Next Biometrics Group ASA

OSE:NEXT

Earnings Call Transcript 2022-Q2

[Peter Heuman, executive]

So welcome, everyone. So -- and I think we are up and running live. So welcome, everyone, to this webcast. We're going to go through the quarter 2 2022 results for NEXT Biometrics. I'm Peter Heuman. And with me here today, I have also our CFO, Eirik Underthun.

The material we are going to introduce to you is now available on nextbiometrics.com under Investors. And we will end the session, as we normally do, with a Q&A session [Operator Instructions]

But with no further ado, I think we should go straight into the agenda probably. We are not going to provide you that many slides. Some of you might have felt, just like me, that it feels like it's been a little bit of a quiet quarter from NEXT Biometrics. However, I don't think you should be worried. There's a lot of activity going on even though we haven't seen that many press releases and such. But we will come to that when we also get to the outlook.

So today, we're going to just go through shortly the quarter 2 report and the summary. We're going to spend a little bit more time on the outlook. There's a lot of stuff happening. We want to shed some light over that, and then we end with a Q&A session.

So with that, Andrea, I think we just get going with quarter 2. I will start off. I think here are some of the main messages that we brought today in the report. What we do believe is very important for the company, I think you heard me talk about this for quite some time now. I know that it's maybe frustrating, but it takes time. I still believe it's the right thing to do. You are now shareholders. If you're listening to this in a company, which actually have 30 customers who have decided to integrate NEXT Biometrics sensors into their products, I do at least believe that, that's going to be a much better holding rather than sitting on a company which when we started the transformation of this company basically had one company who had integrated NEXT Biometrics sensors. So today, we are up to 30.

During quarter 2, and also reflecting a little bit what we talked about during the outlook in quarter 1 where I made -- gave you some insight into 2 design wins that we were already having and had gained into quarter 2, we have added 3 more. So with the one larger one that we got in quarter 1 and with the 5 new design wins that we acquired here in -- during quarter 2, we have provided 6 design wins right on target for the first half year.

Many of these design wins during quarter 2 you haven't seen announcements around. We try not to send out announcements even if we are getting new design wins if we don't have a very good committed volume from the customer initially. There might still be potential in these design wins, but we don't want to provide any false or wrong messages out to you guys when we have the design wins.

So some of these customers are -- have just placed smaller initial orders with us. We know what products they are, et cetera. But we need to get more material and larger orders and then we're, of course, going to inform you. I have 1 or 2 of these customers want to be very confidential. Would there have been substantial numbers behind them, we would still have sent out a press release about it. But this is why you haven't seen anything about these customers.

But the good thing is there's now 30 customers that have decided to implement NEXT Biometrics sensors into their product. And we are following our pace and the target that we have on number of design wins for the company. So that's tracking fairly well, I think.

On the revenue side, it's on the low side. We are -- we can all agree on that. We are impacted by the delays of the authorities in India, where we do believe at least that that's going to have a material impact on our business. I'm going to talk a little bit more about that on the outlook. But it's also the lack of the MCUs and the current backlog of NOK 8 million. So we're going to come back to that in the outlook section, but we ended just below NOK 12 million in the quarter.

Gross margin, 36% in the report. It's in the earlier communicated target range between 35% to 40%. We do have plans, and I have found further things in our continuous improvements of this company that there -- I do believe there's potential that we can do even more here, and I will talk a little bit more about that later as well.

OpEx remains even under below NOK 15 million.

So I think the design win pace, the gross margin and the low operational costs are the highlights of the report. And for sure, revenue is the fourth or the missing piece of the puzzle that we are working very hard to get to a higher level.

And with that, I think I will leave to our CFO, Eirik, so he can go through a little bit more details related to the numbers of the quarter 2 report. So over to you, Eirik.

[Eirik Underthun, executive]

Thank you, Peter. So during this quarter, the revenues were NOK 11.7 million compared to NOK 10.5 million in quarter 2 2021. We continued to be impacted by the semiconductor shortage, and the revenues would have been NOK 19.7 million if we had components available and we could clear the backlog that we have had also in previous quarters.

The gross margin was 36% versus 21% in quarter 2 2021. What we saw in this quarter was an improved product mix with higher margin products, and we also saw this improvement relative to quarter 1 2022.

The OpEx excluding options and COVID loan relief of -- the OpEx was NOK 14.2 million versus NOK 13.6 million based on the adjusted -- adjustments in the OpEx. So we're at a similar OpEx level even though we've seen a high U.S. dollar currency during this quarter.

The adjusted EBITDA was lower than quarter 2 2021, but improved by NOK 1.5 million when we adjust for the COVID-19 loan relief that we booked in quarter 2 2021, which amounted to NOK 7.8 million.

The cash position was NOK 82.5 million at the end of the quarter versus NOK 94.7 million at the end of quarter 1 2022. During this quarter, we continued to work to improve our available stock of components and various microchips so that we could prepare for the increased volume that we're planning to ship in the future quarters, although we're still missing some of these components as of 30 June. But as Peter mentioned, we're seeing some improvements on this metric.

So to summarize, the gross margin is trending higher. We're continuing the long-term positive trend. We're also continuing with our quarterly low OpEx levels.

With this, I turn to Peter. Thank you.

[Peter Heuman, executive]

All right. Thank you, Eirik. So just to finish off the numbers and the summary of the quarter 2, the takeaways, I think what you can bring with you is, and maybe I'm repeating ourselves, but you don't need to worry. The operating costs are below target even.

From a cash flow perspective, I think you heard a nuance from Eirik here that we have actually started to bring some more inventory in and that, of course, speaks for that you should be able to expect an improvement in revenue and deliveries and shipments from NEXT Biometrics in the coming quarters. I will come back to that.

The design win, yes, you are now shareholders and investors in the company with 30 customers instead of 1 just 2 years back and I think that's heading and growing constantly quarter-to-quarter.

Gross margin in this quarter, with some higher shipments of the FAP20 is on 36% level, and I do believe we can do even more here. And if we start to increase the level of FAP20 deliveries, I feel comfortable that we should be able to trend in this region or maybe even higher.

So operating costs, operational cash flow, design wins and gross margin continued to trend in the right direction. The missing piece of the puzzle, where I'm at least hopeful that we, during the last 2 quarters, are going to start to see a bit of growth is the missing piece of the puzzle of this report. Otherwise, these are the positive outcomes.

So with that, I think that's what we wanted to bring you in summary for quarter 2. And I think with no further ado, we can go straight to the outlook. And here, I think we have 3, 4 slides. And I wanted to talk to you about the press release that you saw just a couple of days back. And if you remember, we sent a press release where we announced what we believe a very important partner to us for the biometric updated program that will be launched and should already have been launched in India.

We did that, I think, in February, but we only had 10% of that initial order in this long-term contract from the customer and the partner committed. 90% of that initial order had a milestone in it, and it became optional for the customer. But we have succeeded in passing that milestone and that's why we sent out the press release. So now this $2.2 million order is irrevocable from the customer. So we have, together with the customer, passed a very important tollgate in the certification of our partner's product in the local India market.

I do believe this is a very important slide if you also reflect to the missing piece of the puzzle of NEXT Biometrics because with this local partner, but also with the tech giant who have also passed, we didn't have any milestones or so there on a specific order with them, but both those companies have passed a very important test criteria to get their local products certified in this new program in India recently. And we have actually succeeded with our sensor on -- with a very good outcome of the test criteria.

Now the India-based OEM has a few more steps to complete before they can get their certificate of their products and we are all hoping now, we, our partners, that the India authorities will start to launch this upgraded program in India. Our local partners believe that it's now going to happen around the end of the year, late quarter 4. You should be aware that I think the original plan was that this updated India program should have been launched already during 2021. So it's more than 1 year delayed. Of course, part of that is due to COVID, et cetera.

For us at NEXT Biometrics, it's crucial that this will be launched. And why do I think that's so important? Because if you look at the current certification program in India, historically, there are 3 million to 6 million -- I have told this during an investor call before, but I think it's bear repeating just so you understand the volume potential and how important this customer and potentially the tech giant will be for us when this market launch.

Historically, under the old or current, you can say, certification program in India, there are 3 million to 6 million units being sold per year and that has been going on for a couple of years here. When the new certification program will be launched, these volumes are going to be picked up by the ones who are certified, and we are with 2 of those partners then as long as they pass the full certification. And normally, in an 80-20 rule, there are 5 to 6 suppliers who pick probably 80% of this volume.

So you can understand both of these partners, this India OEM and the tech giant, have picked our FAP20 sensor. If we can just have them gain at least 5%, 10% of these volumes for NEXT Biometrics, that's going to be the difference between a loss-making company and a profitable company. So we are very keen, and for us, it's a very important partner.

In addition to the annual volumes that you have seen historically in this biometric market, there will be a replacement market of between 15 million and 20 million units. Now don't get me wrong, they are not going to be replaced overnight. But from the moment they launch a new certification, the authorities do that in India, if for example, 1 electronic product will be broken, you will not be allowed to replace it with an uncertified or from the historic certification, you're going to have to replace it with a new certified product. So there will be a replacement market of size -- of a good size and there is a historic yearly annual demand.

And if our partners can just gain, like I said, a decent part or even a small part of that total market, I think it's going to be more than enough for NEXT. So for us, it feels crucial that we support our partners and that we can see that they succeed with their full certification and that the India authorities launch this program as soon as possible. Our partners believe it's going to be around quarter 4 2022, yes.

So then you have some time lines and maybe what you can expect and what you can follow if you're interested further related to this specific partner.

I think we can go to next slide, Andrea. I also wanted to give you an example of a design win that we have already secured in quarter 3. You haven't seen a press release by the same reasons as I said before. We have received a design win confirmation. We have seen the product. We however not received a substantial enough initial order to be able to send out a press release. But I can explain for you what kind of product that our sensors are being integrated into.

So this is with a company in Turkey called Ones Technology. They build 3, 4 different products with biometrics in it. Where we now have been integrated with one of the NEXT Biometrics sensor is high-security physical access solution. So it's kind of gates with wall-mounted biometrics for indoor and outdoor usage. It's for companies where safety is very important, and the product integrates a biometrics sensor and a smart card reader. And the initial order and what they have integrated is not our FAP20, but one of the, what we call the 200 series sensor modules from NEXT Biometrics.

We do expect annual recurring -- repeat orders on this one. I think you should expect this will not be something that flips around NEXT Biometrics, but it's a positive example, another use case for us that we can demonstrate for other customers. And you should probably count in that if I look at the total volume this company is doing with the 4 products they are producing today, we are now currently in one of them. If we can get into more of them and if you look at the total volume they are doing currently, I think you should not expect more than in the tens of thousands of yearly volume where we are right now.

But if we can get into more of their products, then, of course, the volumes will grow. But we will keep you posted as soon as we see that we get a tangible sizable order from the company. But this was an example of a design win that is already secured during quarter 3.

Okay. Andrea, we can go to the next slide. So there's more activity going on. And if you recall, I talked a little bit about how we are trying to get -- increase our and scaling up our sales resources as well as extending our market reach by adding distributors. And we have intensified this work. The ones that we announced during quarter 1 in Latin America and Vietnam, there is a lot of samples that have been sent. I know that in Brazil, for example, we have, through this distributor, a pilot project out for test already in a live environment and they are now ordering even more and paying for even larger size samples from us. So we do expect that we're going to start to see the first orders coming in here during the second half and towards the end of the year.

But as you probably saw yesterday, through one of our important customers who have worked and where we have started to get a relationship through our customer to this Chinese distributor, then Ulf and our sales team have intensified the work with this distributor in China. They are called XM Holder. And yesterday, we made an announcement that we are adding XM Holder as a Chinese distributor in our distributor network and they started off by placing an initial order of NOK 2.4 million, and they are picking up some different samples of our sensors.

The good thing with this is this order is not related to the customer -- NEXT Biometrics customer that they are normally supplying with goods from NEXT Biometrics. This is for external parties. We do believe that this Chinese distributor, since China is kind of the world factory and has a growing business potential because they are selling to many Chinese OEMs primarily, but these OEMs are selling their products globally.

So we think it's a very good spot to be in and we start to put some expectation on this distributor, but hopefully also that -- adding that to the Latin America and Vietnam distributors. And I hope that we're going to start to see a little bit of traction and a way for us as a fairly small Scandinavian product development company to increase the market reach and scaling up our sales in this way.

So at least a good start with this Chinese distributor, and we are adding that distributor to the already announced distribution network that we have started to establish. So hopefully, we're going to come back and report further on this during end of quarter 3 and then quarter 4.

So with that, Andrea, I think we can go to the next slide. And to summarize the outlook. We are continuing to try to keep the pace of our design wins, so hopefully towards the end of this year, which is to keep -- to bring 3 design wins per quarter, meaning 1 per month at least on average. So that means that we're going to be somewhere around 36 design wins by end of 2022, something we are working hard for. And that means that you're going to be part of a company who is now integrated to almost 40 different solutions, technical, electronic, biometric products. And this is a growing number of customers doing that. So of course, that's a top priority for us.

As I said on the last slide, we're going to continue our focus through this newly established distribution networks that we are intensifying.

I talked about that we are very well positioned in India with these 2 large established partners, one local and one is the tech giant. They do believe that the market will now launch during quarter 4. And I do hope that we are going to start to see already in quarter 4, if that happens, we should start to see some of the first orders through these companies during quarter 4. I don't promise you this, but we are following closely. And depending on when the launch will be in India and then when the market will kind of open up, around that time should be the time when these partners start to place their orders. So I think that is kind of crucial for us in the company to start to increase the revenue and potentially also the margins.

Number four, as you heard both Eirik mention before and also myself, we have started to see some positive signs regarding the supply chain challenges. For us, it's easing up and I'm pretty sure we're going to start to be able to deliver and shorten our backlog during quarter 3 and quarter 4.

But what we are eager and in dialogue with many of our current design win customers is if they see the same, and we are also at least having temporary reliefs from our challenges, but we want to make sure that both we, but even more important, if we can feel comfortable that our customers are starting to see that it's easing up as well, we do expect that they should start to be able to produce more of their end products. And if they do, there's going to be more orders starting to come in on these existing design wins to NEXT Biometrics. So I think this is something we're going to talk more about and be able to explain even further when we come to quarter 3.

Then number five, and to be honest with you, I can sit here and talk about all these design wins. There is a time lag from design win till you start to see orders coming in, shipments being done and therefore revenues being booked in NEXT Biometrics. What me and Ulf and the sales team have as a specific target is if we can identify a large-volume recurring customer with a predefined demand where they have, for example, historically sold a product in a certain yearly volume and now decide to integrate a NEXT Biometrics sensor because then we would be able to inform you about this design win and we would be able to define what you can expect from a revenue perspective. And it is actually only that is required to get this company from a loss-making company into a profitable company.

So I have a specific target on that in the company. We were actually very close here during the quarter to sign such a customer. We were very close. So that's why I am rather frustrated that we didn't succeed, but we haven't given up. That potential customer has not gone to a competitor. We are still in dialogue. So I hope I will be able to come back to you.

But we have more of those that we are identifying because I think that would be a very successful add-on to the basic work that we are doing in the company. So that's what we are very focused on. And this is what we believe will create the foundation for long-term growth in the company.

So with that, I think we have tried to give you a quick summary of quarter 2 and here a rather quick highlights and insights into what you can expect during quarter 4 -- quarter 3 and a little bit beyond.

So with that, I think we should open up for Q&A because I don't think we have more slides. So Eirik, have we received any questions?

[Eirik Underthun, executive]

Yes. The first question. Congratulations with the 36% gross margin in quarter 2. You said you are expecting future improvements on the gross margin. What's driving this change? And what can we expect going forward?

[Peter Heuman, executive]

That's a good question. And I want to be a little bit careful. We are still standing behind the long-term target of 35% to 40% gross margin. But what makes me comfortable that there are potential to maybe go even further is, first, I start to see the true potential of our FAP20 and what it can bring. So can we get volume in our FAP20, then that's going to secure us in that region in a very good way.

Number two, now I've been here for 2.5 years. We have brought more customers. I've gone through the -- both historic main contract that we had, but also some of the new ones. And we are now implementing, for example, on some customers where the company didn't do that before and I think that's kind of a loss that they didn't do historically and that we didn't even do when I started in the beginning with all the changes that are implemented, but we are now implementing some support and maintenance agreements, especially in some of those design wins, historic or new, where we see repeating business, rather recurring, maybe quarterly orders, et cetera, they need to have a support and maintenance agreement with NEXT. That will add up to the existing gross margin on these customers. So there, we have some potential to support that as well.

And then the third thing is we are, of course, trying with the challenges that everyone is aware of on the supply chain side where prices have gone up. We are trying to also, in some cases, at least gain some support from there from our customers. It might not be that we create an extra buffer. But in some cases, they are also helpful and understandable that we can -- that could also be a smaller -- a factor that could help us.

[Eirik Underthun, executive]

Thank you, Peter. Now there was also a financial question here. How -- by how much was the inventory buildup in quarter 2 2022?

So the answer is the inventory was, at the end of quarter 1, NOK 18.5 million. Then it was NOK 22.3 million at the end of quarter 2. So that's an increase of NOK 3.8 million during quarter 2 2022.

Next question. There has been a delay in the opening of the biometric fingerprint market in India. Do you expect the new market to open up in quarter 4 2022?

[Peter Heuman, executive]

Yes. That's a good question and a tricky question. I mean I cannot give you -- we have our thought process on this in NEXT Biometrics. But what we try to do and what we try to guide you on is basically the information from our local partners who are closest to these authorities. They are closest. They are -- it's -- we are providing them our sensors, but they build their products and it's their full product that needs to be certified. They know all the ins and outs of this.

I mean at least there is not that much corona and COVID challenges in India right now. We hear from our partners, they believe it's going to open up during the end of the year. I do not know for sure. I know for sure that it will be very helpful for NEXT Biometrics. So we are all for that the sooner, the better.

I do also know that many who have had or are part of the historic certification program in India are being challenged if they don't get the new certifications. So there is a pressure locally in the country to get the authorities to start to launch this. And I think -- I do believe that we will benefit a lot from it. But I don't dare to give any more guidance. I try to just provide the input that we get from our local partners.

[Eirik Underthun, executive]

Peter, there is another question here. And you're still able to send questions in the Q&A log here in Teams, so please do if you have any additional questions.

Peter, you said that NEXT supply chain challenges are expected to moderate. Can we expect that you will ship all the unfulfilled orders in quarter 4, for example? And could you also please shed some more light on the improvements in NEXT customers' ability to secure microchips.

[Peter Heuman, executive]

Okay. So maybe 2 questions, and good questions again. And related to the first question, with what we see right now, and I think we are clear in the report that it's mainly within our PC customer business where we have built this backlog, I don't want to guarantee you that we will be able to pull in and ship the complete backlog during quarter 3 and quarter 4.

I feel comfortable to say that by the end of the year, I think the backlog will be much smaller. I think right now, we are reporting a backlog of around NOK 8 million. There might be a few million left. But I think the majority of the backlog should be gone by the end of the year. And so hopefully, that's adding up to the underlying demand that we see.

And as you see that we are also saying that we have invested in building up the inventory a little bit here during quarter 2, and that's because we need to deliver during quarter 3 and quarter 4. So I think that's a little bit what I can say from the first -- related to the first question.

Related to the second part of the question. I find that very important because -- since our customers are building electronic products and we do know that some of them have found it very difficult during a time to get allocations of, for example, microcontrollers, we are trying every week at least in the context we have with these customers to identify whether they are also seeing a temporary relief or a long-term relief of being -- getting higher supply.

Because we do believe that the ones who will start to see this easing up they will build more products, and hence, we're going to get more orders. It's a little bit tricky to get full facts. There's a lot going on in the market for sure, and it's changing on a constant basis.

But we try to stay very close to our customers to ensure that we get information and understanding so that we can build and help them supply. But hopefully, they are also going to see if it's easing up for our company, I at least have good expectations that it's going to start to ease up also for some of our 30 design wins.

[Eirik Underthun, executive]

There is another question. How do you handle payment risk for deliveries of NEXT products to your customers? Do you want to answer that, Peter, or you leave it to me?

Okay. So we are having various kinds of customers in NEXT Biometrics. And it's a credit evaluation process who gets the, let's say, favorable payment terms and what is the terms of the sale. And sometimes we need to do prepayment of goods before we can ship it, and sometimes we do also payment in 30 days and sometimes a little bit longer than that. So that's what we're monitoring closely that our customers are paying for our products and that we are collecting on our receivables.

And then there was one more question. I think that's the last one I've received. I have some question about the high-security access design win in Turkey. What kind of customer is this? Is it a system integrator? And what is the potential for such a product in Turkey?

[Peter Heuman, executive]

Yes, okay. Thank you. Good question. I think I highlighted quickly there, sort of, during that slide there. But it's a Turkish access solution providers, so they build access solutions. Like I said, they have 3 or 4 products, I think it is, with biometrics in it. We are now into one of these products, the one I showed here earlier.

We have hopes that with good performance in this first product that we should gain some of the other products as well. And I think I even said here earlier that I don't think we have only received initial orders. When they start to sell this product, I don't think that we should expect more than in the tens of thousands, but on a constant recurring yearly basis.

And I don't think this will ever be the largest design win for NEXT Biometrics, but adding up also these customers and these products into our design win pool is what I believe we can have 10 customers doing 10,000, 20,000, 25,000 sensors a year, that would be 250,000. If they would go for FAP20 in those products, that's a pretty -- from where we are right now, that will be a very sensible volume for us.

So -- and also for our sales force, it's very difficult to go out with strong proof points to new customers if you don't have that many customers. Now it's easier for our sales force. We have -- we are in payment and fintech. We are in high-security access control. And we are there with live customers building products. It makes their job easier. So hopefully, they can score even more design wins.

So I think it's an important customer. It's different use cases and also in different markets globally. Did that answer the question, Eirik?

[Eirik Underthun, executive]

I believe so. We have no more questions now. So if you want to add some concluding remarks, Peter?

[Peter Heuman, executive]

No. But I think we are good, we shouldn't hold you too long. So the highlights of the report is the capital OpEx level, the design win traction and the decently good gross margin. The missing piece of the puzzle, but where we have some hope that we will also be able to ship away some of our backlog here during quarter 3 and quarter 4, and that we have built up some inventory. Hopefully, we will also start to get the missing piece of the puzzle with our design win partners up -- trending a little bit more upwards. I think that would be a closing remark from my side.

And with that, I think if we don't have more questions, Eirik, I think we should say thank you very much for attending. We appreciate that, and looking forward to meet you again after quarter 3. And if you have any further questions or come up with something after this, feel free to try to reach out to me or Eirik. Our e-mail addresses are on the Investors site, et cetera. All right. Thank you very much.