Next Biometrics Group ASA

OSE:NEXT

Earnings Call Transcript 2018-Q3

[Ritu Chanchal Favre, Chief Executive Officer]

Good morning. My name is Ritu Favre, and I'd like to welcome you to the Q3 earnings report for NEXT Biometrics. At the core of our company, we provide biometric solutions for the secure authentication for identity management market. This market today, the fingerprint sensing marking today, is about 1 billion units worldwide. It's largely focused in the consumer segment of the fingerprint sensing market: cell phones, tablets and notebooks. What we see is a new wave of biometric applications that are emerging in the smart card and government identification space. These markets require a large-sized sensor so that you can actually have a more secure solution that does provide a very seamless user experience. NEXT's core competitive advantage is our ability to provide a cost-efficient, mass production, large-sized sensor in rigid and flexible formats. To date, we have shipped more than 5 million sensors, and we are now a proven biometric supplier in this market.As we look at the highlights for Q3 2018, we have had a very, very busy quarter. We have been tremendously productive over the past couple of quarters in executing and implementing our strategy. We recorded a revenue of NOK 30 million, 20% higher than the second quarter. We also were very excited about our gross margin performance. We have recorded 30% gross margin, which is a 40-point swing in margin over the past 6 quarters. We have also really begun to strengthen our sales and marketing teams so that we can pivot to the revenue side of the business and aggressively pursue the markets that we're going after.Since we closed the quarter, we've also made several announcements in the Q4 time frame. I'll be speaking quite a bit about our segmentation of the smart card market itself. We are looking at it as a high-end, government-grade market and a payment market. We have previously announced our relationship with our customer, Tactilis. We announced that we will -- we have been selected for 3 new pilots that Tactilis is undertaking, and I'll speak a little bit more about that through the presentation. We have also made a pretty significant announcement in the payment smart card space. We have announced a joint reference platform with Infineon that will help accelerate time-to-market in the payment card segment. We also continue to evolve in our India strategy for Aadhaar, we have received Android and BIS certification, and we have begun shipping our first orders in -- during the course of the fourth quarter. And then, I will also be speaking quite a bit about the biometric-enabled point-of-sale terminal market. And we have received our first orders in that space as well, and that covers government ID, access control and we also see an opportunity in the smart card segment. On the gross margin side, we have continued to really improve in this area, we have talked about this over the past several quarters. Again, we have had a 40-point swing over the past 6 quarters in gross margin, recording a 30% gross margin this quarter. The key drivers for this improvement are the new ASIC that is now shipping in high volume, yield and scaling impact. And then as we look at the new markets that we're going into, we expect to see a long-term trend that continues to improve in gross margin because our strategy is to focus on high-volume, high-margin, high-growth markets. And with that, we will shortly move into the next section. We are seeing some headwinds on the India side of our business. We have spoken quite a bit about Aadhaar. We are seeing some uncertainty in the shorter term. And I'll spend quite a bit of time in the market section talking about what we're seeing in the India market.The key drivers of uncertainty are the recent Supreme Court ruling, which I will spend a little bit of time talking about how that impacts the different segments in India. There is an election that's coming up in 2019 and typically, the government will slow down any new orders that would be released into the market during the election season. And then we're also seeing a transition from the Level 0 specified products to the Level 1 specified products, and I've spoken about that in the past, I will talk a little bit more about that in the India section. What this sort of means from a NEXT perspective is that we do see a very positive long-term potential for this program as well as for government ID, but we do expect to see a shorter-term revenue and cash flow impact based on some of these uncertainties in India. And with that, I will turn it over to Knut.

[Knut Stalen, Chief Financial Officer]

Thank you. So revenues in Q3 2018, as Ritu said, ended on NOK 30.2 million, that's up 20% compared to previous quarters. We have also gradually delivering volumes to other segment, but the majority of the revenue is still coming from our notebook deliveries. We have significant impact of the new ASIC. So now we have reached 30% gross margin, and that's up from 26% and a year ago, we had minus 7% year-to-date compared to now we have 26% positive gross margin.The EBITDA loss adjusted for options ended on NOK 35.7 million, that's down compared to previous quarter. And the majority of the impact here is, of course, the increase in gross profit. We expect that the gross margin is -- continue to increase and OpEx is flattening out.Next slide. In this chart, it showed total OpEx, meaning payroll and other operating expenses ex options. We see clearly that the expenses are increased in the R&D section, both in payroll and also in our projects. In Q3 '18, it's still down with NOK 2 million compared to previous quarter. We expect payroll and OpEx to stabilize and flatten out in the coming quarter, but payroll will be affected when you include option expenses in the future.When I look at the balance sheet and the cash flow development, cash flow from operation this quarter was NOK 41 million negative. This is the same level as previous quarter. In Q3, NEXT reduced accounts payable from NOK 23 million to NOK 15.8 million. The accounts receivable and inventory are on the same levels as previous quarters. And if you normalize the balance sheet items, the negative cash flow from the operations should be closer to EBITDA ex option around NOK 36 million negative cash flow from operations.The cash end of the quarter was NOK 71 million compared to NOK 113 million at beginning of the quarter. Short term, the cash is likely to be impacted by uncertainty in India and slower-than-expected ramp at Tactilis. Thank you.

[Ritu Chanchal Favre, Chief Executive Officer]

So I want to spend a little bit of time talking about individual market segments. We've had a strategy that we've communicated in the past that we are moving from a single-customer, single-product, single-market to a multi-market, multi-customer, multi-product strategy. The reason for doing that is that our technology is very well suited for applications that require a higher level of security. As we look at the notebook market, which is where we have been playing, we do see this market beginning to tend towards the convenience and cosmetic look and feel of fingerprint sensors, and so there is a proportion of the notebook market that we believe we can address that does require the high security. So in the notebook space today, our -- we are done with all of our product development, and our intention now is to target customers that require the high security that our sensor offers. In the access control space, I will spend a little bit of time speaking about that. We have had a strategy to take the existing portfolio that we have. We are not doing any new product development for the access control space, and we will leverage distribution in channel partners to sell the portfolio that we have. If you look at the top section of this, this is where we are focused as a company. We are looking at smart card as our #1 priority. Our flexible sensor with the large size is ideally suited in this particular space. In the government ID space, there are mandates and specifications that require a specific minimum size of a sensor. And again, this is where we are ideally suited. So the smart card space and the government ID space mandate a minimum size for the sensor for the security advantages that, that offers. In the government ID space, we will take the certification that we've received in India, continue to do our sales and marketing efforts around that and then offer FAP20 portfolio to the market to expand our government reach into other regions.So let me spend a few slides talking about smart card. There is a lot to talk about today in the smart card space. We have been doing a lot of work, and we're starting to really see the fruit of the efforts that we've been putting into this space. We are segmenting smart card into 2 sort of large segments, one would be called the government-grade, high-end smart card segment and then the other piece is the payment card segment. And I'll spend some time in a couple of slides talking about payment cards. However, I want to start with the government-grade cards where we have been working with our lead customer, Tactilis, for some time. Tactilis is headquartered in Singapore with operations in Penang, and we have previously announced a contract some time ago for a 650,000-unit veteran card program that we are doing together with Tactilis. In addition to that particular program, Tactilis has recently signed a letter of intent for 3 smart card pilots with a global organization, and NEXT has been selected in this program with Tactilis. We expect to see the pilots begin in the Q1 2019 time frame. And as Tactilis makes announcements about this pilot, we will provide additional information to the market about this particular pilot.In the government-grade, high-end segment of the card market, the performance requirements are very similar to the Aadhaar program in India, and so we're able to leverage that same benefit that we're providing in India to the high-end, government-grade card market. Here, it's very important to have multifunction capability and be able to provide advanced management of user data. And again, this is where NEXT's technology is ideally suited in this particular space. I'll speak about it in a couple of slides, but we see this portion of the market emerging sooner than we see the payment card market emerging.So I'm going to spend quite a bit of time on this slide. It's a very, very busy slide, but I want to try to unpack what we see happening in the payment card -- the biometric portion of the payment card market. I had presented this slide last year, and I was very excited about this slide because again, I'm an engineer, as everybody has to hear about all the time, and this is really exciting to me. At the heart of our company, we are a technology company. What I had spoken about last year is that we have a really cool, flexible sensor technology. And what I was talking about last August is that the road from a really cool flexible sensor to being able to provide a biometric-enabled smart card is a fairly lengthy ecosystem that we have to go through. So what I had talked about last year is we have MCU that does the extraction and matching. We have an ASIC. There's our sensor, and there is a secure element that's provided by other parties. This then needs to be put into a -- some sort of a flat inlay sort of intermediate step, get planarized and then has to be wrapped with a heavy card plastic so that eventually then you can ship this out into the market. This one again, I presented last August. Again, this is a fairly busy slide, but if you go back to the Q2 earnings in 2017, I had talked about this slide. What we are now really starting to understand about this particular market, with Alain coming onboard, with his decades of experience in the smart card industry, in the secure authentication industry, we are getting a deep insight into this particular market. And what we're finding out is the biometric-enabled smart card market is still a developing and maturing market. The payment scheme payment networks, people like Visa, Mastercard, China UnionPay, American Express, Discover, are putting specifications and standards together so that this entire ecosystem can come together, and it can be end-to-end ready to go into the market. The customers that NEXT would be targeting are here in this middle portion of this ecosystem. And if you kind of look at it top to bottom, you have the global payment smart card makers around the world. These are people like IDEMIA, Gemalto and G&D. These are the people that would be putting this entire ecosystem together. So they have capability to go from the ASIC and the sensor all the way to a fully manufactured card by themselves, and this is what their business is. They partner with people like ST, Infineon and NXP to do the secure element portion of it and then deliver this into the banks and the issuers. So if we think about this, this is one class of customers. I would say that these are the ones that are working very closely with the payment scheme providers, and they are very careful about the way they go to market. They have a global brand. They are looking to do this in a very careful, thoughtful way. If we look at the next class of customers that NEXT would be targeting, this would be what I would call regional payment smart card kinds of customers. This is people like Valid in Latin America. People like ABnote and CPI in the United States and then several smart card makers in China and India. In this case, what we're finding is that they do not have this end-to-end capability to do everything on their own. They have to partner with all aspects of this particular supply chain, which if you think about it, does not really exist today because it is still developing. And this then causes a bit of delay in this market. So what I will be talking about in another slide is one way to enable the regional payments smart card makers to get to market quickly is to have a biometric reference platform that takes all aspects of this away from them having to come up with a solution and that they can take a reference platform and go to market very quickly with it, with all of these pieces being taken care of for these customers. So I will talk about that in one slide, and that's a pretty significant accomplishment that we have had over the course of this quarter. The final class of customers is what I would call closed-loop, multifunction, high-end, government-grade kinds of cards. And here, we would put Tactilis. And we are very excited about a lot of the different leads that Tactilis is coming up with in this space utilizing the NEXT technology. So again, what I would say is in this payment card space, we are still seeing development. There is a lot of innovation happening in this space. There is many, many companies that are in this space. What I will say is that this market is definitely coming. It is taking time to develop, it's a what I would call -- it's the banking industry, we want to make sure in this space that everything is ready to go, that it's going to work very well, that it has high security. We are seeing limited pilots through the world, and there is just a lot of focus in this particular market. So with that, this is sort of what I have been alluding to through the course of my comments. We have recently announced a joint reference platform with Infineon to provide a biometric contact-based payment card reference platform to these regional customers that I was speaking about. So this actually is a real picture of the fully functional biometric card that can go into a point-of-sale terminal and actually do a payment transaction. We are going to be at several conferences over the course of the coming weeks, and we will show this demo to all of our customers.We have a lot of interest from our regional payment smart card customers. And as we go into the next quarter, we should be expecting to announce several different agreements that we're getting into with these regional payment customers. Infineon -- as I was talking about a few minutes ago, Infineon, NXP and ST are the 3 secure element players. Infineon is a dominant player in the secure element space so we're very, very excited to be working together with them to provide this complete reference design into the market.So this is my final kind of slide on the smart card market. Again, this is a heavy area of focus for us. What you'll see in the top part of this chart is our view on the ramp of the smart card market. You'll see that it goes from closed-loop systems into government-grade, high-end cards mass market, and then you'll see the retail banking payment card portion of the market really begin to take off. NEXT has aligned its road map with the way that we see the market developing. So we've been working with Tactilis on the chipset, which has been out, and we will be continuing to ramp contracts with them as they ramp up. We have talked before about our One Touch Flex contact-based flexible biometric solution. This is what's integrated in the reference platform that we will providing. This is now shipping into the market. We are also working on our contactless solution. We already announced that we are able to harvest power in -- for -- to power contactless solution. In April, we had announced that we are able to take power from a contactless terminal and power our technology. We will have a biometric subassembly by the middle of 2019 that is contactless, and we would plan to also have a contactless reference platform the 2019 time frame. We will then also do a chipset and massively integrate our contactless technology during the 2020 time frame in time for this ramp in the smart card market. So that kind of covers the highest priority market for NEXT. And with that I'm going to move into the government ID space. And so I spoke a little bit about the Supreme Court ruling in India causing some shorter-term uncertainty in our efforts in India. So what we are finding with this particular ruling is that there are portions of the market that are still very much approved by the government, and then there's other portions that are either barred from accessing the Aadhaar backbone or that will have a slight decline in the market. And what we're finding is anything to do with government benefits, direct benefit transfer to the citizenry of India, is still allowed. So government applications, in-branch banking is still allowed. Anything to do with a point-of-sale, private company payment kind of a transaction is still under scrutiny by the government, and we do expect to see some impact in the market from that particular ruling. Telecom is barred. So people cannot go into a store and open an account for a new phone using the Aadhaar system. So what this all sort of means is we had talked in the past that this is a market that would be in the 3 million to 4 million unit range per year in the 2018 to 2019 time frame. Based on this particular ruling, based on the Level 0 to Level 1 transition, based on the 2019 election, we are revising that to a 1 million to 2 million unit per year sort of a range. However, because of the convenience of the Aadhaar program, with every Indian citizen registered in this program and the very rapid way that people can get access to their benefits, we do believe over time, this will continue to be a long-term attractive market. We maintain our 5 million to 10-million-unit annual projection in this particular space.We also recently announced that we have opportunities emerging in the biometric point-of-sale terminal market. We announced a contract with Telpo from China for a point-of-sale application in India. We expect orders to be shipping this quarter from a module basis, and we do expect this to be in the hundreds of thousands of units range. I will speak a little bit more about the biometric-enabled point-of-sale terminal because we are seeing a lot of opportunities in that space. So in the access control space, we have also spoken about this quite a bit as well. So we have been doing a lot of work here. We've been talking about partnering with our distribution and channel partners in this particular space, and we found that this is a very fragmented market. In the past, we've talked about it being fragmented in the range of 10,000 units per socket, and what we have been finding is that we need to even more finely subsegment the markets that are very well applicable to our large-sized sensor technology. So we have now honed into health care; identity access management, which would include blockchain; secure transactions, which is primarily biometric-enabled point-of-sale terminals; and physical access. And so again, with Alain coming onboard, we've really been strengthening our sales and marketing approach, and we've decided that we have to have really good relationships with our channel partners so that we can go into these specific markets. The other part that we were finding challenging is that while we were offering a solution to the market, we did not have a complete matching solution for the market. We recently announced an algorithm purchase from Neurotech, and this now allows us to come into the market with a complete solution that allows a very seamless user experience. So we believe that these 2 factors, subsegmenting the market in a better way and offering a complete biometric solution, will allow us to start having shipments ramping in the 2019 time frame in these particular markets.I am going to spend a little bit more time now talking about the biometric-enabled point-of-sale terminal market because that is actually emerging as a market that we had under scoped in terms of the size and the potential. So what you'll see is we've made 2 announcements over the course of the quarter. This is an actual picture with the NEXT sensor integrated into the TYSSO point-of-sale terminal which is headed for a United States customer, and then the Telpo point-of-sale terminal that I had just spoken about a couple of slides ago. We are seeing this more and more to enable high-security payment transactions. It's also being used for time and attendance and physical access in these sorts of devices. We do expect to continue to have announcements in the area of biometric point-of-sale terminals, and we are seeing opportunities across smart card, government ID and access control. I do expect to talk a little bit more about this in the future -- in our future communications because I do see this as a real opportunity for our technology.And then the final market is our notebook market. We did have our all-time high notebook shipments in the third quarter. And I said, this market is moving towards a more consumer convenience-based, fingerprint-sensing technology platform. We will continue to market our products into the space where customers are looking for the benefits of a secure large-area sensor. As I have spoken about, we have our FAP20 sensor that we'll be sampling in the third quarter, and we are seeing some interests from some of our notebook customers for the FAP20 as well as our existing product lines in their higher-end, high-security laptop applications. We do expect, over the course of the coming 12 months, to continue to ship to our Tier 1 North American customer, however, we expect the number of platforms using the NEXT sensors to decline. At the same time, we expect the number of platforms in the Fujitsu platforms using our sensors to increase over the course of the next 12 months.To try to wrap that up, we had a lot of information to share this cycle, and we wanted make sure that we got all of this information out into the market. If you look at the evolution of NEXT Biometrics, we really are into our journey of transforming ourselves from a single-customer, single-market, single-product company into a multi-market company that is targeting high-value, high-growth, high-margin kinds of applications. We move from creating the rigid, flexible sensor technology into creating the foundation for growth over the past 1.5 years or so. We have really emphasized product development and leveraging our technology into new markets that can utilize the benefits of the technology, and we're spending the bulk of our R&D in the smart card and government ID space.As we look forward, we expect to significantly ramp the business; start to ramp the smart card products, both in the high-end and the payment card segments; leverage the existing certifications in India; and then go into the FAP20 space and target additional government applications; and then really begin to drive revenue and profitability with the sales and marketing team that we have put in place. So as we look forward into the outlook for the company, again, we expect to begin volume shipments with Tactilis in the high-end smart card space. As I was speaking about, we expect to leverage our biometric reference platform with Infineon in the payment smart card space. We will be ramping India sales with our existing certification and then begin to sample the FAP20 in the Q4 time frame into other government opportunities and other government markets, establish a strong position in this new growing biometric-enabled point-of-sale terminal space, really focus our OpEx in the smart card space where we see the biggest opportunity for the company going forward and then continue to increase gross margin to our long-term target and flatten out our OpEx. And with that, we'll take questions.

[Unknown Executive]

Are there any questions from the audience? No. Then I have one question from the web. Have you started delivering to Fujitsu?

[Ritu Chanchal Favre, Chief Executive Officer]

Yes, we have begun shipping to Fujitsu, and that's encompassed in our financials.

[Unknown Executive]

There are no other questions from the web.

[Ritu Chanchal Favre, Chief Executive Officer]

Fantastic. We did a great job communicating all the information. Thank you very much, everybody. I appreciate it.