COMPANY ANALYSIS 24 July 2017

Summary

Fingerprint Cards (FINGb.ST)

List: Large cap Snap!(dragon) Market Cap: 10,860 MSEK  Q2 EBIT was a weak SEK 72 million (exp. SEKm 219) as Industry: Semiconductors CEO: Christian Fredrikson we expected a sales drop of -40 percent while the Chairman: Jan Wäreby outcome was -51 percent. The adjusted gross margin fell

to 42 percent, worse than we and consensus expected, and therefore needs to be closely monitored ahead. OMXS 30 Fingerprint Cards 140  Inventory normalized by declining SEK 229 million 120 from Q1. Operating cash flow reached SEK 528 million. 100 80 Besides that we believe the relief rally for the FPC shares 60 was related to the Qualcomm Snapdragon deal where 40 FPC 1028 will be pre-integrated in six mobile platforms. 20 0 At the moment these platforms employ 235 models. 25-Jul 23-Oct 21-Jan 21-Apr 20-Jul

 We keep our reasonably pessimistic scenario of SEK 22 per share but we have lowered our base case to SEK 52

(58) related especially to the slower TAM trajectory and the weak Q2 gross margins.

Redeye Rating (0 – 10 points) Management Ownership Profit outlook Profitability Financial strength

5.0 points 2.0 points 6.0 points 6.0 points 7.5 points

Key Financials

2015 2016 2017E 2018E 2019E Share information Revenue, MSEK 2,901 6,638 5,172 6,040 7,518 Share price (SEK) 34.6 Growth 1,142% 129% -22% 17% 24% Number of shares (m) 314.0 EBITDA 954 2,661 1,213 1,663 2,241 Market Cap (MSEK) 10,860 EBITDA margin 33% 40% 23% 28% 30% Net debt 17E (MSEK) -1,559

EBIT 910 2,613 1,144 1,525 2,052 Free float (%) 100 % EBIT margin 31% 39% 22% 25% 27% Daily turnover (’000) 18000 Pre-tax earnings 910 2,614 1,118 1,498 2,031 Net earnings 798 2,035 867 1,168 1,584 Net margin 28% 31% 17% 19% 21%

2015 2016 2017E 2018E 2019E

Dividend/Share 0.00 0.00 0.83 1.12 1.51 Analysts:

2015 2016 2017E 2018E 2019E EPS adj. 2.54 6.48 2.76 3.72 5.05 Viktor Westman

P/E adj. 46.8 9.7 12.5 9.3 6.9 [email protected] EV/S 12.5 2.8 1.8 1.4 1.0 EV/EBITDA 38.1 7.0 7.7 5.2 3.5

Important information: All information regarding limitation of liability and potential conflicts of interest can be found at the end of the report.

Redeye, Mäster Samuelsgatan 42, 10tr, Box 7141, 103 87 Stockholm. Tel +46 8-545 013 30. E-post: [email protected] Fingerprint Cards Redeye Rating: Background and definitions

The aim of a Redeye Rating is to help investors identify high-quality companies with attractive valuation.

Company Qualities

The aim of Company Qualities is to provide a well-structured and clear profile of a company’s qualities (or operating risk) – its chances of surviving and its potential for achieving long-term stable profit growth.

We categorize a company’s qualities on a ten-point scale based on five valuation keys; 1 – Management, 2 – Ownership, 3 – Profit Outlook, 4 – Profitability and 5 – Financial Strength.

Each valuation key is assessed based a number of quantitative and qualitative key factors that are weighted differently according to how important they are deemed to be. Each key factor is allocated a number of points based on its rating. The assessment of each valuation key is based on the total number of points for these individual factors. The rating scale ranges from 0 to +10 points.

The overall rating for each valuation key is indicated by the size of the bar shown in the chart. The relative size of the bars therefore reflects the rating distribution between the different valuation keys.

Management Our Management rating represents an assessment of the ability of the board of directors and management to manage the company in the best interests of the shareholders. A good board and management can make a mediocre business concept profitable, while a poor board and management can even lead a strong company into crisis. The factors used to assess a company’s management are: 1 – Execution, 2 – Capital allocation, 3 – Communication, 4 – Experience, 5 – Leadership and 6 – Integrity.

Ownership Our Ownership rating represents an assessment of the ownership exercised for longer-term value creation. Owner commitment and expertise are key to a company’s stability and the board’s ability to take action. Companies with a dispersed ownership structure without a clear controlling shareholder have historically performed worse than the market index over time. The factors used to assess Ownership are: 1 – Ownership structure, 2 – Owner commitment, 3 – Institutional ownership, 4 – Abuse of power, 5 – Reputation, and 6 – Financial sustainability.

Profit Outlook Our Profit Outlook rating represents an assessment of a company’s potential to achieve long-term stable profit growth. Over the long-term, the share price roughly mirrors the company’s earnings trend. A company that does not grow may be a good short-term investment, but is usually unwise in the long term. The factors used to assess Profit Outlook are: 1 – Business model, 2 – Sale potential, 3 – Market growth, 4 – Market position, and 5 – Competitiveness.

Profitability Our Profitability rating represents an assessment of how effective a company has historically utilised its capital to generate profit. Companies cannot survive if they are not profitable. The assessment of how profitable a company has been is based on a number of key ratios and criteria over a period of up to the past five years: 1 – Return on total assets (ROA), 2 – Return on equity (ROE), 3 – Net profit margin, 4 – Free cash flow, and 5 – Operating profit margin or EBIT.

Financial Strength Our Financial Strength rating represents an assessment of a company’s ability to pay in the short and long term. The core of a company’s financial strength is its balance sheet and cash flow. Even the greatest potential is of no benefit unless the balance sheet can cope with funding growth. The assessment of a company’s financial strength is based on a number of key ratios and criteria: 1 – Times-interest-coverage ratio, 2 – Debt-to-equity ratio, 3 – Quick ratio, 4 – Current ratio, 5 – Sales turnover, 6 – Capital needs, 7 – Cyclicality, and 8 – Forthcoming binary events.

Company analysis 2 Fingerprint Cards Investment case

 Critics have an oversimplified view of increased competition as the sole problem  Major stock market distrust from missed targets, insider crime accusations etc.  Earnings beat in Q4’17 could make the stock move  Attractive margin of safety

Critics have an oversimplified view of increased competition as the sole problem Our interpretation of the severe drop in shares of FPC is that the general view out there, in the eyes of the critics, is an image of increasing competition causing the decline. Consequently, it is argued that dual sourcing will put fierce pressure on the gross margins. We are not dismissing this valid counter-argument but we believe the picture is more complex than that, involving some important, short term issues, whose impact are not fully understood by the stock market. FPC failed to see and prepare for the higher sell-in than sell-through, which caused a bull whip effect and excess inventory build-up throughout the whole value chain. This part of the story is well known but making matters worse, shortage of displays (LCD as well as AMOLED due to lower capacity and yields respectively) has led to unfavourable market share loss among FPC customers with high FPS penetration. The winners and the fastest growers have instead been the tier 2 and tier 3 smartphone manufacturers not relying on e.g. Samsung’s AMOLED displays, whereas FPC instead has focused on a handful module manufacturers working with tier-1 players, leaving some low hanging fruit for e.g. Goodix. Our conclusion is that these factors are all surmountable and short-term and if we are correct in this sense the share price decline is likely a classic recency bias overreaction.

Major stock market distrust from missed targets, insider crime accusations etc. We are not overly surprised by the negative trend for the share price given all the negative news such as profit warnings, insider crime accusations, fines from NASDAQ Stockholm Disciplinary Board due to shortcomings in the information disclosure and so on and so on. All these factors add up to a major distrust towards FPC, which should not go away anytime soon. As investors do not trust FPC they also tend to ignore e.g. the market leadership and the advantageous position with access to capacity as well as the strategic transition moving from selling semiconductor components to providing biometric solutions (e.g. own algorithm, Delta ID, SoC etc.). We also feel that the mistrust for FPC make investors neglect FPC’s solid position in the new verticals that will contribute to a fast total market growth. The coming new segments may be way delayed but it does not

Company analysis 3 Fingerprint Cards mean that FPC does not have the partnerships necessary etc.

Earnings beat in Q4’17 could make the stock move All trust has vanished. Forget about the number of launched smartphone models, bid rumours, Samsung orders, stock repurchases, Delta ID or other value-adding acquisitions, etcetera. Figures above consensus expectations is what is required to break the downward spiral for the share price. We need one or more likely multiple, strong “one finger salute” reports that beat earnings consensus. We believe consensus will be surprised on the upside in Q4’17.

Attractive margin of safety Our base case of SEK 52 per share implies an attractive margin of safety in relation to our reasonably pessimistic scenario of SEK 22.

Company analysis 4 Fingerprint Cards Snap!(dragon)

The FPC Q2 report was seen as a relief by the stock market, especially due to the operating cash flow of SEK 528 million. The strong cash flow supports FPC’s statement that the inventory levels indeed seem to have normalized - an important step in improving the stock market’s trust in the company and Management. However, FPC still do not have reliable market data and is therefore not allowed to give any guidance. It also pointed out that the guidance has historically been very inaccurate. FPC e.g. now expects 2017 volumes of about 800 million compared to previously 900 million, as a consequence of the inventory issues and slower penetration than forecasted in the entry level segment. The Qualcomm Snapdragon deal could be an important game changer here (more on that deal below). Overall, the smaller players have a harder time coping with the aftermath of the inventory issues. In the same way the harsh market environment has been positive for FPC’s competitive landscape as competition, according to the FPC CEO, is now decreasing. It is too soon to talk about a shakeout but there seems to be no new players. In addition, dual sourcing that has previously been a negative factor is starting to work more in FPC’s favour now.

FPC did comment that the market shares declined below 50 percent in Q2 but that is has begun to regain shares again due to launches from large customers like e.g. Huawei and Oppo. Given the low visibility a possible quick return to market shares above 50 percent should be taken with a grain of salt. Our interpretation of FPC’s statement is that the regain in recent customer wins could push FPC above 50 percent again assuming customers’ market shares are roughly the same (which they on the contrary probably won’t be). Not only the large customers but all of FPC’s customers have started to order sensors again in Q2 though. As for phone models 19 new models have been launched by 12 customers, whereof 3 new ones (UMIDIGI, AGM and one still not named). We have not studied the win ratio in detail but the number of wins are not as good as last year although fewer phones in total seem to have been launched. In addition to the phones, FPC also had launches with Microsoft Modern Keyboard and Huawei Matebook E as well as in the smartcard space, which we will return to below.

All in all, we believe there were no ground-breaking news in the Q2 report compared to our previous two updates. New readers are advised to read our still largely relevant March update in order to understand the full background of our investment case and analysis of why FPC stumbled and why it could likely get up again, alternatively the shorter summary after Q1.

Company analysis 5 Fingerprint Cards Weak gross margins & major deviations in our estimates Evident from the table on next page and our initial report comment we were far from right in most of our estimates but the major differences were clearly in sales that came in 18 percent lower than our estimates, which we believe is due to us underestimating the market share losses.

Estimates (Redeye and average of SME Direkt consensus) vs reported

Q2 2016 Q2 2017A Q2 2017E Difference Consensus Difference

Net sales 1666.1 823.4 1005.3 -18% 859 -4% COGS -852.4 -523.5 -582.6 -10% -491 7% Gross profit 813.7 299.9 422.6 -29% 368 -19% Gross margin 48.8% 36.4% 42.0% -13% 42.8% -15%

OPEX -227.9 of which sales costs -45.8 -55.8 -61.0 -9% of which administrative costs -34.5 -37.2 -35.0 6% of which development costs -60.0 -101.3 -108.0 -6% of which other operating income/expenses 36.3 -33.6 0.0 n/a EBIT 709.7 72.0 218.6 -67% 155 -54% EBIT margin 42.6% 8.7% 21.7% -60% 18.0% -52%

Net financials 0.1 -24.7 0.0 n/a 1.0 -2570% Profit before tax (PBT) 709.8 47.3 218.6 -78% 154.0 -69%

Income tax -155.4 -14.5 -48.1 -70% -34.0 -57% Profit for the period 554.4 32.8 170.5 -81% 120.0 -73%

EPS 0.35 0.10 0.54 -81% 0.39 -73%

Adjusting the gross margin of 36 percent for the obsolescence charges of 8 percentage points the underlying gross margin reached a considerably better 42 percent but was still down 2 percentage points from Q1’17. In addition, amortization of capitalized development costs, had a larger relative impact on the lower revenues equivalent to about 2 percentage points of revenues, compared to 3 percentage points in Q1. In our opinion the Q2 gross margin was a bit weak and as we do not know if this is more due to product mix or lower prices (likely a combination of both) we chose to be conservative and believe it is the second one. The CEO several times pointed out that constant innovation is required to keep the gross margins around the target of 40-45 percent. FPC’s innovation of increasingly smaller sensors has a close to 100 percent relationship with lower cost of silicon. FPC states that it largely drives the ASP decline of over 20 percent but the main question is rather how much of the COGS (silicon) savings that it can keep to itself.

The underlying OPEX, outside of the SEK 16 million in currency effects and SEK 18 million in transaction costs from the Delta ID acquisition, was in line with our estimates.

Company analysis 6 Fingerprint Cards FPC 1028 to be pre-integrated on Qualcomm’s mobile Snapdragon platforms In conjunction with the Q2 report FPC also announced that the FPC 1028 will be pre-integrated in six of Qualcomm’s mobile platforms as FPC and Qualcomm in an aligned approach look to take on the important entry/mid- level segments of in total over 500 million units where especially the entry level phones is expected to grow faster than the market. It is therefore actually a good thing, according to us, that the entry level market growth has been delayed. Qualcomm and its ultrasound sensor will remain an FPC competitor in the high end segment though, meaning the Qualcomm threat is not entirely gone.

The nature of the pre-integration of FPC 1028 deal means that FPC will be listed as the only preferred vendor, although there are no exclusivity. The pre-integration will reduce time to market for the smaller tier 2 and tier 3 smartphone players. The processes of mounting sensors and chips as well as performing the testing and adding the software all take precious time. According to FPC smaller players neither have this time or the resources, meaning FPC and Qualcomm not only solve the time to market dilemma but also give the customers a cost advantage (albeit no lower gross margins for FPC as we understand it) and increased simplicity so that they can focus more on their core business.

The Qualcomm Snapdragon platforms (435, 430, 427 and 425) together with Qualcomm 210 and 212 Mobile Platforms in total at the moment include about 235 mobile device models. The phone models are from every large smartphone OEM on the market. Qualcomm in the end of 2016 owned 39 percent of the worldwide smartphone application processor market followed by Goodix owner MediaTek (23 percent) and Apple (15 percent). There are basically three suppliers sharing the Chinese market: Qualcomm, MediaTek and local Chinese company Spreadtrum. According to Gartner and Digitimes Qualcomm is gaining market shares in China by getting its Snapdragon processors into handsets at MediaTek’s customers Oppo, Vivo, Xiaomi, and Meizu. The grab could be as much as 40-60 million units.

Spreadtrum seems to have somewhere of around 220 models on its platform, whereof only 1 model with FPC so far (read more on Spreadtrum in our previous update). We believe it is important for FPC to pursue more Spreadtrum models as Spreadtrum in 2009 entered India - the fastest growing and the third largest market, soon to be number two. Spreadtrum states that its platform is adopted by almost half of the smartphones shipped to India.

Delta ID R&D targets substantially lower costs for iris The Delta ID acquisition was finalized during Q2. Delta ID’s sales year to date of SEK 6 million mean that Delta ID was acquired at a P/S multiple of about 62x. The annual burn rate is currently about SEK -40 million.

Company analysis 7 Fingerprint Cards One important reason behind acquiring Delta ID, according to FPC, was Delta ID’s focus on smartphones where FPC claims Delta ID has the best solution. Samsung chose Princeton Identity though but it is important to note that Samsung was the largest funder when Princeton was spun off from SRI Identity in 2016 and prior to that Samsung was a long-time partner of SRI International. Technological superiority was therefore not necessarily the reason why Princeton won the new Galaxy phone. In fact, the iris scanner of the Galaxy S8 was hacked by using a high resolution photography printed on a piece of paper. As Samsung with its investments in Princeton Identity appears to have already made its choice we view the effect of this blunder as mostly negative for FPC since it may harm the market acceptance for iris. Nevertheless, SRI Identity has over 20 years of experience in the iris business and has e.g. also worked with eye tracking since 1965. Princeton has a wider scope with government and boarder control applications etc. whereas Delta ID has focused on smartphones and coming down in size and cost.

Delta ID has so far won 8 phones from Fujitsu, Samsung, two secret customers and NEC (the cloud/server solution). Even though Delta ID 2017 sales thus far amount to SEK 6 million and about 350 000 units (assuming a USD 2 ASP) FPC has talked about market volumes in the hundreds of millions. We therefore expect FPC to use all of its channels possible to boost Delta ID sales. An important target before reaching such volumes though is bringing down the current cost levels of USD 6. Delta ID’s iris solution requires a second camera to filter the infrared light but as we understand it R&D is focused on developing a switchable filter which in theory would eliminate the need for a second camera, something we believe will substantially lower the costs for implementing iris in smartphones.

Taking on Goodix with more new module houses & distributors We have previously called for more partnerships in order for FPC to be able to take back market shares from e.g. Goodix in the fragmented tier 2/tier 3 space (over 150 potential customers) and we are therefore pleased to see that FPC continued to increase its reach in the eco system by adding a new module house partnership with Biel Crystal of Hong Kong following Chinese A-kerr (SPEED) and Fingerchip that we wrote about in our previous update. The Hong Kong based distributor Arrow Electronics also joined FPC’s partner consortium. The new partnerships bring the total to at least 11 module manufacturers and 16 distributors. Although not announced by FPC itself we believe FPC now is working with module house Truly Optics, which we find promising as Goodix growth likely is largely related to the strong growth of Truly Optics.

Company analysis 8 Fingerprint Cards Increased smart card traction In smart cards, traction for FPC appears to increase given news on more deals and partnerships. The MeReal deal is related to Plein open air casino and will initially only be used for granting employees access and record- keeping for time and attendance. Judging from the 43 casinos and hotels in the group’s portfolio, one would think we are looking at negligible volumes but the customer hopes to add more applications (access and payments) for employees as well as for its 1 million VIP players who currently carry a “Fairplayer” loyalty card, i.e. this deal actually has volume potential and there are likely a lot of other, similar opportunities.

In addition, Zwipe announced secured orders from two payment card players, one in Asia and one Global Tier 1 card manufacturer with expected deployment in Q3/Q4 2017. Last but not least FPC entered a new partnership with its Korean partner the global smart card supplier Kona I. The project includes four new smart cards. In our opinion these deals and progress was pretty much what to expect but we noticed strong, positive “it actually happens”-reactions on the stock market, which leads us to believe that the stock market has discounted a rather limited smart card potential.

Management delivered on its normalized inventory promise Operating cash flow came in at a good SEK 528 million and the cash at the end of the period of SEK 934 million should put a stop to the risks and rumours regarding the need for a rights issue. Perhaps most important, inventory levels, according to FPC, were normalized in the end of Q2, which we believe is an important step in rebuilding credibility for the company and its management. FPC’s own inventory decreased from SEK 1 048 million in Q1’17 to SEK 818 million, which clearly was good but according to FPC these are still high levels although more normalized than abnormal. We therefore assume there is a risk for obsolescence charges in Q3 as well even though we had expected FPC’s promise of normalized inventory in Q2 to be a conservative estimate due to the low visibility in the other parts of the value chain (from e.g. large shifts in the customers market shares) and given all problems and profit warnings etc. during the past quarters.

Company analysis 9 Fingerprint Cards Financial estimates

For 2017 we now expect 8 percent lower sales than our previous estimates (see the table below) due to lower volumes in smartphones, largely related to a slower penetration ratio in entry level phones (total TAM of 800 million instead of 900 million). We expect continuing inventory depletion in Q3 and we also therefore find it likely that Q3 will include further obsolescence charges and thus lower gross margins.

Redeye's revised estimates

Q3'17E Q4'17E 2017 E 2018 E 2019 E

Net sales - previous estimate 1,976 2,182 5,637 6,920 9,054 Adjustment (%) -15% -9% -8% -13% -17% Net sales - new estimate 1,684 1,978 5,172 6,040 7,518

Gross profit - previous estimate 887 978 2,440 2,921 3,693 Adjustment (%) -27% -18% -10% -17% -19% Gross profit - new estimate 647 800 2,194 2,422 2,992 Gross margin 38.4% 40.4% 42.4% 40.1% 39.8%

EBIT - previous estimate 684 764 1,622 1,979 2,561 Adjustment (%) -38% -25% -29% -23% -20% EBIT - new estimate 426 575 1,144 1,525 2,052 EBIT margin 25.3% 29.1% 22.1% 25.3% 27.3%

Profit before tax 426 575 1,118 1,498 2,031 Tax -94 -127 -250 -330 -447 Profit for the period 332 449 867 1,168 1,584 Profit margin 19.7% 22.7% 16.8% 19.3% 21.1% EPS (fully diluted shares outstanding) 1.06 1.43 2.76 3.72 5.05 Number of shares (millions) 314.0 314.0 314.0 314.0 314.0

We believe in a strong positive effect from Qualcomm in winning business in the entry level segment but expect no material impact prior to 2018. However, the slower TAM trajectory in smartphones affects our mid-term smartphone volume estimates by on average 60 million units per year. We would also have preferred to see more progress on the IoT side and therefore lower our 2017-2021 volume growth to 114 percent.

We expect a slower OPEX growth and selective expansion ahead as the recruitments made in Q2 to a large extent was initiated in 2016.

Sales Assumptions Our sales assumptions per segment is listed in the table on the next page:

Company analysis 10 Fingerprint Cards Assumptions for sales estimates - 2016-2021 CAGR 2016 2017 E 2018 E 2019 E 2020 E 2021 E 17-21

Units Mobile devices 319.5 316.0 380.0 417.8 442.4 448.8 9.2% Smart cards - 2.4 22.0 45.0 95.0 125.0 PC and PC peripherals 0.1 6.5 20.0 45.9 54.9 52.5 68.6% Automotive - 0.0 0.4 1.5 2.5 4.5 Delta ID & other non-sensor sales 0.8 3.3 19.8 42.6 83.3 219.5% IoT 1.6 2.4 5.0 13.0 30.0 50.0 113.6% Total units (only sensors) 321.2 327.3 427.4 523.2 624.8 680.9 20.1% Units, percentage change YoY 1.9% 30.6% 22.4% 19.4% 9.0%

ASP Mobile devices 2.4 1.8 1.5 1.5 1.4 1.4 -6.1% Smart cards - 2.6 1.9 1.7 1.7 1.6 -11.3% PC and PC peripherals 2.7 2.6 2.5 2.2 2.0 2.0 -6.3% Automotive - 0.0 9.0 8.0 7.5 7.0 Delta ID & other non-sensor sales 2.0 1.5 1.0 0.9 0.8 -19.5% IoT 7.6 5.5 3.2 3.0 2.7 2.4 -18.7% Weigthed average ASP (only sensors) 2.4 1.8 1.6 1.6 1.6 1.6 -3.6% ASP, percentage change YoY -23.6% -13.7% 0.0% -1.1% 1.0%

Total sensor/module sales, USD 777 605 681 834 986 1,085 15.7% Non-sensor sales, USD - 1.60 5.00 20 40 70 Net sales, SEK 6,638 5,172 6,040 7,518 9,025 10,164 18.4% Net sales, percentage change YoY 228.9% -22.1% 16.8% 24.5% 20.1% 12.6%

We expect Delta ID to contribute SEK 44 million and SEK 176 million respectively in years 2018 and 2019 (see the table above).

As mobile devices is a smaller part of the total in our new estimates the blended ASP is slightly higher, relatively speaking.

Company analysis 11 Fingerprint Cards Valuation conclusion & the share

We keep our bear case at SEK 22 per share but lower our base case from SEK 58 to 52 due to slower TAM growth and revised IoT assumptions as we would have preferred some more information on this part by now and therefore assume we have been too optimistic on IoT.

In addition, we have also lowered our gross margin estimates further as the outcome in Q2 was substantially weaker than expected. In our last update we wrote the following on gross margins: “We have reviewed our assumptions on the gross margin in FPC’s new dual sourcing environment and expect faster falling gross margins, similar to what happened in the smartphone camera sensors market. Importantly, dual sourcing does not necessarily mean lower volumes for FPC from customers choosing sub-standard or good-enough sensors over FPC. However, the mere threat from a substitute could be enough for customers to get a significantly stronger bargaining power against FPC, meaning the same volumes for FPC but at discounts and lower prices. We do not believe the price pressure necessarily will make ASP drop in line with the gross margin contraction as new solutions will be more advanced, although higher COGS together with the price pressure will limit the mark-up.“ These ideas are relevant for our new downward revisions as well. It is also interesting to contemplate on the gross margin consensus as consensus had even higher Q2 gross margin estimates than us despite considerably lower sales expectations. Consensus might come down a bit more here but we do not expect any major target price revisions as consensus seems to be rather pessimistic already.

The st0ck market’s confidence regarding FPC is still close to rock bottom levels albeit normalized inventory (as promised) was a good first step in regaining trust. However, as we have described in our investment case we believe the only thing that would really make a difference for the share price is strong reports well above consensus estimates.

Company analysis 12 Fingerprint Cards DCF valuation & scenario analysis

In our valuation of FPC we have used a discounted cash flow valuation (DCF) for three different scenarios to come up with our fair value range:

 Base case – the scenario we believe is the most likely  Bear case – a reasonably pessimistic scenario  Bull case – a reasonably optimistic scenario

The purpose behind the valuation range is to illustrate the uncertainty regarding the future of FPC as well as to illustrate what is factored in at a given price.

Based on our Redeye Rating model we use a required rate of return of 12.4 percent. This required rate of return, a terminal growth rate of 2.0 percent and a tax rate of 22 percent are used in all three scenarios. A discount rate of 12.4 percent might appear high for a Large Cap company, however we believe it is mandated to add an additional margin of safety due to e.g. the fast changing high-tech market.

Base case – biometric solutions for multiple segments In our base case FPC successfully completes the transition from component supplier to a leading provider of biometric solutions. Our assumptions are summarized below.

FPC: valuation assumptions in Base Case Assumptions 2016-26 2017-26 DCF valuation CAGR Sales 6.8% 10.6% WACC 12.4% EBIT margin (weighted avg.) 24.9% 23.9% NPV of FCF 8,768 ROIC (average) 237.0% 83.0% NPV of terminal value 6,410 ROE (average) 34.6% 26.0% EV 15,179 Terminal Net cash 1,162 Terminal FCF growth rate 2.0% Adjustment for dividend 0 EBIT margin (terminal) 20.2% DCF value 16,341 EV/SALES exit multiple 1.5x Fair value per share 52 EV/EBIT exit multiple 7.5x Current share price 35 Potential/Risk 50%

 Revenue growth at a CAGR of 7 percent from 2016 to 2026 for revenues of SEK 12.7 billion in 2026  Revenues from the mobile device segment averages SEK 5.2 billion during 2017-2026 and peaks at SEK 5.5 billion in 2021  Other segments start to significantly contribute to revenues in 2019 and gradually increase in importance the following years  Blended ASP stays more or less flat from 2017-2025 as we expect modules and combinations of multiple sensors and biometric modalities to be more expensive whilst the price of fingerprint sensors for the mobile device segment experience a slower decrease

Company analysis 13 Fingerprint Cards  Gross margin for hardware gradually decreases to 30 percent on average in 2025 but overall gross margin is 37 percent as non- sensor sales/software solutions have a higher gross margin  OPEX increases to 17 percent of revenues in 2025 as other segments are less scalable than the mobile device segment and also as a consequence of rapidly increasing R&D spend  EBIT-margin reaches 20 percent in 2025

Bear case – market share losses and margin pressure The bear case factors in both gradually declining market shares, adverse events and disruptive technologies that could negatively affect FPC. Our assumptions are summarized below.

FPC: valuation assumptions in Bear Case Assumptions 2016-26 2017-26 DCF valuation CAGR Sales 0.9% 4.7% WACC 12.4% EBIT margin (weighted avg.) 18.2% 16.1% NPV of FCF 4,254 ROIC (average) 206.9% 49.9% NPV of terminal value 1,564 ROE (average) 27.0% 17.6% EV 5,838 Terminal Net cash 1,162 Terminal FCF growth rate 2.0% Adjustment for dividend 0 EBIT margin (terminal) 9.3% DCF value 6,998 EV/SALES exit multiple 0.7x Fair value per share 22 EV/EBIT exit multiple 7.4x Current share price 35 Potential/Risk -33%

 Single digit sales growth as FPC loses market share in the mobile device segment and adoption of FPS in other segments is considerably slower than in base case  In our bear case we assume that FPC will have no revenues from non-sensor sales  With less scale, FPC will not have the resources to continuously innovate and its solutions face increasing commoditization  Gross margin decreases and falls to 37 percent in 2018 to reach 30 percent in 2025 as FPC loses bargaining power due to dual sourcing.  With less scale, OPEX as a percentage of sales reaches 21 percent, despite significantly lower R&D spend than in our base case

Bull case – Nvidia of biometrics In our bull case FPC manages to continually reinvent itself and reposition itself in the value chain. Our assumptions are summarized below.

Company analysis 14 Fingerprint Cards FPC: valuation assumptions in Bull Case Assumptions 2016-26 2017-26 DCF valuation CAGR Sales 16.3% 21.8% WACC 12.4% EBIT margin (weighted avg.) 28.8% 28.5% NPV of FCF 20,115 ROIC (average) 275.3% 125.1% NPV of terminal value 18,057 ROE (average) 43.3% 35.5% EV 38,192 Terminal Net cash 1,162 Terminal FCF growth rate 2.0% Adjustment for dividend 0 EBIT margin (terminal) 24.6% DCF value 39,334 EV/SALES exit multiple 1.9x Fair value per share 125 EV/EBIT exit multiple 7.5x Current share price 35 Potential/Risk 270%

 FPC manages to drive consolidation in the market and achieves a position allowing it to launch new business models where software sales make a larger contribution to revenues than in our base case  Double digit revenue growth for each year from 2018 to 2023 for revenues in excess of SEK 30 billion in 2025  The market share in the mobile device segment gradually declines to reach 35 percent in 2025, though the penetration of FPS and other biometrics is higher than in our base case  In the long term, blended ASP is higher than in base case as FPC manages to successfully expand its product portfolio with a high share of multimodal biometric system solutions  Gross margin stays over 40 percent until 2024 despite similar gross margins on HW as in base case, which is due to a higher share of non-sensor sales with a gross margin of 75 percent  Long-term EBIT margin to stay close to 25 percent supported by huge economies of scale

Company analysis 15 Fingerprint Cards Summary Redeye Rating

The rating consists of five valuation keys, each constituting an overall assessment of several factors that are rated on a scale of 0 to 2 points. The maximum score for a valuation key is 10 points.

Rating changes in the report No changes

Management 5.0p The Board as well as Management are basically brand new but have solid track records. The CEO has relevant and important experience from being CEO of FSecure. FPC’s execution was impressive during the ramp- up to delivery of one million sensors a day. However, historically it has not been good at meeting its targets and it did not anticipate the inventory build-up in 2016. In addition, share buybacks was made around ATH levels. Communication is gradually improving but we believe more transparency is needed. All in all, this results in an average management rating. Ownership 2.0p The insider holdings in Board and Management are insignificant in relation to our rating requirements, with a few exceptions, such as e.g. the COB. Most of the board members own no shares or close to 0. We find it positive that the CEO is buying shares, although his position at the moment is too small in relation to his salary. No owner has nowhere near 10 percent of the equity. On the positive side though a principal shareholder is represented on Board and holds a corner, which gives some protection against a hostile takeover bid.

Profit outlook 6.0p With a highly scalable business model, several new verticals as well as new offering that can provide growth beyond mobile devices and a leading position in a fast growing market, FPC is awarded with a high rating. What weighs on the downside are especially three factors pertaining to competitive dynamics; the number of new entrants, price pressure and how sustainable FPC's competitive advantages are. The market for biometrics solutions is still immature and new entrants attempt to steal market shares. There is a downward price pressure in the market but so far FPC has done a good job in combating declining ASP. Finally, as for the sustainability of the competitive advantages we believe FPC has a strong market position but we need to see a prolonged period of market leadership before we adjust our rating further upwards. Profitability 6.0p

Our profitability rating is retrospective and conservative. For a higher rating we require a longer period of high ROE, EBIT margin etc. and an ability to deliver strong cash flows.

Financial strength 7.5p FPC’s balance sheet is all in all solid even though most of the cash was invested in Delta ID or spent on share buybacks. The factors that weigh on the negative side are: the cyclicality of the mobile device industry and the high exposure to a few large customers such as Huawei. As FPC enters new verticals, and thereby lessens its dependence on individual customers and segments, we may re-evaluate our rating.

Company analysis 16 Fingerprint Cards

Income statement 2015 2016 2017E 2018E 2019E DCF valuation Cash flow, MSEK Net sales 2,901 6,638 5,172 6,040 7,518 WACC (%) 12.4 % NPV FCF (2017-2019) 2101 Total operating costs -1,947 -3,977 -3,958 -4,377 -5,277 NPV FCF (2020-2026) 6663 EBITDA 954 2,661 1,213 1,663 2,241 NPV FCF (2027-) 6408 Non-operating assets 1162 Depreciation -6 -6 -10 -15 -23 Interest-bearing debt 0 Amortization -37 -41 -59 -123 -166 Fair value estimate MSEK 16335 Impairment charges 0 -1 0 0 0 Assumptions 2017-2023 (%) EBIT 910 2,613 1,144 1,525 2,052 Average sales growth 14.5 % Fair value e. per share, SEK 52.0 EBIT margin 25.3 % Share price, SEK 34.6 Share in profits 0 0 0 0 0 Net financial items 0 0 -26 -27 -21 Exchange rate dif. 0 0 0 0 0 Profitability 2015 2016 2017E 2018E 2019E Pre -tax profit 910 2,614 1,118 1,498 2,031 ROE 110% 121% 33% 33% 34% ROCE 126% 155% 39% 38% 41% Tax -112 -579 -250 -330 -447 ROIC 401% 1777% 83% 78% 91% Net earnings 798 2,035 867 1,168 1,584 EBITDA margin 33% 40% 23% 28% 30% EBIT margin 31% 39% 22% 25% 27% Balance 2015 2016 2017E 2018E 2019E Net margin 28% 31% 17% 19% 21% Assets Current assets Data per share 2015 2016 2017E 2018E 2019E Cash in banks 1,031 1,162 2,067 2,657 3,364 EPS 2.54 6.48 2.76 3.72 5.05 Receivables 618 1,132 879 997 1,203 EPS adj 2.54 6.48 2.76 3.72 5.05 Inventories 153 673 491 453 526 Dividend 0.00 0.00 0.83 1.12 1.51 Other current assets 37 435 50 60 70 Net debt -16.31 -3.70 -4.97 -7.17 -9.74 Current assets 1,839 3,402 3,488 4,167 5,163 Total shares 63.24 313.97 313.97 313.97 313.97 Fixed assets

Tangible assets 21 29 51 76 75 Valuation 2015 2016 2017E 2018E 2019E Associated comp. 1 0 0 0 0 EV 36,343. 18,570. 9,300.9 8,609.4 7,800.9 Investments 0 0 0 0 0 0 6 Goodwill 0 0 698 698 698 P/E 46.8 9.7 12.5 9.3 6.9 Cap. exp. for dev. 0 0 332 332 332 P/E diluted 46.8 9.7 12.5 9.3 6.9 O intangible rights 50 71 189 302 376 P/Sales 12.9 3.0 2.1 1.8 1.4 O non-current assets 0 0 0 0 0 EV/Sales 12.5 2.8 1.8 1.4 1.0 Total fixed assets 71 101 1,269 1,407 1,480 EV/EBITDA 38.1 7.0 7.7 5.2 3.5 Deferred tax assets 0 0 0 0 0 EV/EBIT 39.9 7.1 8.1 5.6 3.8 P/BV 32.6 8.9 3.5 2.7 2.1 Total (assets) 1,910 3,503 4,757 5,574 6,644 Share performance Growth/year 15/17e 1 month 4.3 % Net sales 33.5 % Liabilities 3 month -3.8 % Operating profit adj 12.1 % Current liabilities 12 month -65.9 % EPS, just 4.2 % Short -term debt 0 0 0 0 0 Since start of the year -45.0 % Equity 64.2 % Accounts payable 650 1,080 569 604 677 O current liabilities 114 61 518 489 349 Current liabilities 763 1,141 1,087 1,093 1,026 Shareholder structure % Capital Votes Long-term debt 0 0 508 406 305 Avanza Pension 6.9 % 5.9 % O long-term liabilities 0 0 0 0 0 Nordnet Pensionsförsäkring 2.0 % 1.7 % Convertibles 0 0 0 0 0 Velociraptor LTD 1.9 % 15.9 % Total Liabilities 763 1,141 1,595 1,499 1,330 Vanguard 1.8 % 1.5 % Deferred tax liab 0 0 0 0 0 Magnus Unger 1.3 % 1.1 % Provisions 0 136 68 73 78 Danica Pension 1.1 % 1.0 % Shareholders' equity 1,147 2,226 3,093 4,001 5,235 BlackRock 1.0 % 0.8 % Minority interest (BS) 0 0 0 0 0 Folksam 0.9 % 0.8 % Minority & equity 1,147 2,226 3,093 4,001 5,235 Swedbank Försäkring 0.9 % 0.8 % Handelsbanken Liv Försäkring AB 0.8 % 0.7 % Total liab & SE 1,910 3,503 4,757 5,574 6,644 Share information Free cash flow 2015 2016 2017E 2018E 2019E Reuters code FINGb.ST Net sales 2,901 6,638 5,172 6,040 7,518 List Large cap Total operating costs -1,947 -3,977 -3,958 -4,377 -5,277 Share price 34.6 Depreciations total -43 -48 -70 -138 -189 Total shares, million 314.0 EBIT 910 2,613 1,144 1,525 2,052 Market Cap, MSEK 10860.1 Taxes on EBIT -112 -579 -256 -336 -452 NOPLAT 799 2,034 887 1,190 1,601 Management & board Depreciation 43 48 70 138 189 CEO Christian Fredrikson Gross cash flow 842 2,083 957 1,328 1,790 CFO HassanTabrizi Change in WC 67 -1,055 766 -84 -357 IR Christian Fredrikson Gross CAPEX -25 -79 -1,238 -276 -262 Chairman Jan Wäreby

Free cash flow 883 949 485 968 1,171

Capital structure 2015 2016 2017E 2018E 2019E Equity ratio 60% 64% 65% 72% 79% Debt/equity ratio 0% 0% 16% 10% 6% Net debt -1,031 -1,162 -1,559 -2,251 -3,059 Analysts Redeye AB Capital employed 115 1,064 1,534 1,751 2,176 Mäster Samuelsgatan 42, 10tr Capital turnover rate 1.5 1.9 1.1 1.1 1.1 Viktor Westman 111 57 Stockholm

[email protected] Growth 2015 2016 2017E 2018E 2019E Sales growth 1,142% 129% -22% 17% 24% EPS growth (adj) -654% 155% -57% 35% 36%

Company analysis 17 Fingerprint Cards

Revenue & Growth (%) EBIT (adjusted) & Margin (%)

8000 1200.0% 3000 60.0%

7000 1000.0% 2500 40.0% 6000 800.0% 2000 20.0% 5000 600.0% 4000 1500 0.0% 400.0% 3000 1000 -20.0% 200.0% 2000 500 -40.0% 1000 0.0% 0 -60.0% 0 -200.0% 2014 2015 2016 2017E 2018E 2019E 2014 2015 2016 2017E 2018E 2019E -500 -80.0%

Net sales Net sales growth EBIT adj EBIT margin

Earnings per share Equity & debt-equity ratio (%)

7 7 0.9 18.0% 0.8 16.0% 6 6 14.0% 0.7 5 5 12.0% 0.6 10.0% 4 4 0.5 8.0% 3 3 0.4 6.0% 4.0% 2 2 0.3 2.0% 0.2 1 1 0.0% 0.1 -2.0% 0 0 0 -4.0% 2014 2015 2016 2017E 2018E 2019E -1 -1 2014 2015 2016 2017E 2018E 2019E

EPS, unadjusted EPS, adjusted Equity ratio Debt-equity ratio

Conflict of interests Company description Fingerprint Cards (FPC) develops and sells biometric solutions. It is the Viktor Westman owns shares in Fingerprint Cards: No world’s number one fingerprint sensor supplier and one of the largest fabless semiconductor companies in Europe. Redeye performs/have performed services for the Company and receives/have received compensation from the Company in connection with this.

Company analysis 18 Fingerprint Cards

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Redeye Rating (2017-07-24)

Rating Management Ownership Profit Profitability Financial outlook Strength 7,5p - 10,0p 44 42 17 11 22 3,5p - 7,0p 71 65 99 35 45 0,0p - 3,0p 12 21 12 82 61 Company N 127 128 128 128 128

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Company analysis 19