Good morning, ladies and gentlemen, and thank you for standing by. Welcome to today's Q1 Report twenty eighteen Conference Call. At this time, all participants are in a listen only mode. There will be a presentation followed by a question and answer session. I must advise you that this conference is being recorded today, Thursday, 05/03/2018.
And I'd like to turn the conference over to speak today, Christian Pedriksen. Please go ahead, sir.
Yes. Thank you. Good morning, everyone, and welcome to the call. Let me first go through the main highlights from the quarter as usual and then give you a short business update and flavor. Our results in the first quarter were impacted by a continued weakening of sales as we anticipated in our year end report already earlier.
We saw sales declining by 58% year over year and our gross margin decreased to 15% from 41% last year. We see declining production volumes of smartphones for the Chinese market compared to last year, as we have also said earlier, which clearly impacted our sales. Main reasons for the clear decline in China has been lengthening replacement cycles, declining carrier subsidies and OEM consolidation, which we see continuing in the at least for a while. But the single most important factor behind the decrease in sales and gross margin in the quarter is, for us, the product mix. As the shift towards smaller and cheaper fingerprint sensors continued during the quarter, the same trend has been there already in Q3, Q4 and now continued in Q1.
Now we see today that over 75% of our sensor shipments is with our most cost efficient sensor. So it has been quite a dramatic shift in the last year. Let me also highlight that our results was negatively impacted by restructuring costs amounting to 40,200,000.0. That corresponds to a 14 adverse impact on our operating margin. This cost is related to the previously announced cost reduction program, which has been executed according to plan.
Our key priority at the moment is, of course, to return to profitability and positive cash flow, and we are working on several fronts to achieve this goal and at the same time, be able to invest into new areas. Next slide, please. Now if we look at our core business in fingerprint sensors for smartphone industry, we are facing intense competition in the market, which is no news. But at the moment, the market continues to contract in value terms. 2018 will continue to be a challenging year for Fingerprints.
We'll be operating in tough business conditions on the mobile side, which is now expanding in many areas in biometrics, while at the same time investing for growth in new focus segments such as the biometric smart cards. We have focused on cost control as well, while diversifying our business in order to generate growth again and lower the risk and create more stable revenues and not be reliant on one segment and a few customers only. As you know, we initiated an extensive action plan at the 2018 to adapt the company's cost base to the rapid changes in the market and ensure the company's long term development and success. We estimate now that these measures will achieve cost savings of some SEK $360,000,000 in 2018, and it will take start taking effect already in the second quarter. I am pleased to say that the cost reductions have been executed as planned and are already fully in motion.
Now our ambition is to keep the leadership position in capacity sensors for smartphones, which today still, of course, accounts for the bulk of our revenues. Now we have continued to maintain that leadership position in this market also in the quarter, but clearly, our margins have been affected by that. In order to continue and keep our market share, our margins our margins improve our margins in this segment, we have been running a high priority development project with the aim of launching a fingerprint sensor with lower production cost than the present generation of sensors, while maintaining a very high performance of biometric space. Now we expect to introduce this new low production core sensor to the market in the second half of the year. We have, of course, other measures also going on in the capacitive sensor market for cost efficiencies.
Going forward, the main focus of R and D activities in capacitive fingerprint sensors will be on ensuring competitive production cost and highest biometric performance. So it's a very clear role that we have when it comes to capacitive fingerprint sensors. In parallel, we are positioning the company to take advantage of the new opportunities. Our objective has been for new segments to make up about 10% of our sales in 2018 as we continue to diversify business. We are well on our way to achieving this goal.
Our solutions are already found in many different product areas such as Godolas, which will be millions of units this year, laptops and tablets. At the same time, we are well positioned to take advantage of the introduction of biometrics in new areas, not at least in smart cards, which obviously will be the single biggest opportunity in the next few years. Next slide, please. Let me tell you a bit about our business development initiatives during the quarter. First, 17 smartphones equipped with our sensors were launched in the quarter.
Clearly, the decrease from last quarter is also due to slowdown in the Chinese smartphone market. We also launched the first third generation sensor. This is a single chip solution, a single die, removing the need for a companionship while maintaining and even exceeding the performance benefits of the dual chip sensor. I'm also excited about the face recognition solution we are developing. Initially, it is for smartphones.
We see a growing interest, of course, in this industry for touch like biometric solutions. And we will see a combining of many different biometric modalities coming ahead in this year and next. Clearly, the technologies are diversifying now when it comes to biometrics and mobility. The main driver is to increase both security and convenience for us. And I'm convinced that when we add face recognition to our iris and fingerprint solution, that makes us very well positioned in the market.
We expect our face recognition solution to be integrated in custom products during the 2018. Now when it comes to the face as well as iris, in neither of those do we have hardware. So these are both software solutions with algorithms only when it comes to our solutions there using standard hardware components in the industry. In the quarter, we also announced a partnership with Altra aimed at offering biometric solutions for the automotive industry. This follows our earlier announcement regarding our exclusive ten year agreement with Gentex on our Iris solution, combining that with the cloud, which is also for the automotive industry.
And finally, one more thing on Iris, we have also got an offers deals in Indian retail for point of service terminals That will make it possible to make payments to AdHard, which means basically using iris for central matching identification of users. Next slide please. Now we see a continued high activity level in the smart card area. And we announced again two recent market trials where our sensors are used, one in The Middle East together with Dynemia and the other one in Japan with Visa and Swipe. Also, generally in January, Visa announced pilot institutions that will begin using a payment card with fingerprint sensor.
There is a lot of activity in this market, and we are more convinced than ever that this market will happen. The question is only which volumes will come at what time. We are all eager to move forward to a future that will be free of PINs and passwords as consumers are now starting to realize how biometric technologies can make their life easier and safer. We believe biometric secure payments will one day make other authentication methods almost disappear. Obviously, this is a new major area for us, and we are well positioned to take a leading place in this market as it goes into actual volume deliveries.
We see continued increase with all new partners and key players in the smart card area, And everybody is rushing to make the ecosystem ready, and there is much more pool now all through the chain. Of course, we still have to certify all of the chain for mass production and deliveries. We have also seen now smaller volumes, of course, starting in access control area, which Dynatrace requires where we have received our first orders also. Next slide, please. So summing up, our Q1 results were obviously weak, and we must do better, and we have all the actions in place to do that.
The quarter was impacted by continued weakening of sales, mainly, of course, due to our own product shift to low cost sensors, but also the first time ever decline in the Chinese mobile market. We continue to have a leadership position in our core business, capacitive sensors for smartphones. But we obviously have to focus on driving cost efficiency in this area to remain competitive, not least by developing now the more cost effective sensor, which will come out in the second half of the year. Now we have committed to reducing our overall cost base, as previously explained, and we have executed upon this plan to take out SEK $360,000,000 during this year. The program will have full effect on cash flow starting from Q3.
And once again, we are fully on track and all the actions have been executed. I am very pleased with the performance of our people through this painful process to run through with such speed and excellence in this case. I have to say it shows the extreme commitment of the people of this company and shows the big heart of all the people who have left us, incredible company and incredible people, I have to say. And in parallel, we are continuing to diversify our business into new areas. That is what drives us now and excites us.
Our technology in capacity with fingerprint is trial and tested and is in hundreds of millions and soon we will have shipped not in a while, we will have shipped even the billion sensors to smartphone users worldwide. The fundamental technology can be adapted and applied in new segments, like biometric smart cards or door locks, for example. And funny enough, door locks are shipping in the millions this year already with fingerprint sensors. Finally, yes, market conditions in the mobile business are challenging, but we expect some stabilization and sequential growth for us in Q2. Furthermore, we expect cash flow from operating activities to sequentially improve during Q2 and be positive due to a tax refund and an improved operating results.
We are developing and expanding our biometric technology portfolio and we took the next step in Q1 in the era of face recognition. Our objective remains to be the leading biometric company, which requires us, of course, to continuously develop and enhance our technology, but also now finally to expand in new geographic areas and new business areas outside of the mobile business. That work continues. Thank you. And with that, let me hand over to our CFO, Hassan Tabrizi.
Thank you, Christian, and welcome ladies and gentlemen to this next session where I will give you a summary of our first quarter financial performance. As previously communicated on February 9, our revenues for the first quarter continued to weaken as we recorded SEK 289,700,000.0, which is a decline of 58% compared to the same quarter last year. The continued shift in our product mix towards smaller and cheaper sensor had a significant impact on our revenues for the quarter. Furthermore, and due to the immense competitive pressure as well as continued weak Chinese market development, our volumes declined year on year. Our gross profit of SEK44.8 million for the first quarter was a decline by 84% compared to the same quarter last year and our gross margin continued to weaken as we recorded 15%.
The weaker gross margin year on year was due to a lower average selling price ASP resulting primarily from a significant change product mix. Furthermore, the gross margin was negatively impacted by 5,400,000 or 1.9 percentage points related to restructuring costs as well as additional R and D project depreciation. Next slide please. On our operating expenses, excluding the operating income and expenses, our operating expenses for the first quarter totaled SEK $218,000,000. This is to be compared with SEK 199,000,000 in the same quarter last year.
The increase in costs versus the same quarter last year is due to the restructuring cost of SEK 40,200,000.0 that were accounted for in the quarter. Excluding the restructuring costs, our operating expenses for the quarter were at SEK 178,000,000, which is 11% less year on year. Development costs of SEK 36,200,000.0 were capitalized during the quarter, which corresponds to 30% of the total development costs. This is to be compared with 19% for the same quarter last year. The increase is due to the increased number of development projects underway.
In relation to revenues, our first quarter operating expenses ended at around 75% compared with 29% for the same quarter last year. Next slide please. Our operating results for the quarter was a loss of SEK174.9 million. This is to be compared with a profit of SEK70.8 million for the same quarter last year. The results were largely impacted by the decline in revenue and the decreased gross profits.
The operating results was also negatively affected by the restructuring cost of SEK 40,200,000.0. Excluding the restructuring cost, the operating results was a loss of SEK 134,700,000.0. Now moving to the balance sheet and the working capital. Our working capital excluding cash and tax items increased and at the end of the first quarter, we recorded an increase of SEK16.7 million compared with the 2017. Our inventory at the end of the first quarter increased by SEK74.7 million compared with the 2017.
Next slide please. Our cash flow from operating activities including changes in working capital was negative million at the end of the first quarter. The operating loss was the main reason for that negative cash flow. Also, during the quarter, 18,800,000.0 pertaining to part of the remaining purchase consideration for the acquisition of Delta ID was Cash flow from financing activities was a negative SEK124.3 million and consisted of repayment of the acquisition loan of Delta ID.
And during the quarter, our cash balance decreased by million at the end of the quarter. And the disposable cash balance was $534,000,000. Now before I finish and as this will be my last earning for Fingerprint Cards, I would like to take the opportunity to thank you everyone and wish you all the best. Now thank you for listening and back to you, Stefan.
All right. So I think we're ready to take some questions now.
We have a question from the line of Victor Westman. Please ask your question. Your line is now open.
Hi guys. Thanks for taking my question. You wrote in the report that the main focus of the R and D activities will be to ensure a competitive production costs. Should we read this as the current production cost is not competitive? And looking at your 15% gross margin, are your competitors above that now or
I think that what you can read is that, obviously, 15% is not good enough at all for us. And we have worked, and we will, in second half, come out with the next generation for us, a very competitive product, world class leading product into the market, right? So which we need to bring capacitive sensors. So still with in at least the same, if not even improved performance. And that we need to bring because as over 75% of our sensor volumes now are kind of low cost sensor, then obviously, we need to that shift has made us sort of the focus is very strong when it comes to capacity business to get there.
We will be competitive with the new sensors for sure again. And we have been, of course, all the time. But with the price erosion, you always have this close between basically, you have close between your generation of sensors that you deliver, right? There is always a wave of new things coming. And then you have the older ones where you when you do the shift, right?
And there you see the gross margin impact. It is not the only action we have, of course, when it comes to we can do many things to improve. And but those are the big steps that you do. And then you do other things within the quarter anyhow with the products.
Yes. Okay. Good. And one follow-up also, if I may. I noticed you expect Q2 to be better.
You explain why you think that is? Is that you have won back some market share or something else?
We didn't we have said on the market share that we had a declining market share last year. On average, it was 40% for the last year and because still of the dual sourcing having impact on us and even triple sourcing in some cases. Clearly, from Q4 to Q1, we don't give now per quarter the market share, but we did not lose any market share. So it was the same when we entered these two quarters. And but you can see the impact, of course, because we don't see an easiness in the ASP or in pricing either.
So we have reacted to that in the market. That can be seen in our gross margin clearly. And now we have actions on the cost side to improve it. I think from the market share, no difference in the market share from Q4 to Q1, right, at least.
Yes, I understand. So but why
do
you then think that sales will be better in Q2? Is there any specific reason for that?
Yes. I think it's just the way we see. Maybe there is a little bit of stabilization. The Chinese first, it is a seasonally stronger quarter for us. But then also the Chinese market, we don't see deteriorating further now when we have gone into it.
Chinese market has clearly been, as I said, in decline when it comes to the mobile phone business, the volumes. Although actually, ASP has seems to be climbing a bit even in the globally, but when it comes to the mobile phone business. But it is because of that, it's seasonality stronger for us. We have kept our market share, and we don't see the market getting worse anymore, at least. So I don't dare to say that the Chinese market is improving, but it's not getting worse.
We believe that we will that's why we used the word stabilize, and we will hence, we see a sequential growth now in sales in Q2. Yes.
Thank you very much for that color, Christian.
Thank you.
There are no further questions over the audio at this time. Please continue.
I think we can take some questions from the web then. We have one question coming from Daniel Juvei. Given the 58% decline year on year, wouldn't it be fair to raise your estimated revenue target for areas outside of capacitive sensors for smartphones above the 10% target.
I think, yes, I think that's a very fair comment actually. And obviously, that target has become easier for us. And but we didn't want to go out and raise it now when we are in the first quarter behind us. But it is very right and very fair comment, by the way, that obviously we that target has become easier for us. It's not the way we wanted it.
It's not the way I would like it to become easier, obviously. It's by far the way we like it, but it is true that, that target is now easier for us, obviously. And clearly, we need to yes, Hassan is right. Clearly, we need to do better than that. But that's the kind of target we have set to the market.
But yes, very good point, and we realize that we should do better now.
And then we have a question on the inventory. Do you expect to reverse the inventory buildup in Q1 in the coming quarters? Or will we see further inventory write downs in 2018?
Yes. So Hassan here. Yes. So I mean, we can all agree actually that our inventory levels are high and we are obviously doing everything we can to sell our products from that inventory. I would like also to add that this also could come to a price, which is actually lower margins.
But of course, when we do our assessments, we have to evaluate that versus write offs. On the risk, we I think we cannot rule out for now that additional write downs necessary. We'll have to wait and see and we will continue to do our regular assessments on our inventory levels. And but I don't want to rule out any additional results that might be needed going forward.
And then we have a question on the competition. Please give some more insight into the competition. Do you have any advantages against them?
Yes, I think there is if I look at the competition, it's of course much more diversified because there is many different. I'm going to give you a few answers, right? So I think we are we have proven that we can do well in market shares. We can fight for that, although it clearly has been a very hard development when it comes to both our revenues and the ASP and the product mix for us. And that can be seen in the competitors as well in mobile capacity market.
So in the mobile capacity market, we are competitive. We have the best quality, the best security. But obviously, now it is not the only solution that flies in mobile. So you have touchless, face has come in, you have not only capacity fingerprint sensors, but you have also other fingerprint sensor technologies that are coming in, in various ways. So clearly, you need to pick your choices.
You have optical for hot zone and you will have ultrasonic for hot zone. You have also all of these technologies looking at trying to get to half display and full display. All of them require own investments and own product solutions. So you will see a huge diversification. And even just looking at face itself, you will see many different face solutions.
On the high end, you have the Apple. On the low end, you have much cheaper versions with standard cameras, IR cameras and so forth. So much more scattered, and you need to pick where you're going to be, right? So from a competitive point of view, we have chosen to be in iris and in face, but only doing software. So it's not the high end expensive solutions, but it's the software where you can the OEM then chooses the hardware themselves.
I think we are very competitive. We have the best Iris solution in the world. It is the best performance, the best security. The phase we are building, we believe, will be competitive in kind of mid and low end segment. And then, of course, if I look at the biggest Chinese competitors, we can, of course, see the same we can see same kind of pain in many of our players now with the drop in the capacity industry mobile phone industry, right?
So but we're doing well in that market, but it's just a very different market than it used to be. Then we see very different competitors when we go to smart card industry or we go to automotive industry or the IoT. So there are different players in all of these. Actually, the competitive landscape is quite scattered. There must be forty, fifty different players actually now in this biometric area easily.
But I'm sure that when the dust settles, a few technologies will evolve as winners and a few players who have then made the right bets on those technologies will evolve as the winners here as well. And clearly, from a market opportunity, smart cards is by far the biggest opportunity for us as a company, if I look at the any other opportunities around. And there we are, of course, basically very strongly positioned right now if I look at the competitive. We are the only ones who can do contact and contactless at the moment, for example, and have the needed low battery performance, low power performance in that space, right? And have the production capability action.
That's a few words on it. So it's a scattered I didn't want to get into names because, as I said, it depends on which industry you pick, right? You will get very different competitors.
And one more question on the cost reduction program. Could you please deepen it a bit more? What measures did you actually take?
Yes. So I mean, as we communicated earlier this year, we have launched our cost saving program aiming to with objective, of course, to save million during 2018. And this program has been launched and it's progressing according to plan. Now we will continue, of course, to drive efficiency through our organization and to improve our cost base continuously. We will do anything what is necessary basically actually to act quickly and to protect our competitiveness going forward as well.
And of course, in a situation, if we continue to see a decline in revenues and margins, we will have look into our cost base again and make it more efficient and probably lower even further.
Yes. I can just add on the cost reduction program simply. Once again, I think it's been very strongly executed by a lot of people. It is a painful process, but it has been extremely well executed. We have done and we have executed on all the needed actions to do those numbers that we've said.
And even the cost is exactly what we said it would be, and we have taken that cost already out in the numbers as a summary.
And the question on Ultrasonic in Display, could you please give us an update on this? And will this be ready for mass market this year?
Yes. I think the ultrasonic solution, of course, as I was saying, there are many solutions in the market now. Now we have seen of course, Ultrasonic as a hot zone, which is one finger on the display, has been launched some time ago. We've never really made it in the market. It wasn't good enough.
The performance wasn't good enough. So it's not only about launching a solution, it has to actually work and it has to be cost efficient and it has to be volume production capable. Remember those, right? Just launching a phone with a few thousand examples doesn't make it happen yet. Then on our ultrasonic, which is a full display, it will not be out this year.
There will be no I don't believe there will be any full in display solutions coming out this year. Clearly, anything for hot zones and so forth will be kind of in between steps now in the industry as we all gone for the full in display solution. I think on our progress, I'm pleased of the progress. We have done good steps, both technically and in customer interactions. Also, have solved a lot of issues when it comes to when you look at the volume production of it and so forth.
But there is still a lot for us to do on it. So it will not be out this year in any mobile phones. But there is good progress for us in the ultrasonic solution itself.
And one more question on smart cards. What's your estimated probability of ever making money on this business? If so, when?
Yes, we I think the answer is yes, we will make money on the smart card business. I think a lesson learned obviously from the mobile phone business is that you have to take all your skill sets as well so that you, at the same time, drive down cost as you pick up the volumes in that business. But yes, we will we have our own clear expectations on what kind of gross margins that you can do in that kind of industry. You have to remember, ID is, of course, more complex to make the smart card. Actually, funny enough, it's more complex to make a sensor for the smart card than it is for the mobile phone.
It has to be much more thin. There is power consumption questions. Everything is different when it comes to smart card business. But yes, we have we I believe that you can do a you should be able to do a 40% gross margin in any of these businesses once it stabilizes. But as we can see, when you get into tougher space, it's not that possible to do for the short term, at least.
And on the smart card, I have to say once again that we have a very strong position in that industry right now. And we have many and best established partnerships with all the key players. And it's a very different ecosystem to be working in as well. And we have worked with that now for quite a while. So I'm extremely positive about the development in that industry right now.
And the one question on Iris. Are you expecting any new phone releases with Iris?
Yes, we have. Of course, we launched in two automotive partnerships in with Iris as well. We will continue to do that in the mobile phone industry. And then we have expanded also with the Aadhaar program in India. We will see combinations of face and iris.
So yes, that will continue to work for us as well, right? That is a key part of our offering.
One final question then. It's a question on the capital. Will you need more capital? No, no. And that's, of
course, why we have done all these activities and actions for us. No matter how painful they are, we will continue to work on keeping ourselves so that we can invest our money into the new innovation that we drive. That's, of course, that's our task. And we also said that the second quarter as we said, the second quarter will be cash flow positive, although it is, of course, partially dependent on clearly on the cash that's coming from the tax authorities back to us. But also improved performance.
So the answer is that, yes, we will leave on all cash, so no more needed. And with that, we will close down. I can see that there actually also questions on Samsung. Maybe I'll take that one as well. I can see on the screen when I look at some of the questions.
I see questions from Samsung. We will obviously continue working on Samsung. We have clearly not been able to answer them. And but there is nothing, of course, preventing us from doing that as well, even if we haven't done so far. Clearly not something we're proud of.
It's not the proudest moment that we haven't gotten there, but so this year, so yes. And then final comment is on the next quarter, we will release our Q2 report on July 19. So that's for the second quarter then. So when it comes to this area, we will be back then. And with this, thank you very much for joining.
Thank you all. I wish you a good day. And on this forum, we will talk on July 19 again. Thank you very much, and bye now.
That does conclude our conference for today. Thank you for participating. You may all now disconnect.