect not only strong growth in actual remedies from business outside of mobile capacitive but it will also account for about 25% of our revenues versus 10% of our revenues last year. This diversification and growth will continue strongly also next year.
Next slide, please. And finally, in payments, our business development efforts continue with high intensity. As you can see on this slide, we announced collaborations with a number of players in Asia during the quarter with the objective of introducing biometric cards without technology to all major markets in the world. These partners are based in markets such as Mainland China, Taiwan, India and Japan.
And as previously communicated, we are supporting additional commercial launches in Morocco, bringing our total to eight launches worldwide. We still expect several banks to launch this year still with our solution in the biometric card business.
Next slide, please. Looking ahead, despite the short-term pain in mobile capacitive business because of the lockdowns in China, our focus remains on profitable growth and cash flow generation. The slowdown in the mobile market that we saw in China during the second quarter was very strong and has, as we can all see now, negatively affected the whole ecosystem that is OEMs as well as all component suppliers to the mobile phone industry. And clearly, also, it impacted us. We believe that the effect is temporary and the situation will and is gradually normalizing as we can see the inventory levels being depleted in the mobile ecosystem.
Our strategy remains unchanged, and we focus on strengthening our position, and we have gained market share in mobile capacitive. We are getting into a totally new market for us in mobile under-display from the fourth quarter this year, which is a substantial win for us. We will continue to drive diversification and growth in the new fast-growing segments, PC, access and payments that helped lift our gross margin in the second quarter to 31% from 27% in the second quarter last year and from 20.4% in the last quarter.
Fingerprints revenue stream will continue to diversify at the rapid pace for the remainder of this year and in 2023. Our business model is highly scalable. And even if we cut some costs now, we will focus on cash flow generation while maintaining a high level of R&D activity to focus on the growing new segments for our biometric.
With all these actions, we also want to stay efficient in our operation and hence, we will drive cost reductions not only internally, but also in our products to keep us strong and have the freedom to invest and be ready for the rebound also as it is coming in mobile capacitive.
And with that, let me hand over to our CFO, Per Sundqvist. Go ahead, Per.
Per Sundqvist
Thank you, Christian, and good morning to everyone. So then let’s move to the first slide in the financial results section. As we have mentioned earlier, we saw a sharp and quick decrease in the quarter of our revenue, which corresponds to a drop by 21% in relation to Q2 last year. However, the drop is 33% in constant currency terms. And as Christian pointed out earlier, this decline is due to the lockdowns in China, which were in effect during most of the Q2 and this, in turn, have had a significant impact on the domestic consumer market for smartphones.
We view this situation as temporary but the near-term market outlook is still colored with quite a bit of uncertainty, which is the reason that we have withdrawn our previously communicated forecast for the year. Our gross margin developed favorably in Q2, increasing from 27.2% to 31.1%. The main explanation behind this improvement is, as has been mentioned before by Christian, the product mix effect as the PC and access areas share of our revenue are steadily increasing, both organically as well as part of our total revenue. And we also expect this trend to continue into next year.
Next slide, please. Looking at the development of the rolling 12 months trend this quarter, we see the impact of the Chinese lockdowns on our revenue. While the gross margin trend is going in the opposite direction as a result of the fact that higher-margin products now account for a growing share of our revenue streams. We expect that our revenue will continue to diversify and thereby lowering our risk level as well as driving our long-term growth.
Next slide, please. Operating expenses in Q3 were SEK 83 million versus SEK 104 million in Q2 last year and SEK 96 million last quarter. Other operating income expenses increased to a positive SEK 21.4 million versus the SEK 2.5 million level last year. However, SEK 16.7 million is attributable to positive operating exchange rate effects, mainly the U.S. dollar, which can be compared to SEK 3.4 million last period. It should also be mentioned that the significant movements in currency has had an impact also on the lines other comprehensive income and parent company shareholders. As to the recalculation effect on the U.S. dollar has affected those assets.
Development costs of SEK 23.4 million were capitalized during the quarter, which is to be compared with SEK 17.5 million in the same period last year. This corresponds to 41% of total development costs and to be compared to 32% in the same quarter of 2021. Even though we are making some quick necessary cost adaptations and reductions to mitigate for the short term, temporary demand in — drop in the market. We will continue to invest in growth both by driving product innovation and by broadening our supplier base. We will keep on and maintaining a strong focus on cash, cost and efficiency improvements as we move forward.
Next slide, please. Our core working capital, that is accounts receivables plus our inventory and less our accounts payable, was SEK 251 million at the end of the quarter, which is to be compared to SEK 91 million in the same quarter last year and SEK 279 million last quarter. If we look at the development of core working capital in relation to our rolling 12 months revenue, it increased to 20.2% from 7.1% in Q2 last year but decreased somewhat from 21% last quarter. The increasing trend in working capital that you see on this slide, although it reversed somewhat this quarter, has been the planned action and the result of weighing several factors necessary to support, secure and serve growth in today’s complex market environment.
With, for example, inventory buildup to meet the sales growth as well as to mitigate and minimize any potential supply chain disruptions. However, having said that, the sharp drop in demand has, of course, meant that we quickly have had to adjust our supply planning accordingly, but with some inertia in the process still lingering in the numbers this quarter due to the very short sales — sharp sales drop.
Next slide, please. Our cash flow from operating activities was a negative SEK 28 million in the quarter compared to a positive SEK 50 million in Q2 last year. At the end of the quarter, our cash position stood at SEK 213 million versus SEK 193 million last year and SEK 255 million at the end of Q1 2022. Cash flow from investing activities, that is capitalized development expenditure was negative SEK 20 million and to be compared to SEK 19 million last year.
Thank you, everyone, and we are now ready to take questions.
Question-and-Answer Session
Operator
[Operator Instructions] There are currently no phone questions. I will pass the call back to Stefan.
StefanPettersson
Okay. Let’s take questions from the web. First one is relating to payment cards in France. Do you have any news on the launches, the commercial launches in France?
ChristianFredrikson
Yes. Thank you. And there are launches in France are progressing. We haven’t really released a number. There is a growth every week. They are going to more — we have said that both Crédit Agricole and BNP Paribas are going nationwide. So that is going on for them. They have still been doing so that you have to go to the brands to enroll. And that obviously is not the way it should be going forward in terms of getting it to mass market. So going to the branch to enroll still keeps the growth numbers in terms of size, not at the level that it needs to be for mass market development.
So they are doing it. It continues is still more on the high end of the product. It is going well. There are no — there are — there is basically only positive feedback from the consumers who are using the cards. They have very good feedback in terms of the performance of the sensor of the payment.
So no rejections. There are — it is working well. There are no — there are not — no customers who had problems with the cards, either physical or others so that they would have returned the cards or wanted to jump off using the card.
And we will work on trying to get also some, of course, numbers to the market when we would be allowed to release what kind of user numbers are coming there. But there is growth every week in terms of the user numbers.
I think that’s what we have from France at the moment. So the expansion continues.
StefanPettersson
And one question on our bond. Do you need to refinance this bond this year?
ChristianFredrikson
No. I think that — yes, go ahead.
StefanPettersson
No, I was just saying that no, there’s no need for that this year.
Yes. And can you explain what’s behind the current receivables, current receivables number?
ChristianFredrikson
Current receivables?
StefanPettersson
Yes, there’s other current receivables
ChristianFredrikson
The number which number is that
StefanPettersson
There’s one 546.1?
ChristianFredrikson
I think — I believe that the — that’s the mother company internal balance that you’re looking at that. But group-wise, that’s been eliminated its internal loans. Other current liabilities in the group is only 8.9, and it’s mainly taxes and social fees.
StefanPettersson
And we have one question on UBS target. Is it still SEK 40? And UBS is no longer analyzing FPC. So they withdraw — they have withdrawn that forecast. And yes, I think that’s it for questions from the web as well. So I will…
Operator
Sorry, Stefan. We do have one phone question. Would you like to take it?
StefanPettersson
Yes. Go ahead.
Operator
We will now take our phone question. Please standby.
Markus Almerud
Yes. Can you hear me?
Operator
The first question comes from Markus Almerud from Penser Bank. Please go ahead. Your line is open.
ChristianFredrikson
Yes, we can hear you.
Markus Almerud
Yes. Markus Almerud here from Penser Bank. A couple of questions. If I can start with just China because I mean, you keep saying that China is temporary, and it should be because it’s due to lockdowns and lockdowns will open up at some point in time.
You showed the numbers going up until May in terms of mobile phone shipments. Can you give us a little bit color from the ground on what’s happened after that? And how the market has been affected by kind of the — I mean, China opening up? So in terms of — if consumers are actually coming back, if it’s very slow, just some more color.
ChristianFredrikson
And of course, we are following this daily and we clear and the whole ecosystem is. So, I mean, of course, with the dramatic closure, there was first a real heat in the war stop in the whole ecosystem in terms of new orders and everybody has been focusing on trying to clean inventories and understand when the lockdowns are over.
As we got into June and the lockdowns where the opening up happened, we could see that clearly that the inventories are being depleted across the whole chain — across the whole ecosystem. And the first 5 months, we said it was minus 27% down. And of course, when you do that kind of reduction suddenly and close down and the demand goes down so drastically. Then, of course, the inventories had been built for different volumes, right? So then it becomes an inventory depletion situation.
And we are probably — we are clearly one of the better off in terms of we haven’t built that on inventory. We never got to that so much, and we have been fairly cautious on inventory. But we can see that, obviously, June was much better than during the April, May, which were the worst months of the lockdown, right? And we can see that July so far is much better than June.
So we can see that the deflation is happening. And when we talk about temporary, we mean that we don’t say that the zero-COVID policy from China would disappear. We’re counting on it to continue, and there will be lockdowns happening in different parts of China, but it is not on the same level as it was in the second quarter where this was a total shutdown of extreme proportions, right?
So it’s not saying — because the whole year is still looking at minus 18% in terms of mobile phones, but it’s after the adoption and the inventory depletion to more normal levels, which we see happening, as long as the temporary move for us means that it’s not a full lockdown anymore, but it is more as it is going on right now. So there are still lockdowns in certain cities, in certain areas of certain cities, but they are shorter and it keeps moving around. It is still a zero-COVID policy that we’re counting on, and that will continue in the country for the foreseeable future at least.
Markus Almerud
And two follow-ups on that. Firstly, have you seen — now that we had the shutdowns — we’ve had closures before we had the first COVID closures we had massive develop money coming out for the government to try to stimulate — I mean, to stimulate consumers. Have you seen any of the likes or not yet? Or do you expect or what’s the talk, et cetera?
ChristianFredrikson
Yes. We have, of course, I’m sure we’ve all read about it. But we have seen, of course, big campaigns and discounts and tax benefits, rental, taking rentals down and a huge amount of money being put into building infrastructure and trying to help the economy to keep started again as they did in the last.
Now these shutdowns were, of course, much more longer and more severe than in that perspective and for the last time in 2020. But yes, we have seen those big campaigns and discounts and shopping centers doing many different things to get the economy going. And that activity has been quite strong, actually during — starting from June and going on in July.
Markus Almerud
And then on the inventories across the value chain, is it possible to know where you are in terms of level? So we finished sharp depletion of inventories. But how much further then to go? How much left is in the inventories? Are they quite empty now?
Is it possible to say?
ChristianFredrikson
I suppose it depends a bit on different players have had some of our competitors had, for example, if I look at our competitors, they have much more inventory than us, some of the OEMs are more than the others, depending on how aggressive they have been. I think the levels are getting more normal now. And then the question is, will they deplete them more, but you’re getting — so it’s more in the normal situation now in general, but you still have players who have excess inventory still if I look at it. But in general, it is getting more normal. And so you will have some point where, of course, where they need to start again.
Then it’s also a question of what product mix you have, right? So if you have more older products and inventory, you can push that down very low, right? And then in the new ones, you will have to move to start to fill in the channel we — be able to do campaigns and get the products out. So maybe that’s where we are right now, right?
Markus Almerud
And moving on to PC maybe. I mean, we read reports about the shipment of PCs being down quite dramatically. But then at the same time, you have the mix within the PC with normal inflation marks PCs and then you also have the Chrome books, et cetera?
And then from what I understand from how you’re right, I mean both access and PC are growing quite significantly. Can you talk a little bit about this to explain how this all hangs together, what you see going forward in terms of PC shipments. And if that really matters if the penetration rate will kind of outweigh that. So just to explain a little bit around that.
ChristianFredrikson
Yes. I think for this PC market, we see that this year is probably a 9% drop versus last year in the total global volumes. So there is a reduction in the overall PC shipments as a market also because I suppose what everything that is happening on in the world with the word inflation.
And of course, there was quite a lot of boost because of the COVID in terms of people getting more digital with PC by as well. So there is a drop of 9%, 10% in that range in the overall market. That has less impact on us because the penetration for fingerprint sensors is coming from such a low point, it’s below 20%, and it is now growing, right? So I think for us in terms of the PC growth, it continues and continues very well still as well as in access because they’re so much still in terms of the low penetration there, right? So that’s why we can see that our revenue mix is changing outside of mobile capacitive.
As I said, we will do at about 25% and above in terms of our revenues will be outside of mobile capacitive and that will be even more next year, clearly even more next year. So it will continue now in terms of diversification that is happening for us. And we see that happening, and we see that continuing to happen. And now, of course, it is more about having a bounce back and getting to a little bit and clearly better situation in mobile capacity business, which has been, of course, a dramatic for us in Q2.
Markus Almerud
And then I assume, I think you’re right also that you have match — you have one match on chip solution, which is being sold in, I guess, the enterprise computer market, which would be a first for you? And in terms of discussions, I mean do you see — do you have several discussions ongoing and I would like to hear more of this? I mean, if you measure kind of like the discussions that you have both on the enterprise and on the consumer market in terms of PC, are they kind of accelerating? Or are we keeping a fast, steady pace? Or how would you describe them in terms of direct
ChristianFredrikson
Yes, I think it’s — yes, I think I would say that it goes as planned and it is an accelerated pace of — we have gotten into the four out of the six largest OEMs in the market in the world. And now we are in an accelerating phase of working with match on host and match on shape in terms of doing new models and getting into the models and all that work is expanding into more models. That’s a fantastic phase to be expanding the business. We’re also looking at expanding our offering so that we can go and do more in terms of the full solution, in terms of the security and everything that comes with it. So that is, of course, when we look at next year, where we want to get because that would bring us more revenue when we take a bigger portion of the offering.
So that is also when we talk about that we need to do cuts here that there are areas where we will absolutely not cut because we can increase our — not only increase the penetration, not only increase the models that we get into, but actually also increase our offering even going up to maybe doubling our revenue in terms of just the offering capabilities. So there’s a lot that we can do in the PC because we’re only just kind of got it into it, right?
Markus Almerud
And then finally, just a couple of words about access because access is also contributing quite well and is going to continue. Can you talk a little bit about what is it that growth mostly there? What is the largest contribution is it the access cards? Because I would assume that the small blocks in China is also kind of suffering at the moment on the back of everything that’s going on there.
So a little bit more about that?
ChristianFredrikson
Yes, you’re right. That, of course, because of the lockdowns, the building projects have also stopped. So obviously, selling access and door locks into new buildings has been much slower, has been impacted. That has clearly had the same impact for us. But then we have other access business.
Access business is very scattered. So we don’t have one as huge market as the door lock market has been for us in — especially in China, but door lock market is now growing in other parts as well in some countries in Europe, in U.S., some in other Asian countries are also moving in door locks. But then you have a lot of these subsegments, if I may say, or different segments. You have electric scooters. You have the cards, access cards, you have all kind of devices, security keys, you have different dongles and so forth.
So there are many different places now where the access market is taking off, and those are proving, right? So you have different security solutions coming in as well, right? So I think those combined means that the access market is growing in different areas. And you just need to keep the inventory — or the R&D effort also that we do those a little bit different solutions into those and utilize the basic solution, but then maybe do a little bit more on the software side and so to get into different places. But they are all quite big volumes in itself, right?
Markus Almerud
That was all for me for now. So thank you very much.
Operator
There are currently no further phone questions. I will hand the call back to you.
Stefan Pettersson
Okay. Thank you. Let me hand back to Christian then for some final remarks before we close the call.
Christian Fredrikson
All right. Thank you very much. Thank you for joining. It has been quite a roller coaster again for us in terms of mobile capacity business with the lockdowns in China. I am positive about the new diversification and new products that are coming.
And we hope that the worst is over when it comes to the lockdowns in China, they not do a total shutdown as forceful as it was in the second quarter, but more of zero-COVID with less of a total shutdown that happens going forward for us. And then we see a rebound in the mobile capacity business when the inventories are depleted. We look forward to push forward in the new growth areas for us as well, which obviously is now extremely important for us and continues as planned.
I thank you very much for joining. We will speak soon again in this forum in the next quarter, and I wish you well. Take care of yourselves, and we will talk soon again. Thank you very much. Bye now.
Be the first to comment