Electronic Equipment, Instruments & Components | Sweden · Fingerprints’ sensors featured in 16 new smartphone models While the market is challenging, Fingerprints’ sensors were

Commissioned research 24 July 2018

Marketing material commissioned by Fingerprint Cards

Fingerprint Cards AB Electronic Equipment, Instruments & Components | Sweden

KEY DATA

ABSOLUTE & RELATIVE PERFORMANCE

Source: Thomson Reuters and Bloomberg VALUATION APPROACH

Source: Nordea estimates

Nordea Markets - Analysts Jörgen Wetterberg Senior Analyst Dan Johansson Analyst Henning Zakrisson Analyst

Sales surprisingly high, profit hit by one-offs Higher sales than expected Fingerprint Cards’ (Fingerprints’) sales were SEK 389.9m for Q2, 31% above consensus. This implies that Fingerprints’ market share might not have declined as much as we had forecast or that the ASP had not eroded as much as assumed. The operating cash flow was SEK 302m, mainly owing to a SEK 253m tax refund. This alleviates some of the financial strain as the company now has SEK 440m in net cash. However, profit needs to turn positive in the coming quarters for the company to feel safe about its future cash position.

Negative gross profit The inventory writedown hit gross profit and margins heavily. However, adjusted for this, Q2 profit was in line with consensus while the gross margin remained low at 15%. The gross margin was lower than consensus and our estimates, as we had anticipated a pickup from Q1.

Estimate revisions Higher-than-expected revenues prompt us to raise our estimates for the next few quarters, while our long-term revenue forecasts are mostly based on new business lines and therefore have not been changed drastically. We lower our gross margin estimates for the remainder of 2018, but forecast them to return to around 30% when the cost-cutting programme is in full effect and new products are launched. We also increase Fingerprints’ market share and ASP in capacitive sensors. In addition, we also increase our price erosion assumption affecting in-display fingerprint sensors. The total impact of these changes lifts our sales forecast but also raises costs. Valuation Based on our fundamental DCF approach and using a WACC of 11.4%, we reiterate an unchanged fair value of SEK 5.5-9.6 per share for Fingerprints. For a more detailed review of our estimates and valuation approach, please refer to the Estimate revisions section.

Source: Company data and Nordea estimates

Country SwedenBloomberg FING.SSReuters FINGb.STShare price 6.44Free float 93%Market cap (m) SEK 1,923Website www.fingerprints.comNext report date 2018/10/26

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SUMMARY TABLE - KEY FIGURESSEKm 2013 2014 2015 2016 2017 2018E 2019E 2020ENet sales 95 234 2,901 6,638 2,966 1,539 1,685 1,804 - growth 144.9% 1141.7% 128.9% -55.3% -48.1% 9.5% 7.1%EBIT -34 -145 916 2578 155 -893 8 96- margin -35.7% -62.2% 31.6% 38.8% 5.2% -58.1% 0.5% 5.3%EPS -0.60 -2.32 12.50 6.48 0.38 -2.34 -0.02 0.24- growth n.m. n.m. -48% -94% n.m. n.m. n.m.DPS n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.P/E n.m. n.m. 9.5 9.7 41.3 n.m. n.m. 27.0EV/EBIT 6.2 0.7 n.m. 7.2 29.2 n.m. 192.8 15.6EV/Sales -2.2 -0.4 -0.4 2.8 1.5 1.1 1.0 0.8RoE -49.0% 111.0% 120.6% 5.3% -40.4% -0.4% 5.6% 8.1%Div. yield n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.FCF yield n.a. n.a. n.a. 5.4% 3.5% -5.7% 2.9% 6.3%ND/EBITDA n.m. n.m. -1.1x -0.4x -1.9x n.m. -3.8x -2.7x

24 July 2018 Fingerprint Cards

Marketing material commissioned by Fingerprint Cards 2

Company update: Q2 2018 report Fingerprints reported Q2 net sales of SEK 389.9m, up 35% sequentially but down 53% from Q2 2017. The gross margin adjusted for the inventory writedown was 15%, the same as in Q1. The operating profit was impacted by restructuring costs from the cost-cutting programme and by writedowns in inventory and capitalised R&D, ending up at SEK -578.2m.

Market conditions remain challenging

The company states that the market conditions in capacitive fingerprint sensors for smartphones remain challenging, even though sales have stabilised. ASPs (average selling prices) are still in decline and volumes are uncertain, especially in the Chinese market. This is combined with a further move in the market towards low-cost sensors, now representing 80% of Fingerprints’ sensor volumes. The company forecasts the ASP drop this year to be at least as large as last year’s, and hopes that it will stabilise after that. The CEO also makes comments regarding the presumably more expensive, in-display fingerprint solutions being subject to a similar price pressure in the coming years. It should be noted that Fingerprints still has not showcased its in-display solution and that the price erosion comments were about the segment as a whole rather than on prices of the company’s own products.

Operating cash flow saved by tax refund

The operating cash flow was SEK 302m, mainly due to a SEK 253m tax refund, without which the number would have ended up at SEK 49m. Net working capital also had a positive impact of SEK 152m. The cash and cash equivalents in the company’s balance sheet were SEK 737.5m, translating into a net cash position of SEK 440m. Better–than-expected cash flows during Q2 alleviate some of the financial distress and saves the company some time to transform its profit trend to avoid having to turn to the capital markets to raise more cash.

QUARTERLTY NET SALES PROGRESSION

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Fingerprints’ sensors featured in 16 new smartphone models

While the market is challenging, Fingerprints’ sensors were integrated into 16 new smartphone models from seven different manufacturers in the second quarter, and the two first products using the third-generation capacitive sensor were launched by Xiaomi. This is about as many new models as in the last quarter, but presumably in more volume-heavy smartphone lines since revenues increased despite the declining ASP.

Product development The FPC1511 sensor was announced during the quarter, and is considered to be one of the main products helping the company to defend its margins and retain competitiveness. It is now slated to be integrated into mobile phones in the end of 2018 or the beginning of 2019.

In-display sensor still in development

As for the in-display fingerprint sensor for smartphones, no further comments were made about the launch of Fingerprints’ solution, but the CEO commented that the modality is not guaranteed to be a long-term norm in the ever-changing smartphone market. He also made some remarks about the ASP for the product segment likely declining in the same manner as it did for capacitive sensors, and that this will lead to higher attachment rates in the coming years.

Fingerprints is working on a full-screen ultrasonic fingerprint sensor as well as an optical “hot-zone” solution for in-display sensors.

Two development projects have been discontinued

While the CEO did not specify exactly which development projects had been discontinued, he did mention that the writedowns of capitalised R&D stem from two different discontinued projects, one that has been in development for a long time and one more recent. These projects were supposed to move Fingerprints into new business lines, where it, as of now, is not possible for the company to go.

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One of them might be face recognition

The CEO states that the previously discussed face recognition technology is “not in the cards at the moment” and the report states that the company, in terms of touchless solutions, is focusing on its iris recognition solution. Combined with the capitalised R&D writedowns, we suggest that this implies that the face recognition development has been discontinued, or at least that the focus has shifted significantly towards iris recognition.

New embedded products launched during the quarter

Smartcards, automotive and embedded To have 10% of revenues stemming from other segments than smartphones is still the company’s goal for 2018. This was restated in the Q2 report, backed up by a number of product launches in the Embedded business line. Some products mentioned were USB memory sticks, door locks, cryptocurrency payment cards and a smart suitcase. Another big order that was mentioned was the integration of iris recognition sensors from Fingerprints in the Indian point-of-sales terminals from ApnaPay.

First smartcard orders received

Fingerprints received two initial orders for the T-shape module and sensor for smartcards during the second quarter. The company stated that while this was a milestone for the business line, it will take longer for volumes to really increase. The CEO remarked that the results from the market trials have been positive and that guidance is still for limited volumes to be released in 2019 and slowly picking up from 2020.

Restructuring and changes in management The company expects the cost-cutting measures announced in June to be completed in Q3 and to cut opex by two-thirds compared with 2017. Q2 restructuring costs were SEK 43 m, but around SEK 22m more could be expected in Q3 if the initial guidance for restructuring costs proves accurate.

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Management team reduced in size

A restructuring of the organisation was in place by 1 July 2018, with the management team being reduced to six members from the previous ten. This was made possible with, among other changes, the merger of the two business lines, Smartcards and Automotive & Embedded, into one unit with a single Senior VP, Thomas Rex.



Estimate revisions Although the Q2 numbers were mostly in line with our estimates, we take Fingerprints’ recent statements into account and revise our forecasts accordingly in the coming years. We detail our estimate revisions below, and reiterate our valuation range of SEK 5.5-9.6.

Sales predictions enhanced The largest deviation from our estimates was that Q2 sales came in 44% higher than we had expected. This leads us to conclude that while the market is challenging, Fingerprints has a greater ability to sell its products than we had believed, and its market share might not have taken as large a hit as previously thought. We therefore increase our sales revenue forecasts considerably for the coming quarters, particularly for Q3, which has historically been a strong quarter.

Gross margins supressed until the new sensors and cost-cutting programmes are launched

The gross margin, adjusted for the inventory writedown, was sequentially flat at 15%, leading us to cut our gross margin forecasts for the remainder of the year. However, we still expect future margins to increase with the launch of the low-cost sensor FPC1511 and growth of new product segments.

Opex declined, but was burdened by restructuring

Operating expenses were SEK 198m, with SEK 49m in sales expenses (-13% y/y), SEK 73m in administrative expenses (-20% y/y after adjusting for restructuring charges of SEK 43m) and development costs (-24% y/y). We expect operating expenses to continue to decline as a consequence of the announced cost savings. Another SEK 22m in restructuring costs are expected for Q3. The opex run-rate should fall below SEK 400m annually by the end of 2018, before adjusting for R&D capitalisation and expenses, we estimate.

FINGERPRINTS' REVENUES


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ADJUSTED GROSS MARGINS

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Heavier price erosion in in-display sensors

While Fingerprints’ CEO stated that the price erosion in capacitive fingerprint sensors for smartphones in 2018 was likely to be as pronounced as it was in 2017, our estimates might have been on the aggressive side. We increase our ASP forecast for H2 2018 as a result of this. His comments about in-display sensors being subject to as heavy a price pressure as we witnessed in capacitive sensors in the coming years, as more competitors release their products, made us increase our price erosion projection somewhat for the product. At the same time, we make no changes to the initial price level and we increase attachment rates owing to our assumption that smartphone manufacturers’ willingness to pay for the technology will not wane.

Face recognition revenues set to zero

While we now believe that Fingerprints has shut down or shifted focus from its development of a face recognition technology, we still believe that its main share of the touchless sensor market is going to be in iris recognition, where it already has the technology available. We revise our estimates for touchless sensors’ volumes by heavily reducing the part stemming from face technology. Since this was not a material part of our revenue estimates, it barely changes our forecast.

CAPACITIVE SENSOR ASP IN-DISPLAY SENSOR ASP

Source: Nordea estimates Source: Nordea estimates

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FINGERPRINT CARDS: EARNINGS REVISIONS

SEKm Q3E Q4E 2018E 2019E 2020E Q3E Q4E 2018E 2019E 2020E Q3E Q4E 2018E 2019E 2020ESales 470 389 1,539 1,686 1,806 281 269 1,110 1,266 1,452 +67% +44% +39% +33% +24%Adj. gross profit* 94 78 276 489 569 67 70 242 361 428 +39% +11% +14% +36% +33%Adj. gross margin* 20% 20% 18% 29% 32% 24% 26% 22% 29% 30% -4.0pp -6.0pp -3.8pp +0.5pp +2.0pp

Adj. EBIT* -56 -62 -336 8 96 -83 -70 -393 -25 76 +32% +11% +14% +133% +27%Adj. EBIT margin* -12% -16% -22% 0% 5% -30% -26% -35% -2% 5% +18pp +10pp +14pp +3pp +0.1pp

Pre-Tax profit -83 -67 -926 -7 96 -138 -90 -1,010 -40 76 +40% +25% +8% +84% +27%EPS -0.21 -0.17 -2.34 -0.02 0.24 -0.34 -0.22 -2.51 -0.10 0.19 +40% +25% +7% +84% +27%

Capacitive units shipped (m) 59 54 202 212 215 42 46 165 173 155 +40% +17% +22% +23% +39%ASP (USD) 0.8 0.8 0.8 0.7 0.6 0.7 0.6 0.8 0.6 0.5 +15% +18% +9% +9% +9%In-display units shipped 0 0 0 2 9 0 0 0 1 10 0% 0% 0% +100% -15%ASP (USD) 4.0 3.5 4.2 2.9 2.1 4.3 4.0 4.4 3.5 2.8 -6% -13% -5% -17% -27%Touchless units shipped 4 4 16 48 69 4 4 16 52 76 0% 0% 0% -7% -10%ASP (USD) 0.24 0.24 0.19 0.17 0.15 0.24 0.24 0.19 0.17 0.15 0% 0% 0% 0% 0%Smartcard sensors shipped - - - 5 13 - - - 5 13 0% 0% 0% 0% 0%ASP (USD) - - - 4.0 2.8 - - - 4.0 2.8 - - - 0% 0%Source: Nordea estimates*Gross profit has been adjusted for the SEK 305m inventory writedown in Q2 2018 and EBIT has been adjusted for SEK 105m restructuring costs from the cost-cutting programme in 2018

DiffNew Estimates Old Estimates



Q2 results beat estimates on sales, while gross margin lower than expected

Sales results beat our estimates and consensus by 44% and 31%, respectively, and adjusted gross profit was in line, but the gross margin subsequently came in below expectations. The negative operating profit was pretty much as we had expected, leading us to mostly revise our estimates for sales and gross margin, primarily in 2018. We expect consensus to make similar adjustments as well.

FINGERPRINT CARDS DEVIATION TABLEActual Nordea Deviation Cons. Deviation Actual Actual

SEKm Q2 Q2E vs. actual Q2E vs. actual Q1 2018 q/q Q2 2017 y/ySales 390 270 120 44% 297 93 31% 290 35% 823 -53%

Adj. gross profit 59 59 -0.1 0% 61 -2 -3% 45 32% 300 -100%Adj. gross margin 15% 22% -7pp -31% 21% -5pp -26% 15% -2% 36% -

Reported EBIT -578.2 -585 6 1% -544 -34 -6% -175 231% 72 -903%Operating margin -148% -217% +68pp +46% -183% +35pp +24% -60% 146% -

EPS -1.49 -1.48 0.01 1% -1.37 0.12 9% -0.47 216% 0.10 -1526%Source: Thomson Reuters, Nordea estimates, and company data

Marketing material commissioned by Fingerprint Cards

Factors to consider when investing in Fingerprint Cards Fingerprints has a chequered past, to say the least. Its journey as a listed company was rather uneventful at the outset, despite experiencing slow adoption of capacitive fingerprint sensors because its technology was ahead of its time. When it started gaining momentum, Fingerprints enjoyed a head start and growth was immense, providing its shareholders significant returns. However, competition finally caught up, and the company’s decline came equally fast. The company now faces great challenges, but is not down for the count just yet. With the introduction of new biometric modalities (eg in-display fingerprint sensors and iris recognition) and growth in new emerging segments, we see the possibility of a new dawn for Fingerprints. In combination with more streamlined operations, the business could once again return to earnings growth and close the current margin gap to its peers. However, expanding from one to three or more industrial segments, and from essentially one product line to four, is a balancing act when cash is scarce – it carries both high risk and potentially high rewards.

There are four main factors to consider

We consider the following factors critical when evaluating an investment in Fingerprint Cards:

• Its potential to become a next-generation technology leader

• Adjacent biometric market opportunities and an increased attachment rate for new applications that increase earnings diversification

• Streamlined operations and a new product offering set to improve margins

• Its potential as a takeover target

The most important risks are mainly related to future revenue streams

The main risks to consider are the following:

• Fingerprints’ competitive position could be threatened by new smartphone biometric sensor standards

• Uncertainty regarding the future size and growth of new market opportunities within smartcards, automotive and embedded solutions

• Challenging market conditions with immense competition and pressure on price

• The potential need to turn to capital markets in the future due to the pressure on the company’s financial position

• High concentration of existing and potential customers, with the ten largest customers accounting for 98.8% of revenues

We believe that in-display fingerprint sensors will become the future norm in smartphones

Technology leadership position still up for grabs

The (near) future is in-display Touchless biometric modalities have become attractive to customers and manufacturers in the smartphone market. Fingerprints was quick to announce that it is developing face recognition software after Apple’s Face ID launch, in addition to its already available iris recognition solution. These two modalities are likely to become increasingly popular and we have already seen a slight increase in face recognition sensors in non-Apple smartphone models over the last year. However, it is clear that the current high-end smartphone ‘arms race’ is about in-display fingerprint sensors. Due to the constantly shrinking bezels and more minimalistic smartphone designs, space for fingerprint sensor attachment is declining on new devices.

This spring, we witnessed the launch of a handful of devices sporting huge displays with fingerprint sensors built into the actual screen of the device. Despite receiving praise for the design, the sensors are reportedly slow, and there is room for



improvement by moving from “hot zone” detection, where only a very small part of the display is able to detect the fingerprint, to full-display detection.

Opportunity for Fingerprints to take a leadership position in next-generation high-end smartphones

So far, Fingerprints is, according to our understanding, the only biometric sensor company to announce the development of a full-display sensor, using ultrasound technology to create a fast and reliable fingerprint sensor that can detect a fingerprint anywhere on the display. While Qualcomm has a finished and ready-to-ship in-display ultrasound sensor, it is ”hot zone-based” and has not gained traction in the consumer market yet. Fingerprints, assuming its product is released ahead of the competition, could enjoy first-mover advantage, and thus once again grab a large share of the high-end smartphone market for biometric sensors.

However, the issue is R&D capability: Fingerprints is a smaller company than most of its competitors. Considering recent cost and personnel reductions, as well as its diversified R&D focus, we are not surprised that Fingerprints will not release the sensor in H2 2018 as previously indicated. The risk of bringing the sensor to market too late, or that it will simply be too expensive, cannot be ignored.

Capacitive sensors likely to be around for the foreseeable future

The opportunities of future product markets Capacitive fingerprint sensors in smartphones have become commonplace, but are likely to be replaced by ultrasound and optical solutions in the coming years because they, contrary to capacitive sensors, work through smartphone displays. However, capacitive sensors are still easy to implement, cheap to produce and offer high degrees of security and convenience. Despite the heavy competition, Fingerprints is still a market leader in this area; as such, when the company ventures into new markets, it brings considerable experience to the table.

SMARTPHONE SHIPMENTS FINGERPRINT SENSOR ATTACHMENT RATE

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New segments like smartcards could add earnings diversification

According to the company, smartcards are the single-largest future opportunity for Fingerprints. With more than 3 billion payment cards shipped annually around the world, the addressable market is huge. Using its newly launched T-shape module and sensor series, the company has already started testing sensor-equipped cards. It is one of only a few players openly planning to enter the maturing market with an actual product. Combined with the increasing implementation of fingerprint sensors in other segments (eg home security, automotive and the Internet of Things), this should diversify Fingerprints’ offering and make the company less vulnerable to volatility in smartphone volumes.

Willingness-to-pay likely low; important to drive cost of sensors down

Even though 3 billion cards seems like a large number, researchers from IDC and ABI forecast the number of biometric payment cards could end up somewhere around 95-160 million by 2022. This corresponds to an attachment rate of less than 5%, out of which Fingerprints would have a market share of 50% at most, according to our estimates. Its gross margins in the early market should reach between 40-60%, but once competition catches up, we would expect this to decline towards 25-35%. Combined with a declining average selling price (ASP) for capacitive sensors and the willingness-to-pay challenge of attaching a sensor to a USD 2 card rather than a USD 400 smartphone, we will most likely see penetration only in the more high-end smart card segments during the first few years. It is clear that this new technology will not return the company to its 2015-16 revenue levels; however, it could help to ensure its future revenue prospects.

New cost-reduction programme to drive opex below SEK 400m before capitalisation of R&D

Product innovation should adapt to demand for smaller and cheaper sensors

Returning to cost leadership To ensure future competitiveness and a return to earnings growth, Fingerprints has implemented a number of measures to improve its margins. The company has already executed one cost-cutting programme and recently announced another one, from which it should reap the benefits during the latter part of this year. The latest programme aims to adapt to the ongoing challenging market conditions for capacitive sensors and is expected to reduce headcount by an additional 125 employees, compared to its total of 347 employees during Q2 2018. These actions will be finalised in Q3 and should generate savings of SEK 350m for 2018, bringing its total annual operational expenses before capitalisation of R&D below SEK 400m, which was the level back in 2015. The recent announcement of the FPC1511 sensor, which the company claims to be its most cost-efficient sensor so far, is yet another driver to adapt to the latest shift in demand, which now favours smaller and cheaper fingerprint sensors. While the pricing of the sensor is not public, it is said to be the most cost-optimised sensor released by Fingerprints so far. If the new cost-cutting programme is executed properly and the FPC1511 gains order momentum by late this year or in early 2019, we believe the company should be able to close the margin gap to its peers and defend its leading position in the market for capacitive fingerprint sensors.

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Broken industry, not a broken company

Inevitable margin scenario is playing out

The current market situation is tough, which could incite consolidation

Challenging market could trigger industry consolidation With sensor prices in freefall, plummeting 30% annually in the last years, the capacitive sensor is being commoditised at a more rapid pace than likely anyone could have foreseen. On top of this, new industry standards are starting to emerge, creating the need for additional investments in R&D at the worst possible time. Industry experts such as ABI still rank Fingerprints as the market leader in a competitive assessment based on innovation and implementation, so its product and patent portfolio still holds value. Its experience in capacitive sensors should also offer first-mover advantages in new verticals and product categories.

The flipside of the brutal price erosion seen in the past few quarters would be that it amplifies the normalisation of a more realistic margin scenario than seen in 2016. Maintaining an EBIT margin of almost 40% for a commodity product is unrealistic in the long term. However, the rapid margin decline likely increases the odds that we are nearing a point where price pressure will start to subside.

With the market leader on the ropes, smaller competitors are also likely to struggle, which could start a wave of consolidation. Against that backdrop, we do not rule out that Fingerprints itself could be a target for companies such as Qualcomm/NXP, ST Electronics, Samsung, etc. Benchmarking its margins against its peers, we see scope for margin normalisation due to the recent underperformance, although margins likely will not return to previous highs. This has also been acknowledged by Fingerprints’ management along with the announced plans to streamline the organisation. A new owner could likely fast-track this development, although it would eventually require consent from the newly-elected chairman of the board, Johan Carlström, who is also the largest owner.

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Risk factors Below, we list the main risk factors that we find relevant for Fingerprint Cards. The purpose of this is not to provide a comprehensive picture of all of the risks that the company may face, but instead to highlight those that we find most relevant. The main risks we see relate to new industry standards, development speed, uncertainty of the potential in new market segments and the current financial position.

The biometric sensor market is going through a paradigm shift

Technology risk and new industry standards While fingerprint sensors are now used in around 60 % of all smartphones produced, the capacitive fingerprint sensor technology used by Fingerprints has been commoditised and the ASP has plummeted. The industry is also increasingly moving towards new standards, such as touchless recognition or in-display fingerprint sensors, and while Fingerprints has new technologies under development, the company has yet to implement them in a finished product. If Fingerprints does not meet its planned product roadmap, it risks losing market shares to competitors, such as Goodix and Synaptics, who have already successfully implemented and adapted versions of the new technology. Recent statements from the CEO as well as remarks made during the Q2 report indicate that Fingerprints have discontinued, or at least shifted focus from, its development of a 3D face recognition technology. The Q2 report also contained substantial writedowns in capitalised R&D, from one long-term and one more recent product development. While the company does not state it explicitly, we suggest that one of these probably refers to the presumably cancelled face recognition technology. While this might have been a necessary move to complete the cost-cutting programme, it also puts the company at risk of missing the target market if face recognition becomes the norm in future smartphones.

Few major OEMs make up for the majority of Fingerprints addressable markets, leading to volatility in both revenues and development costs

Customer concentration In 2017, 98.8% of Fingerprints’ revenue stemmed from its ten-largest customers, and 3 out of the 5 largest smartphone manufacturers are Fingerprints’ customers. This is primarily because almost all of the company’s large OEM customers are in the highly concentrated smartphone market. If Fingerprints fails to compete on product offerings and prices for now and for future generations of sensors, it could lose customers to its competitors, and revenue is likely to take a considerable beating with every lost customer.

Some of Fingerprints’ competitors have a more convincing history of innovation

Development speed The technology used in in-display fingerprint detection is not based on the same technology (capacitance-based fingerprint detection) that launched Fingerprints in the first place and the company does not have a legacy of revolutionising innovations in other areas. The development of in-display sensors presented during the November 2017 Technology Update promises cutting-edge technology in terms of ultrasound fingerprint detection and 3D face recognition. The first would, if presented soon, provide a sensor more advanced than anything currently found in the consumer market, but its development has been delayed. While Fingerprints spends a significant amount on R&D and has a large amount of PhDs in its development force, the company is up against competitors with superior R&D muscle, such as Synaptics and Qualcomm. The recently announced cost cuts and upcoming reductions in personnel could also slow the ongoing innovation process down and hamper the progress of future innovations. The risk is therefore that Fingerprints’ end products will not be competitive enough to maintain the company’s market share in high-end smartphones. With our estimated future revenues being reliant on the in-display launch, this is probably the major risk to consider for investors – a further delayed launch would weaken the outlook for Fingerprints.



There is no consensus on how big the future biometric markets will become

Size and growth of biometric sensor markets In a recent interview, the newly-elected chairman of the board, Johan Carlström, claims that Fingerprint Cards is the market leader in fingerprint detection and that smartcards and IoT will be a new, important market for the company’s detectors. While the current technology that Fingerprints offers would likely be well suited for many products, and the T-shape module for smartcard fingerprint sensors is promising, there is no guarantee that the company will enjoy a strong, long-lasting first-mover advantage in these markets. As new markets, price discovery is still ongoing, and the initial ASPs and the rate of future price decreases are still uncertain. The addressable market size is based on sensitive assumptions relating to the attachment rate, and these ultimately depend on the payment industry’s dynamics and the strategic choices of the major card producers. The ASP in new markets, such as IoT and automotive, is also likely to be lower than in the smartphone industry, as the sensors would not be bundled with the algorithms.

There is a risk that the future payment norm will be mobile phone payments

Future payment methods While using biometric identification as a security measure in payments would benefit consumers and be convenient to use, it is unclear whether or not the future lies in smartcards. In China, mobile payments on smartphones are replacing cash and card payments at a rapid pace, using services such as WeChat Pay and Alipay. Cards as a payment solution have been around for decades, but now that mobile devices are so prevalent, questions are raised regarding the benefits of smartcards as a payment medium compared with smartphones. There is a substantial risk that the smartcard business line levels off before it catches wind and these risks should not be ignored.

The barriers to entry in biometric sensors are not as high as previously thought

Loss of customers and further pressure on ASP Innovation, product mix and an increasing number of fingerprint sensor producers for smartphone implementation have burdened ASPs and proved that the barriers to entry in the biometric market are quite low. Prices could continue to decrease and customers could turn to other competitors in the current market. This customer churn will likely occur even if the company develops new innovations. Dual-sourcing is common in the smartphone industry, with OEMs diversifying their supplier portfolio for components. An extreme example is the recently announced Xiaomi Mi 8, which uses sensors from three different manufacturers (Goodix, Synaptics, and Fingerprints). This is one of the consequences of commoditisation, and the same thing will likely happen for future generations of sensors too. Both the Mi 8 and the Vivo X20 use in-display sensors from Goodix and Synaptics.

PAYMENT METHOD USAGE % WHO USED MOBILE PAYMENTS IN THE LAST MONTH

Source: Company data Source: GlobalWebIndex

Cash27%

Online payment

11%

Mobile payment

22%

Contact32%

Contactless8%

Payment cards40%

0%5%

10%15%20%25%30%35%40%45%

55-64 35-54 31-34Age



Cash is running low, while profits are tumbling

Cash flow shortage and profitability In the quarterly report, Fingerprints reported a cash balance of SEK 738m, and the company had a cash flow from operations of SEK 302m in Q2 2018. This follows a quarter of negative operating cash flow of SEK 204m, and the break in the negative cash flow trend for the company in this quarter was mainly due to a large tax refund. If the negative trend continues in the coming quarters, the company could face financial difficulties. Although high channel inventories are to blame for some of the losses, we argue that new innovations and segments, such as the in-display sensor, must gain traction and that orders for the new cost-efficient FPC1511 sensor need to be secured in order to improve margins. Without these, Fingerprints’ funds could soon be depleted. In comparison, the company’s margins (adjusted for the inventory writedowns in Q2) have been around 15% in the last two quarters, which is less than half of those reported by some of its closest peers. However, even if we expect market conditions to stay challenging, the CEO has stated that the company will not need more funding from the capital markets.

ADJUSTED GROSS MARGINS, FINGERPRINTS AND PEERS

Source: Thomson Reuters

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

Q3 15 Q4 15 Q1 16 Q2 16 Q3 16 Q4 16 Q1 17 Q2 17 Q3 17 Q4 17 Q1 18 Q2 18Fingerprints Goodix Synaptics EgisTec

CASH AND CASH EQUIVALENTS, AND CASH FLOW


-400

-300

-200

-100

0

100

200

300

400

500

600

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

Q2 2016 Q3 2016 Q4 2016 Q1 2017 Q2 2017 Q3 2017 Q4 2017 Q1 2018 Q2 2018

SEK

m

SEK

m

Cash and cash equivalents Cash flow from operations



Detailed estimates

FINGERPRINTS' VOLUMES AND ASPQ4 17 Q1 18 Q2 18 Q3E 18 Q4E 18 2017 2018E 2019E 2020E 2021E 2022E 2023E

USD/SEK 8.23 8.36 8.85 8.85 8.85 8.44 8.73 8.85 8.85 8.85 8.85 8.85Revenues (SEKm) 615 290 390 470 389 2,966 1,539 1,685 1,804 1,912 2,009 2,100Change y/y -62% -58% -53% -44% -37% -55% -48% 9% 7% 6% 5% 5%

Smartphone related units (m)Capacitive 54 38 51 59 54 246 202 212 215 224 233 243ASP (USD) 1.30 0.90 0.85 0.84 0.76 1.40 0.83 0.71 0.60 0.51 0.43 0.39Change y/y -28% -40% -41% -39% -42% -37% -41% -15% -15% -15% -15% -10%In-display 0 0 0 0 0 0 0 2 9 22 42 70ASP (USD) - 5.0 4.5 4.0 3.5 - 4.2 2.9 2.1 1.5 1.1 0.8Change y/y - - - - - - - -30% -30% -27% -25% -25%Face 0 0 0 0 0 0 0 0 0 0 0 0ASP (USD) - 0.24 0.24 0.24 0.24 - 0.24 0.22 0.19 0.17 0.16 0.14Change y/y - - - - - - - -10% -10% -10% -10% -10%Iris - - - - - - - 29 46 60 62 63 ASP (USD) - - 0.24 0.24 0.24 - 0.19 0.17 0.15 0.14 0.12 0.11 Change y/y - - - - - - - -10% -10% -10% -10% -10%

Smartcard related units (m) - - - - - - - 5 13 24 43 66ASP (USD) - - - - - - - 4.00 2.80 1.96 1.37 0.96Change y/y - - - - - - - - -30% -30% -30% -30%

Automotive & Embedded-related units (m)Capacitive 0.50 0.60 0.60 0.60 0.70 4 10 12 14 17 20 24 Touchless - 4.0 4.0 4.0 4.0 - 16.0 19.0 22.7 27.0 32.1 38.2 Source: Company data and Nordea estimates

FINGERPRINTS' P&LQ4 17 Q1 18 Q2E 18 Q3E 18 Q4E 18 2017 2018E 2019E 2020E 2021E 2022E 2023E

Net sales 615 290 390 470 389 2,966 1,539 1,685 1,804 1,912 2,009 2,100Change y/y -62% -58% -53% -44% -37% -55% -48% 9% 7% 6% 5% 5%Cost of goods sold -485 -245 -636 -376 -311 -1,977 -1,568 -1,196 -1,236 -1,300 -1,346 -1,407Gross profit 130 45 246- 94 78 989 29- 489 568 612 663 693 Gross margin 21% 15% -63% 20% 20% 33% -2% 29% 32% 32% 33% 33%

Sales expenses -64 -69 -49 -45 -45 -237 -208 -168 -172 -175 -179 -182Administrative expenses -41 -66 -73 -57 -30 -146 -226 -143 -129 -116 -104 -94Development expenses -100 -83 -77 -70 -65 -391 -294 -168 -171 -173 -172 -171Total opex -204 -218 -198 -172 -140 -774 -728 -480 -472 -464 -455 -447Change y/y 1% 10% 2% -2% -32% 29% -6% -34% -2% -2% -2% -2%Opex/sales 33% 75% 51% 37% 36% 26% 47% 29% 26% 24% 23% 21%Other operating incomes/expenses 34 -2 -134 0 0 -61 -136 0 0 0 0 0

Operating profit -41 -175 -578 -78 -62 155 -893 8 96 148 208 246Margin -7% -60% -148% -17% -16% 5% -58% 0% 5% 8% 10% 12%Net financial items 0- 13- 10- 5- 5- 13- 33- 15- - - - -

Pre-tax profit 41- 188- 588- 83- 67- 142 926- 7- 96 148 208 246 Tax 24 40 120 18 15 22- 193 1 21- 33- 46- 54- Tax rate 59% 21% 20% 22% 22% 15% 21% 22% 22% 22% 22% 22%Net profit -17 -148 -468 -65 -52 120 -733 -5 75 115 162 192EPS -0.05 -0.47 -1.49 -0.21 -0.17 0.38 -2.34 -0.02 0.24 0.37 0.52 0.61Source: Company data and Nordea estimates



Reported numbers and forecasts

INCOME STATEMENTSEKm 2013 2014 2015 2016 2017 2018E 2019E 2020E 2021E 2022ENet revenue 95 234 2,901 6,638 2,966 1,539 1,685 1,804 1,912 2,009 Revenue growth 828.4% 144.9% 1141.7% 128.9% -55.3% -48.1% 9.5% 7.1% 6.0% 5.1% EBITDA -22 -72 939 2,627 234 -785 104 192 244 304 Depreciation and impairments PPE -2 0 -6 -8 -14 -33 -16 -16 -16 -16 EBITA -23 -72 933 2,619 221 -819 88 176 228 288 Amortisation and impairments -11 -74 -17 -41 -66 -75 -80 -80 -80 -80 EBIT -34 -145 916 2,578 155 -893 8 96 148 208 of which associates 0 0 0 0 0 0 0 0 0 0 Associates excl. from EBIT 0 0 0 0 0 0 0 0 0 0 Net financials 1 2 -0 35 -13 -33 -15 0 0 0Pre-Tax Profit -33 -144 915 2,613 142 -926 -7 96 148 208 Reported taxes 0 -1 -112 -579 -22 193 1 -21 -33 -46 Net profit from cont. operations -33 -144 804 2,034 120 -733 -5 75 115 162 Discontinued operations 0 0 0 0 0 0 0 0 0 0 Minority interest 0 0 0 0 0 0 0 0 0 0 Net profit to equity -33 -144 804 2,034 120 -733 -5 75 115 162EPS -0.60 -2.32 12.50 6.48 0.38 -2.34 -0.02 0.24 0.37 0.52 DPS 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 of which ordinary 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 of which extraordinary 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

Profit margin in percent EBITDA -22.5% -30.7% 32.4% 39.6% 7.9% -51.0% 6.2% 10.6% 12.8% 15.1% EBITA -24.6% -30.7% 32.1% 39.5% 7.4% -53.2% 5.2% 9.8% 11.9% 14.3% EBIT -35.7% -62.2% 31.6% 38.8% 5.2% -58.1% 0.5% 5.3% 7.7% 10.3%

Adjusted earnings EBITDA (adj.) -22 -72 939 2,627 234 -680 104 192 244 304 EBITA (adj.) -23 -72 933 2,619 221 -713 88 176 228 288 EBIT (adj.) -34 -145 916 2,578 155 -221 8 96 148 208 EPS (adj.) -0.60 -2.32 12.50 6.48 0.38 -0.19 -0.02 0.24 0.37 0.52

Adjusted profit margins in percent EBITDA (adj.) -22.5% -30.7% 32.4% 39.6% 7.9% -44.2% 6.2% 10.6% 12.8% 15.1% EBITA (adj.) -24.6% -30.7% 32.1% 39.5% 7.4% -46.4% 5.2% 9.8% 11.9% 14.3% EBIT (adj.) -35.7% -62.2% 31.6% 38.8% 5.2% -14.4% 0.5% 5.3% 7.7% 10.3%

Performance metrics CAGR last 5 years Net revenue 36.5% 56.9% 162.7% 213.6% 312.2% 100.4% 63.9% -11.2% -26.7% -9.3% EBITDA 1.0% 48.8% 229.3% 330.6% n.a. 145.8% n.a. -32.7% -44.8% 6.7% EBIT 9.1% 55.8% 389.1% 455.9% n.a. 126.2% n.a. -43.1% -51.1% 7.7% EPS -14.9% 14.0% 302.6% 203.3% n.a. 40.6% -71.0% -62.8% -51.2% 7.7% DPS n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.

Average EBIT margin -35.7% -62.2% 31.6% 38.8% 5.2% -58.1% 0.5% 5.3% 7.7% 10.3% Average EBITDA margin -22.5% -30.7% 32.4% 39.6% 7.9% -51.0% 6.2% 10.6% 12.8% 15.1%Source: Company data and Nordea estimates

VALUATION RATIOS - ADJUSTED EARNINGSSEKm 2013 2014 2015 2016 2017 2018E 2019E 2020E 2021E 2022E P/E (adj.) n.m. n.m. 9.5 9.7 41.3 n.m. n.m. 27.0 17.5 12.5 EV/EBITDA (adj.) 9.8 1.4 n.m. 7.1 19.3 n.m. 15.6 7.8 5.5 3.8 EV/EBITA (adj.) 9.0 1.4 n.m. 7.1 20.5 n.m. 18.4 8.5 5.9 4.0 EV/EBIT (adj.) 6.2 0.7 n.m. 7.2 29.2 n.m. 192.8 15.6 9.1 5.5

Valuation ratios/reported earnings P/E n.m. n.m. 9.5 9.7 41.3 n.m. n.m. 27.0 17.5 12.5 EV/Sales -2.2 -0.4 -0.4 2.8 1.5 1.1 1.0 0.8 0.7 0.6 EV/EBITDA 9.8 1.4 n.m. 7.1 19.3 n.m. 15.6 7.8 5.5 3.8 EV/EBITA 9.0 1.4 n.m. 7.1 20.5 n.m. 18.4 8.5 5.9 4.0 EV/EBIT 6.2 0.7 n.m. 7.2 29.2 n.m. 192.8 15.6 9.1 5.5 Dividend yield (ord.) n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. FCF yield n.a. n.a. n.a. 5.4% 3.5% -5.7% 2.9% 6.3% 7.5% 9.8% Payout ratio 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%Source: Company data and Nordea estimates



BALANCE SHEETSEKm 2013 2014 2015 2016 2017 2018E 2019E 2020E 2021E 2022E Intangible assets 54 70 50 71 1188 1073 1033 993 953 913 of which R&D 0 0 0 0 0 40 40 40 40 40 of which other intangibles 54 70 50 71 1188 1033 993 953 913 873 of which goodwill 0 0 0 0 0 0 0 0 0 0 Tangible assets 5 19 21 29 47 -36 -36 -36 -36 -36 Shares associates 0 0 0 0 0 0 0 0 0 0 Interest bearing assets 0 0 0 0 0 0 0 0 0 0 Deferred tax assets 0 0 0 0 0 0 0 0 0 0 Other non-int. bearing assets 0 0 0 0 0 0 0 0 0 0 Other non-current assets 0 0 1 0 0 0 0 0 0 0 Total non-current assets 60 89 71 101 1235 1037 997 957 917 877 Inventory 20 99 153 673 646 354 354 361 382 402 Accounts receivable 31 116 618 1132 438 231 253 271 287 301 Other current assets 8 20 37 435 313 46 51 54 57 60 Cash and bank 212 102 1031 1162 920 562 398 525 676 874 Total current assets 271 336 1839 3402 2317 1193 1056 1211 1403 1637 Assets held for sale 0 0 0 0 0 0 0 0 0 0Total assets 330 425 1910 3503 3552 2230 2052 2167 2319 2514

Shareholders equity 288 301 1147 2226 2331 1298 1292 1367 1483 1645 of which preferred stock 0 0 0 0 0 0 0 0 0 0 of which Equity of hyb. debt 0 0 0 0 0 0 0 0 0 0 Minority interest 0 0 0 0 0 0 0 0 0 0 Total Equity 288 301 1147 2226 2331 1298 1292 1367 1483 1645 Deferred tax 0 0 0 136 190 190 190 190 190 190 Long term int. bearing debt 0 0 0 0 222 0 0 0 0 0Non-current liabilities 0 0 0 0 0 0 0 0 0 0 Pension provisions 0 0 0 0 0 0 0 0 0 0 Other long-term provisions 0 0 0 0 0 0 0 0 0 0 Other long-term liabilities 0 0 0 0 0 0 0 0 0 0 Convertible debt 0 0 0 0 0 0 0 0 0 0 Shareholder debt 0 0 0 0 0 0 0 0 0 0 Hybrid debt 0 0 0 0 0 0 0 0 0 0 Total non-curr. liabilities 0 0 0 136 412 190 190 190 190 190 Short-term provisions 15 22 101 258 190 185 202 216 229 241 Accounts payable 26 66 549 822 268 292 320 343 363 382 Other current liabilities 2 36 114 61 108 43 47 51 54 56 Short term interest bearing debt 0 0 0 0 243 222 0 0 0 0 Total current liabilities 42 123 763 1141 809 742 569 610 646 679 Liab.for assets held for sale 0 0 0 0 0 0 0 0 0 0Total liabilities and equity 330 425 1910 3503 3552 2230 2052 2167 2319 2514

Balance sheet and debt metrics Net debt -212 -102 -1031 -1162 -455 -340 -398 -525 -676 -874 Working capital 32 132 145 1358 1021 295 290 292 310 325 Invested capital 91 221 217 1458 2256 1332 1286 1249 1226 1202 Capital employed 288 301 1147 2362 2743 1488 1483 1557 1673 1835 ROE -49.0% 111.0% 120.6% 5.3% -40.4% -0.4% 5.6% 8.1% 10.4% 11.0% ROIC -50.8% -93.2% 367.3% 239.6% 7.0% -39.4% 0.5% 5.9% 9.3% 13.3%

Net debt/EBITDA n.m. n.m. -1.1 -0.4 -1.9 n.m. -3.8 -2.7 -2.8 -2.9 Interest coverage -73.2 -286.4 2,289.0 n.m. n.m. n.m. n.m. n.m. n.m. n.m.Equity ratio 87.0% 70.9% 60.0% 63.5% 65.6% 58.2% 63.0% 63.1% 63.9% 65.4%Net gearing -73.7% -33.8% -89.9% -52.2% -19.5% -26.2% -30.8% -38.4% -45.6% -53.1%Source: Company data and Nordea estimates



CASH FLOW STATEMENTSEKm 2013 2014 2015 2016 2017 2018E 2019E 2020E 2021E 2022EEBITDA (adj.) for associates -22 -72 939 2627 234 -639 104 192 244 304 Paid taxes 0 0 -2 -498 -345 193 1 -21 -33 -46 Net financials 1 0 0 0 0 -33 -15 0 0 0 Change in Provisions 15 6 80 157 -68 -5 18 14 13 12 Change in other LT non-IB 0 0 -1 1 0 0 0 0 0 0 Cash flow to/from associates 0 0 0 0 0 0 0 0 0 0 Dividends paid to minorities 0 0 0 0 0 0 0 0 0 0 Other adj. to reconcile to cash flow -15 -20 -64 -157 112 -300 0 0 0 0Funds from operations (FFO) -20 -86 951 2130 -68 -784 108 185 224 270 Change in NWC -11 -88 -43 -1000 444 725 6 -2 -17 -16Cash flow from op. (CFO) -31 -174 908 1130 377 -59 114 183 207 254 Capital Expenditure -38 -76 -17 -63 -204 -56 -56 -56 -56 -56Free Cash Flow before A&D -69 -250 891 1067 173 -115 58 127 151 198 Proceeds from sale of assets 0 0 0 0 0 0 0 0 0 0 Acquisitions 0 -15 0 0 0 0 0 0 0 0 Free cash flow -69 -265 891 1067 173 -115 58 127 151 198

Dividends paid 0 0 0 0 0 0 0 0 0 0 Equity issues / buybacks 221 155 48 -1000 0 0 0 0 0 0 Net change in debt 0 0 0 0 0 -243 -222 0 0 0 Other financing adjustments 0 0 0 0 0 0 0 0 0 0 Other non-cash adjustments 0 0 -9 64 -415 0 0 0 0 0 Change in cash 151 -110 929 131 -242 -358 -164 127 151 198

Cash flow metrics Capex/D&A 104% 123% 107% 173% 1344% 22% 58% 58% 58% 58% Capex/Sales 13.8% 38.8% 0.9% 1.3% 36.1% 3.6% 3.3% 3.1% 2.9% 2.8%

Key information Share price year end (current) 10.9 7.0 118.2 62.9 15.8 6.4 6.4 6.4 6.4 6.4 Market cap - - - 19,735 4,964 2,022 2,022 2,022 2,022 2,022 Enterprise value 211.8- 101.9- 1,031.3- 18,573 4,509 1,682 1,624 1,497 1,346 1,148 Diluted no. of shares, year-end (m) - - - 314 314 314 314 314 314 314 Source: Company data and Nordea estimates

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Analyst shareholdings Nordea Markets equity and credit analysts do not hold shares in the companies that they cover.No holdings or other affiliations by analysts or associates. Fair value and sensitivity We calculate our fair values by weighting DCF, DDM, SOTP, asset-based and other standard valuation methods. Our fair values are sensitive to changes in valuation assumptions, of which growth, margins, tax rates, working capital ratios, investment-to-sales ratios and cost of capital are typically the most sensitive. It should be noted that our fair values would change by a disproportionate factor if changes are made to any or all valuation assumptions, owing to the non-linear nature of the standard valuation models applied (mentioned above). As a consequence of the standard valuation models we apply, changes of 1-2 percentage points in any single valuation assumption can change the derived fair value by as much as 30% or more. All research is produced on an ad hoc basis and will be updated when the circumstances require it

Marketing Material This research report should be considered marketing material, as it has been commissioned and paid for by the subject company, and has not been prepared in accordance with the regulations designed to promote the independence of investment research and it is not subject to any legal prohibition on dealing ahead of the dissemination of the report. However, Nordea Markets analysts are according to internal policies not allowed to hold shares in the companies/sectors that they cover.

Market-making obligations in shares or derivatives and other significant financial interest Nordea Markets has no market-making obligations in Fingerprint Cards

Investment banking transactions In view of Nordea’s position in its markets readers should assume that the bank may currently or may in the coming three months and beyond be providing or seeking to provide confidential investment banking services to the company/companies.

Issuer Review This report has not been reviewed by the issuer prior to publication. Completion date 24 July 2018, 08:29 CET

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