Q3 2018 Idex ASA Earnings Call
Nov 08, 2018 AM UTC
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IDEX.OL - Idex ASA
Q3 2018 Idex ASA Earnings Call
Nov 08, 2018 / 08:00AM GMT
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Corporate Participants
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* Henrik Knudtzon
Idex ASA - CFO
* Stanley A. Swearingen
Idex ASA - CEO
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Conference Call Participants
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* Christer Roth
DNB Markets, Research Division - Analyst
* Fredrik Steinslien
Pareto Securities, Research Division - Analyst
* Hans Rettedal Christiansen
Carnegie Investment Bank AB, Research Division - Junior Analyst
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Presentation
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Stanley A. Swearingen, Idex ASA - CEO [1]
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Good morning, everybody. Welcome to IDEX's Q3 2018 quarterly presentation. I'll be giving an update on the business as well as some of my insights on recent industry events. Then I'll turn it over to Henrik to talk about financials. And then at the end, we'll close with a general question-and-answer session.
I just want to draw attention to the disclaimer because I will be providing some forward-looking statements, so be sure to read through this and understand the implications of that.
So we're excited. It's really been quite a journey. We see the industry is at its inflection point. So we really had talked about when will this market happen, and we're quite convinced the market is happening now. So when we look at the journey, it really started many years ago, several years ago, with ecosystem partnerships where we work with Mastercard and other card integrators to kind of form the strategy of how we're going to create this market. And through the journey, we then had to develop the technology. We then had to make sure we had a supply chain that could ramp the volumes that we're talking about. We're talking about a market that represents billions of units of opportunities. So that had all to be thought through and established.
We then commenced with end-user trials back in early 2017. And that was really getting the technology out with customers and understanding how would they use it, what would the requirements be. So there's a feedback cycle that happens to a trial period. And we went through that, as I mentioned, in early 2017. And through that process, we got a lot of keen insights, had something called remote enrollment, was going to be critical to make this market a reality. And remote enrollment is the ability to enroll your fingerprint on the card in a cost-effective way in your home. So it was quite a heady challenge when it was discussed between ourselves and Mastercard. And we took on that challenge. And we're quite proud that we solved that challenge. We then moved through the certification process, received our first production order, which was a big milestone for the industry. So it's the first mass-deployed biometric payment card. So all the work of many years is culminating in us receiving our first order. And now we're seeing multiple, multiple customers across multiple verticals starting to ramp and completing their integration activities.
So if we look -- and I've shown this slide in past quarterlies. I want to highlight a few things. So if we look at our full biometric solutions, this quarter, we will be launching our next-generation technology. So everything that the market sees and our competitors sees today is a technology we created 18 months ago. So I'm quite excited that we'll be releasing a new power harvesting technology, new matcher technology, new sensor technology. So -- and this is all happening this quarter. So as I've talked about before, being a first mover, you have to sustain that advantage, and how you sustain that advantage is through innovation and continuing to innovate.
We're also -- in this quarter, we will be in usability studies with our next-generation remote enroll. So the remote enroll you see is generation 1. We're actually in, right now, usability studies with real customers on generation 2. The other thing we're really proud of is the expansion of our strategic partners in our ecosystem. So you've seen many announcements of some top-tier players, particularly in China. So we continue to see global demand, as I mentioned, across many verticals. So we'll continue to make announcements in this quarter around new partnerships, new customers, new verticals.
And the other is the innovation pipeline. I'll show a road map a little further in the presentation. But the pipeline continues to accelerate. So one of the challenges as an industry leader is your technology team has to support all the customers you win. And one of the challenges in technology is how do you support all the customers you win and continue to innovate. And you do that by making sure that your technology is very robust, use reference designs and tools so you can bring customers to market very quickly with little overhead by your technical resources so they can, in turn, invent the next generation of technology. So I'm really excited. Our innovation pipeline is accelerating. And I'll show you some exciting new insights of some technology that we're now maturing.
And then as I mentioned, the team approach our off-chip and the ability to leverage industry standard technology, ride Moore's Law, which means we need to be much more aggressive; silicon technologies, which means we can integrate more content.
If we look here at a glance, as I mentioned, landmark world first order, we're very proud of that. Strong commercial traction. We announced Feitian, JINCO, Hengbao. Fransabank launched the first card in Lebanon. Ohsung is a statement of -- when I mentioned reference designs and making sure our technology is easy to deploy, Ohsung is a major player in the smart remote control market. And we were able to take technology that was developed for smart cards very applicable for that application. And with little support, they were able to integrate that and go to market.
Our sensors for dual-interface and contact-based solutions is ready. I want to take a point here in terminology. So dual-interface is contactless and contact. So when you hear somebody say it's a contactless pilot, a contactless pilot may mean it can only work in contactless. We differentiate between contactless and dual-interface saying that card can be used in any terminal, which is a very powerful usage model. And then contact is where you plug it into the machine. So both our contact and our dual-interface are production-ready now, as we sit here today. And as I mentioned, we're readying the next generation. And then the development of market of enabling remote enroll is complete. So we expect this quarter to start commercial launch of the remote enroll solution.
So here, the landmark first order. We received this -- we actually started shipping it the very end of Q3, and we'll continue to ship against that order. And this is for a major card, a global card integrator in support of that for -- as I mentioned, a mass deployment of a payment card. And we expect additional orders. So another thing, how the orders flow in a market like this, is even if the end opportunity is 1 million units over a year, you don't get 1 million unit PO. What you do is you get a PO for 10k, then 50k then 100k and you just -- it starts to roll. So we're starting to see that rolling effect of getting orders, fulfilling orders. And it's actually healthy for us because to go from 0 to 1 million units is exceptional stress on an organization from a supply chain perspective. So I'm actually pleased. Our organization's responded phenomenal. We're shipping on time. Our yields are right where we expected them to be. Our cost structure, everything that we had dialed in from a planning perspective is executing per plan.
Another thing I'm excited about is a couple of quarters ago, we talked about really focusing on PR, focusing on our sales organization. So we're starting to see the benefit of that sales organization taking traction in the market. So if you look at our pipeline, our pipeline doubled last quarter. So as you imagine, doubling of a pipeline in 1 quarter is a huge opportunity. So that's why we said -- with confidence, we said here the inflection point is upon us. And the pipeline and the design win opportunity is just one proof point of that. And so what we see is we see strong interest. It's global. And we have interest from Eastern Europe, Western Europe, Latin America, Asia, U.S., across multiple verticals. So the idea of biometric merged to a smart card captured the imagination of the market. And the value proposition is just crystal-clear. It's not a tough explanation of, boy, what does biometrics bring to a smart card application. Well understood. It's really how fast can we get to market.
And the thing I want to point out is we -- it's one thing to have a pipeline of opportunities, another thing to say that based on the feedback we're getting, we have an exceptionally high confidence in our ability to convert these opportunities into orders. So we continue to ask the questions of where are our competitors, where are we relative to our competitors. And our win rate is showing me we are clearly the leader.
Now we won't take that for granted. We'll always work hard. And that's why we're releasing our next-generation technology. But I think when I show you the -- what off-chip technology brings to this particular application, it's compelling as a differentiator.
So here, the other thing we're really excited about is Mastercard's really ramping up their marketing. So they're in a phase now where they're going out to all their issuers and all their partners. They created a really nice video on not only the use model of biometric cards but remote enroll. And that's featuring our technology. So we're quite proud that something of that nature, we're associated with that. They've also put up presentations to talk about the value proposition to the end users. And they've talked about content biometric cards on their website.
So as we talk about inflection point, there was an announcement yesterday of a pilot in Italy. And it was one of the largest banks in Italy announcing pilot yesterday with a global card integrator and Mastercard. And for us, that's exciting, right? So we've talked a lot before about is this market real. So we're now seeing major banks, and you will see more major banks coming out in the coming months with these types of launches.
In this instance, the pilot is not being done with our technology. If you look at -- as being a pioneer -- and I showed you on the first slide, this journey from pilot to production, we understand how much work is ahead to go from a pilot to a production order. And for us, we look at that, and we know that the technology that the pilot is based on does not necessarily mean that that's the technology that will be submitted for certification nor is it the technology that will be going into mass production. And based on our strong relationship with Mastercard, which we have forged -- as we talked about, this is going on 4 years now -- and our superior product offering, we are very confident in our ability to compete for that business and expand our ecosystem footprint. So for us, net-net net, very positive announcement, very positive statement, increasing our presence in the ecosystem. And again, superior product offering always wins. So we're in a good place as far as that announcement goes.
The last piece I want to talk about is competitiveness. And we've talked -- and I've talked every single quarterly that we expect competitors. We want competitors. Competitors are healthy. They drive innovation. This is going to be a multi-billion unit market. Multi-billion unit markets do not exist without multiple suppliers. So competitors, we welcome. But we're quite confident we'll be the leader, and we'll have dominant leadership share in this market. So I just wanted to make sure that our investors understand the context of some of these announcements and what it means to us as a player in this market.
So if we look here, Fransabank. Fransabank launched a card. We're not talking about a pilot where they said, "Oh, we're going to give it to a few people and try it." They're taking orders for the card. So that's the world's first launched biometric card. Exciting. You can go to their website. Apply now. It's a gold business card. So we're starting to see the issuers really think through how are they going to deploy this, who are they going to offer it to. And in some cases, it's a very complex equation. Maybe it's the first time they're issuing credit. Maybe it's the first they're issuing credit with loyalty. And others, it's not so complex. We issue cards and those cards are just now going to have biometrics. So we see a whole range of different issuer strategies and approaches to this market. But the important thing is we're now seeing, between the announcement yesterday with the Italian bank, Fransabank, Bank of Kuwait, we're starting to see issuers come out. And these are big splashes. For anybody who looked at yesterday's announcement, this was a big deal, right? The executives from the bank had a telecast and so forth, so you're going to see more of this, and there's more confidence in why the market's happening now.
So I'll touch here. One of the things we're starting to see is as the market matures, you start to get more analyst coverage, and the analysts start to dial in some numbers. So when we look here, the payment -- you just have these 3 markets, it's billions of units of opportunity. Then the question becomes, what's the penetration rate and how quickly does it penetrate? So Goode Intelligence just came out with a report. And their call is by 2023, there'll be 579 million biometric-enabled smart cards. And so as I mentioned, the analysts are starting to look at this market, starting to figure out penetration rates. And 579 million cards is a pretty sizable market. And they may be under calling it in my estimation.
So if you look here, one of the things we get a lot of questions on is, all right, credit cards, old technology; mobile payment, new technology. Are these 2 things going to coexist? And so we did the best we could to gather information. And to be honest, there isn't a lot of information out there. And if you look at the payment penetration, you see after a significant amount of investment in promotional activities and other things that -- whether it'd be on Android Pay, Apple Pay, Samsung Pay, very low penetration rate. And so that's what we see in the western world. What we were particularly interested in is China because China has seen a unique adoption of mobile payment schemes. And so what -- that's a microcosm of, okay, if the card can exist when there's a dominant share of mobile payment, then the value proposition is strong. And a recent report came out that last year, the cards issued in China vendor went up by almost 10%. So in a market that has a strong mobile payment penetration, they shipped 10% more cards. So that, by definition, tells you they coexist.
And why do they coexist? They coexist because it's convenient. The card's convenient. It's a known user modality. And as you add biometrics to it, you increase the security, and you don't have to remember pins and passwords. And the other part is the card is the last physical connection for a bank to its customer. So it's an important tool for the bank to keep that relationship. And it also with the increased -- security increases the confidence in using the card. What we've heard in some surveys is people are uncomfortable with mobile payment because the mobile phone is connected to the network, and they don't know if their payment information is being stolen or what happens to it versus with a biometric payment card, all the information stays on the card. And it's using the existing infrastructure.
So if we look at our road map. We have a road map to the world's safest card. And it's a combination of a security road map as well as display integration, which I talked about. So it's end-to-end encryption. Matching in the secure element, being able to do dynamic CVV and biometrics together in a cost-effective way. So we're really starting to address the card present, not present challenge. We're also ensuring that no sensitive data ever leaves the card, which is a very important thing because if the fingerprint was to go to a central database, and that central database was hacked, then everybody would have your fingerprint. In this case, the fingerprint never leaves the secure element. And as I mentioned with remote enroll, it's done in the convenience of your home, so it's never on a network.
So remote enroll. Imitation is the most sincere form of flattery. So we've seen a lot of our competitors coming out with very similar concepts. And another thing of being a pioneer, we expect people to innovate on top of our innovations. Again, we're focused on making this market happen. And so a competitor who takes our idea and refines it and improves it is a good thing for us and a good thing for the market. So the fact that we're now seeing multiple competitors, multiple issuers demanding remote enroll, this is something, again, we created 1.5 year ago.
So when we look at where and when we created that, we're just -- as I mentioned, going through usability studies of generation 2. Generation 3 is in the lab. So we're on generation 3 when our competitors are just coming out with generation 1. And when we look, and talking about the continued innovation around this concept, of course, we filed patents. And we have patent coverage. So this is in multiple territories and multiple patents. And we're far enough along in the patent filing process. We are highly confident we will get patents in this domain. So again, first mover, taking advantage of first mover and turning it into products and intellectual property, which will then turn into good business for IDEX and its investors.
So we look here, we've shown this slide. And it really is end user pulls upon us. The benefits for the issuers are crystal clear. Benefits for governments, we're now actually seeing major government pull for biometric ID cards. And we're engaged with some really exciting opportunities there. And what I've tried to do is try to quantify. As I've said before in a quarterly, you don't grow from 0 to 100 million units overnight. There's a ramp. And we think this year, we're talking 100,000 units. Next year, we see -- we're going to move into tens of millions of units. And when I say tens of million, is that 10? Is that 90? There's a high level of variability depending upon how many issuers uptake when they launch, how they launch. But we know that dual-interface is a compelling part of this ramp. And as I mentioned, we're confident that we'd get through certification and deployment in the first half of '19. So we expect back half of '19 to really be an accelerated ramp for dual-interface. And then you go to hundreds of millions of units. So when you look at this, it doesn't take a huge penetration rate of a smart card market to hit hundreds of millions of units. So this is a compelling market, for us and for all our competitors.
So the road map. So our road map is designed to retain and accelerate our leadership position. So what are we working on now? We believe driving the cost down for the solutions so there's a modest increase to a current chip-based card is what needs to happen to make that penetration rate go from single digits to double digits up to a dominant share of the market. And we saw that in mobile. When mobile came out, it was kind of okay, it's a novelty. You replace passwords. And then it went from that to almost every phone has a fingerprint sensor on it. We expect when the price gets to a certain point, there'll be no reason not to have biometric in every single smart card.
The next step is -- our team's working on the next-generation ASIC. And that next-generation ASIC will start to move some of the value and reduce component count, so that we start to drive not only the cost of the solution down but increase the value content for our offering. And then we talked about sensor display technology. And then a step change in security and then 1 chip. So at the end of this, we go to a 1-chip solution. And that's what today is in a chip card, 1 chip.
So we look this -- you've seen this slide before, but there's a new line on it. And what this is talking about is the value of silicon-based sensors. And so when we look at silicon-based sensors, what this chart basically says is the dimension of the sensing area drives -- is relative to the cost structure, particularly for a silicon sensor because a silicon sensor, the die and the sensor are the same. So the larger you go, the more costly your silicon sensor becomes. And we had an advantage before with our traditional off-chip, and that's the second line down. And what we're now coming out of our labs with and we have in hand is a next-generation advanced technology. And if you look, the line's almost flat. And what that line means is we can have larger sensors at minimal incremental cost of a small sensor. And I'm going to show you on the next slide why that's relevant and important for this market.
So on this slide is an illustration that talks about the relationship between FRR, false reject rate, which is a metric for biometric usability. And on the bottom is the number of enrolls. And so what you see is when you have a small sensor, in order to get to an acceptable FRR, you have to have a large number of enrolls. And in mobile, that works because you have visual feedback, you have a lot of compute resources and you can have a small sensor innovate with matching another technology, and you can move that line and you get acceptable FRR. In a smart card, where you're matching in a secure element, it is exceptionally a constrained environment. And so what you want is you want to get the best FRR with the minimum amount of enrolls. So when you look at the large sensor, the large sensor gets you the optimal solution, which says, "I get the best FRR with the least number of enrolls which consume the least power."
Previous slide I showed you, we can do a large sensor at the same cost as a small sensor. That's why we are really confident about this technology in this application. And just on the right, it's a visual that kind of -- if you have a small sensor, you're just getting pieces of the fingerprint. So you have to capture all those pieces through some process. And so as we talked about remote enroll being important, ease of enrollment then lays the foundation for the optimal biometric performance. And in this market, it's -- larger sensors win.
The next is this is a slide where we discussed before how we integrate going forward. So today, at the top, you see a block diagram of what's in a biometric smart card. The one below it, you see essentially all the content. And the above is moved into our chip. So that's energy harvesting, that's an MCU, that's the biometric sensor, it's all part of our solution. And because we can do that, because we're decoupled from the sensor, we can use advanced lithography, which means we can operate at much lower power, have much more digital content and our cost structure goes much lower as we increase the value through integration.
So our outlook. And I'm very proud last quarter, and I pride myself because I sit with Henrik, each quarter I look at what did we say to our investors last quarter? And did we deliver on what we said we would? And I'm quite proud we did everything we said we were going to do last quarter. And we did everything we said we were going to do the previous quarter. So now this is the outlook for the coming quarter. And there's a little bit of glimpse into the future beyond the quarter.
So as we mentioned, rapidly increasing demand, many successful pilots. So the feedback now, the pilots feedback is because we've refined the solution, the pilots are quite positive, and so we're moving from pilots into production. We pioneered remote enroll. Our supply chain, we've got Tier 1 suppliers, we've got our test infrastructure in place at those suppliers, so it's a very, very streamlined supply chain. And when we look at the leading card ecosystems, they're now rapidly expanding the commercial deployment.
If we look at what's coming up in Q4, we expect additional shipments in support of that initial order. We expect new customers and ecosystem partners in multiple verticals. There will be multiple pilots of dual-interface with our technology in Q4. We'll launch commercially remote enroll this quarter, gen 1. And we'll continue to strengthen our intellectual property position. We think it's important not only to invent but then to file and have the intellectual property protection that goes along with those filings. And then last, we're really confident that our dual-interface solution will be certified and go into volume production in the first half of 2019.
So with that, I'll turn it over to Henrik to talk a bit about financials. And we'll open it up for Q&A.
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Henrik Knudtzon, Idex ASA - CFO [2]
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Thank you, Stan. Yes. So I'll take you through the financials from -- in the quarter. And as you can see, the revenue line is now trending upwards. Although the number is fairly modest, it signifies the shift from mobile to cards. And in the quarter, we started shipping against the production order that we announced. But we also shipped to multiple other card customers, including our dual-interface sensor, which is now being integrated with several customers. The OpEx -- and as I put, in 2019, we do expect -- on the back of the market trends that Stan talked about, we do expect a significant revenue growth going forward.
OpEx in the quarter, about NOK 58 million. It is fairly stable. And as you can see, the biggest part of our OpEx is payroll. In the quarter, it was about $40 million, of which almost $8 million were noncash cost related to the share-based incentive program. The second item of the OpEx is the development spend. That went down from previous quarter, and this is really depending on the phasing of the development projects. We have brought a lot more development resources in-house, so we require less external use. But it's also dependent on the phasing. And I would say, this is a fairly representative level of the average in the last 4 quarters. Other OpEx remains fairly constant. This is really a function of the organization and the headcount. Going forward, we do expect OpEx to remain fairly stable. We have an organization, which is really scaled for the ramp we expect.
In the quarter, the third quarter, the cash flow was minus NOK 59 million. That is really quite representative of the -- typical of the OpEx level. However, in the third quarter, we also made investments in a tester and a prober, which is really an investment to prepare for mass production and secure an efficient supply chain. The cash position at the end of the quarter was NOK 130 million, about USD 16 million. And we don't have any financial debt. That level -- so we expect a fairly stable OpEx going forward. So -- and to break even, we do expect that we need a low double-digit million unit volume. And given what Stan talked about in the expected market, you don't need a very high penetration of the total market to get to that level.
So I think with that, we'll open up for Q&A.
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Questions and Answers
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Christer Roth, DNB Markets, Research Division - Analyst [1]
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Yes. So Christer Roth from DNB Markets. I was wondering if you can just start on the question of cash. Could you say something about how the ramp is expected to look through 2019? You said that you need double-digit volume shipments to get to breakeven. You expecting that's already in Q2? Or -- just to understand the cash need of the business.
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Henrik Knudtzon, Idex ASA - CFO [2]
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Yes. No. That is, obviously, a very good question. And naturally, we monitor that situation very closely. The big -- and we do expect the ramp. The big question, of course, is exactly when that ramp is. And I think it's hard to say, to commit to a number by a certain time. But we do see that things -- customers are lining up, it's moving very quickly. And also, just to keep in mind, IDEX can generate revenues through a couple of different sources. So first of all, it's -- most people think about shipments of sensors, right which, obviously, that will require working capital as well. So if the ramp is really steep, that will also require working capital. But we also do have the ability to license our IP and to generate revenues through royalty fees and other license fees. And we do have a range of solutions, right? So we have sensors, but we also have the remote enroll, we have the matcher, so we have quite a few products in our portfolio.
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Christer Roth, DNB Markets, Research Division - Analyst [3]
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My next question was on working capital. It seems like today your inventory covers quite a limited number of units. I'm just wondering as you ramp, how long before you need to build working capital, build inventory for this double-digit million unit shipments.
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Henrik Knudtzon, Idex ASA - CFO [4]
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Yes. So we already said in last quarter that we have placed orders on our supply chain. So -- and I think we had said that we -- normally, time would be about 12 weeks. But obviously, there's different components with differently lead times. And we've already have planned for a ramp. And we've placed those orders. But as of end of Q3, not necessarily all of it have been received. So -- but it's very hard to give an exact number because it depends on the product mix. But also on exactly the timing of those orders.
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Christer Roth, DNB Markets, Research Division - Analyst [5]
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Great. And on this -- you're talking about integrating more and more the peripheral components into the -- your own chip, kind of bringing down the cost of the solution, stuff like that. Could you say something about quantifying the cost down road map? How much do you plan to get down the cost? And current time line there, how long will you need to integrate the power management on your own silicon and stuff like that, just to get some flavor on that?
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Stanley A. Swearingen, Idex ASA - CEO [6]
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Yes. So magnitude, we're talking several dollars in cost reduction. So it's significant. And the timing of realizing that will be in 2020, early 2020. So really, the timing is quite interesting because the front end of the market, there's a bit less price sensitivity because people are going out or promoting the card. It's a premium product. But we have no illusions that we need to get this cost down to be a modest adder. And so our next-generation ASIC that we're in design of now, with the integration path, we plan to bring that to market and start sampling that in early 2020.
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Christer Roth, DNB Markets, Research Division - Analyst [7]
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That's great. And last year, you were kind of giving that cost reduction through to your customers?
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Stanley A. Swearingen, Idex ASA - CEO [8]
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Of course, we would give a part of that to our customers. And the other part, we'd give to our investors. So we expect the margins to be quite rich, actually, to be able to take multiple dollars out and still have industry-leading margins. Of course, it's a delicate dance that we want to make sure we give the right cost structure, but we also want to make sure that we have the right profit level.
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Henrik Knudtzon, Idex ASA - CFO [9]
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One comment, if I may, on gross margins. So the last time we commented gross margin and targets was actually 1 year ago, the Capital Markets Day. And we did indicate the margin, gross margin is 40% to 45%. That was the target in 2020. I think with the work we've done the last 18 months, we're very confident that we will exceed that target. And we're actually now expecting, I would say, north of 50%. And that's before the next generation, which Stan talked about.
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Christer Roth, DNB Markets, Research Division - Analyst [10]
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Yes. Just clarifying, so using this timer now, but what kind of ASP do you expect initially? Because I think that $3 to $5 range is something that's more kind of a high-volume number. So initial ones that you'll receive in Q1, Q2, what kind of ASP we'll be talking about there just for modeling purposes?
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Henrik Knudtzon, Idex ASA - CFO [11]
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Yes. No. I definitely understand the question for modeling purposes, but...
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Stanley A. Swearingen, Idex ASA - CEO [12]
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It will be higher.
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Henrik Knudtzon, Idex ASA - CFO [13]
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Yes. No. I think that's what we'll say because, commercially, we don't really want to give that number.
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Stanley A. Swearingen, Idex ASA - CEO [14]
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Yes. Competitively, we wouldn't want to, right? But it will be higher. It's just natural, right? It's going to be higher.
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Christer Roth, DNB Markets, Research Division - Analyst [15]
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And last one for me just -- I know you won't talk too much about your competitors, but I'm just surprised to see that, for example, companies like Gemalto, and that trial yesterday is working with, for example, Zwipe, which seems to have quite significantly more expensive total solution costs than you guys, for example, can offer. Is there anything that they offer that -- or other vendors' offer that you can't offer that should induce Gemalto to work with them or even consider working with other companies than you?
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Stanley A. Swearingen, Idex ASA - CEO [16]
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Well, I think you hit the nail in the head and I spoke to it, a pilot and a technology used in a pilot doesn't necessarily need to meet the criteria of cost or ability to ramp. And so when we look at that opportunity and our relationship with Mastercard and our superior technology, we're confident we're going to compete for that business. And we look at -- another global card integrator is now a potential customer for us.
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Hans Rettedal Christiansen, Carnegie Investment Bank AB, Research Division - Junior Analyst [17]
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Hans, Carnegie. I was just wondering, this test, São Paulo trial that you're speaking about, in terms of your self-enrollment solution, can -- does Mastercard have any sort of right to use that together with another solution? Or is it purely -- would they have to sort of pay you guys if they were to use it on a -- in this new trial?
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Stanley A. Swearingen, Idex ASA - CEO [18]
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No, our IP. So basically, our IP and who we license that to is our decision.
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Hans Rettedal Christiansen, Carnegie Investment Bank AB, Research Division - Junior Analyst [19]
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And you -- do you have any plans to sell the rights to use it?
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Stanley A. Swearingen, Idex ASA - CEO [20]
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We do have plans to license the technology. So as you can imagine, there is a delicate balance between doing the right thing to make sure the market happens and enabling the innovation that's necessary and making sure that the money our investors gave us to invest in that innovation is monetized and returned adequately. So yes, we have plans and strategies around that.
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Hans Rettedal Christiansen, Carnegie Investment Bank AB, Research Division - Junior Analyst [21]
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And for you to use it in other trials, there's no exclusivity agreement with Mastercard that would inhibit you to use it?
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Stanley A. Swearingen, Idex ASA - CEO [22]
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Again, it's our IP. We can license it to whatever -- whoever we deem necessary, the right parties to license that to.
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Hans Rettedal Christiansen, Carnegie Investment Bank AB, Research Division - Junior Analyst [23]
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Okay. And then I was just wondering on your development cost, because they fell a little bit this quarter, which was maybe a bit surprising. Have you sort of scaled down your cost structure? Or is it just purely related to timing? And will they increase coming in the coming quarters?
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Henrik Knudtzon, Idex ASA - CFO [24]
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So development costs are external spend. So it's not related to payroll or salary or anything. And it's really -- again, it's about phasing. So if you look historically, they will go up and down by quarter because in 1 quarter, it may be pretty intense and you may need external vendors to provide with components for testing. Or it could be consulting with some certain projects, capabilities we don't have in-house. It could be testing. But -- so that's the reason why they've gone down in the third quarter because that sort of external spend intense phase was basically in the third quarter -- sorry, the second quarter. And secondly, to address expected going forward, I think fairly -- what -- if you look at the last 4 quarters, I think that's sort of a sustainable level. And I would say that even though our external R&D spend has gone down year-on-year, it's actually -- the level of innovation we're doing has gone up because we've really added a lot of capable people. So it's not only about the headcount, but we have a superstar engineering team and a development team. And we're doing more of it in-house. So I think for modeling purposes, I would sort of assume that it's fairly similar going forward. But it doesn't sort of -- it's certainly not because we're scaling down in any way. In fact, we're increasing our innovation and R&D activity.
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Hans Rettedal Christiansen, Carnegie Investment Bank AB, Research Division - Junior Analyst [25]
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And then the last one for me. In your outlook statement, you're saying that you're expecting certification on your dual-interface card by first half year next year. Can you provide some color? Is this with -- sort of which card integrator? Is it with MasterCard? Is it with China UnionPay? Or is it just, in general, you're expecting one...
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Stanley A. Swearingen, Idex ASA - CEO [26]
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Well, we would say it's scheme-based, right, so certification. When we mentioned certification, it's scheme-based. It's not we're going to submit our solution for ubiquitous certification, right? So certification of giving it to an integrator and have them do the integration and sign off the integration complete is not certification, certification process. The scheme has, through the rigorous evaluation, deem this satisfactory to go to market in a Tier 1 issuer base. And I also want to add, we said certification and production. So we expect production to commence in the first half.
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Hans Rettedal Christiansen, Carnegie Investment Bank AB, Research Division - Junior Analyst [27]
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But can you maybe say towards sort of which geography or which scheme?
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Stanley A. Swearingen, Idex ASA - CEO [28]
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I -- what I just said is it's global. This is not -- when dual-interface goes, this isn't going to be a single geography. This will be multiple geographies almost simultaneously.
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Hans Rettedal Christiansen, Carnegie Investment Bank AB, Research Division - Junior Analyst [29]
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And are you currently working on certification towards sort of more than one scheme?
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Stanley A. Swearingen, Idex ASA - CEO [30]
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I can't get into that level of detail. But...
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Henrik Knudtzon, Idex ASA - CFO [31]
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What I think we can add is that we've announced several card integrators in China over the past couple of months. We have a partnership. We're working with a western card integrator such as IDEMIA. So -- and this is, obviously, a solution and a product, which is interesting to all of those. And the product is ready. I mean, just to be clear, from IDEX side, we're actually -- this is our -- the sensor for dual-interface cards, it's ready. Now it's really up to the card integrators to integrate the product into their cards and then whatever process they need to go through to certify the product. So the technology risk, I would say, has been taken out from IDEX. And now it's really moving on to the design-in phase with our card integrator customers to make sure that the total solution actually works.
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Stanley A. Swearingen, Idex ASA - CEO [32]
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The other thing I would say is we've been through the process once. So we know what it entails, we know what the requirements are. So we had already baked in all the requirements and everything we knew about that process when we developed this product. So we would expect it to be a much, much more frictionless process than when you have to pioneer a brand-new certification process. So we would expect -- when we look across the board, the barriers are dropping and they're dropping with the technology maturation, with the ability to certify, with the issuer's pull. So I think all the stars are aligning. And again, we want competition. We think it makes us a better company. We don't fear it because we're quite confident in our team and our ability to innovate. So for us, we want to have competition because, if it was just IDEX, this won't be a multibillion-dollar market. It just -- multibillion-dollar markets can't be serviced by a singular vendor. And so what you're starting to see with the announcement, the Italian company, you're starting to see we need multiple card integrators, multiple suppliers, and that makes for a healthy market. And then we'll compete. Any other questions?
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Fredrik Steinslien, Pareto Securities, Research Division - Analyst [33]
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Fredrik Steinslien from Pareto Securities. So I understand it's difficult to kind of comment on the ramp through 2019. Can you comment a bit more on what you do know, namely the production order that you announced in late September on the ramp that through to -- or Q4 and 2019, you mentioned like 10k, 50k, 100k. Can you elaborate on a time line and what to expect there?
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Henrik Knudtzon, Idex ASA - CFO [34]
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Yes. So we started shipping in Q3, started. And then that will commence through Q4. And just to -- I think the way to look at things is that the total potential, that would be a program, right? So a customer would define a program. Say, they have 1 million customers, they want to have -- issue cards to all of them. That will be a program. And then an order would not be the full program because that's naturally something which goes over time. So this order is something we'll ship against in this quarter as well. But we don't really comment on the number as such because we have pretty tight constraints from our customers as well. So that's -- I think that's helpful.
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Stanley A. Swearingen, Idex ASA - CEO [35]
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Well, I would add something, right? So if you put yourself in an issuer's position and say you're going to go do all the heavy lifting and then deploy the capital, do the enrollment, do all the promotion, you're not going to do that for a small number. To me, that's kind of the proxy is, yes, the upfront order will be kind of getting the pipe clean, getting all the infrastructure in place. But why would you go through all that effort just to introduce it to a small fraction of your customer base? So I think that, hopefully, that will give you a little more insight into kind of the magnitude of the opportunity.
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Fredrik Steinslien, Pareto Securities, Research Division - Analyst [36]
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Yes. And just following up on that kind of magnitude of that order in specific. So say, you had NOK 1 million revenue for, say, 1 week of deliveries in Q3. Is that something to extrapolate into Q4 in terms of the level? Or...
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Henrik Knudtzon, Idex ASA - CFO [37]
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Yes. I think that's another way of asking about...
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Stanley A. Swearingen, Idex ASA - CEO [38]
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Same question. Very creative though.
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Henrik Knudtzon, Idex ASA - CFO [39]
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Yes. Good try.
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Fredrik Steinslien, Pareto Securities, Research Division - Analyst [40]
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Okay. Then on the gross margin then, you have 23%, I guess, in Q3. Is that kind of just a reflection of just the initial volumes? Or is that the reflection of where the margins lie within this order?
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Henrik Knudtzon, Idex ASA - CFO [41]
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I think it is a reflection of initial volumes. So I mean, there's a strong correlation between volume and gross margin. But also, we talked about the gross margin development, right? So the contactless product -- sorry, the contact-based products, that's based on previous generation of ASIC, which has a lower gross margin than our newest one, which I just showed. So I think we do expect higher gross margins going forward with this product.
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Fredrik Steinslien, Pareto Securities, Research Division - Analyst [42]
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And just last one for me. An impressive graph you showed on the pipeline development. Could you elaborate a bit more on what that pipeline development really entails in terms of average volume per opportunity, time line and such things?
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Stanley A. Swearingen, Idex ASA - CEO [43]
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I think that one...
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Henrik Knudtzon, Idex ASA - CFO [44]
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Yes. So I mean, the good thing now is that it's -- that is based on actual customers and not like -- it's by opportunity, by end customers, and I mean issuer, government institutions, et cetera. And we have an idea of the total size of that. What we don't know is the penetration level. But I would say that the opportunity, the total opportunity by customer ranges from, I would say, 100k to the millions, right? Because, let's say, the customer is a bank. A typical bank would have -- a very small bank would have hundreds of thousands of customers but, typically, millions of customers. So the question is really what kind of penetration do they have? So I think it's hard for us to give that kind of, say, well, a customer would be x number of units because that's where the discussions are now, how many customers do we actually deploy this to? And we have shown in the past some ranges, what was the typical assumption of a typical bank customer, a government customer. And it's really -- that's what makes this so exciting is that it's so scalable. And if you choose to do this, why would you do it for a small subset of your customers? And so we do expect that it's definitely in the 100k to millions by customer opportunity. And then the big question is timing, right? Because we strongly believe that there is a market for biometric cards. Five years ago, there wasn't any biometrics in mobile either. And when that was introduced, people said, "Why would you need it?" But it's just such a fundamentally strong value proposition of convenience and security. And people use the payment cards all the time. If you can take away the hassle of the pin, if you can have contactless payment by just touching, typing and go, then it just makes it much more compelling. And people want that. I mean, all the evidence suggests that people want it. And now we're seeing that banks are getting onboard as well. I mean, we have pilots and launches left, right and center. And we know -- we showed you that pipeline. There's lots and lots of customer interest. So the only question in our mind is when will it happen? And yes, we'll see. But we do expect 2019 to really see a step change.
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Stanley A. Swearingen, Idex ASA - CEO [45]
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And I want to talk a bit about the scalability. So one thing that's important to understand that we develop a solution and work with a card integrator. That card integrator may have 40 issuers as customers. So it's a huge lever here. So it's really efficient from servicing the market because we do the tech once. And then it's sold across our entire customer base. So one of the things, as Henrik mentioned, we know who we're dealing with directly, the card integrator. What we don't have appreciation for and, as you can imagine, they're not going to share with us every single customer they're promoting it to. But we know it's dozens, if not 40, 50, right? So there's an amplification effect as these integrators -- and just look at some -- whether it be Hengbao, XH, IDEMIA, they're shipping billions of cards. So if you look, they're shipping today billions of cards, why wouldn't they be promoting this to their existing customer base? So our customers don't have to develop a new customer base. They already have the customer base. It's converting that customer base to a new offering, which is a much lower barrier. Last question.
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Christer Roth, DNB Markets, Research Division - Analyst [46]
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Two very quick ones. Just want to piggyback then on those questions on volume because you've been quite vocal yourself lately in blogs and media, as well as some of your VPs have been quite vocal on volumes expected. And you've stated that you have multiple bank customers, you expect to ship 100,000 units this year already. We're now quite close to the end of the year. And is that still an expectation of yours that you'll see that kind of volume from multiple customers this year? That was the first one. And second, I just got this impression from how you answered his question that on the contactless, you will see high gross margins, sure. But on the contact-based solution, that will be, accounting for your volumes in the first half of the year and next year and Q4 this year, you'll see significantly lower gross margin. Is that gross margin we're seeing now representative for the gross margin that you'll see on all contact-based shipments? Or -- so that was the second one.
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Henrik Knudtzon, Idex ASA - CFO [47]
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No. I also -- so the second one, what I also said is that volume is a key driver for gross margin. So I think you took 50% of my answer and applied that to your logic.
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Christer Roth, DNB Markets, Research Division - Analyst [48]
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Is the 40% gross margin plus on contact as well -- contact-based as well?
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Henrik Knudtzon, Idex ASA - CFO [49]
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We'll see a higher -- we do expect a higher gross margin on contact-based as well.
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Christer Roth, DNB Markets, Research Division - Analyst [50]
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And the volumes?
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Stanley A. Swearingen, Idex ASA - CEO [51]
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Okay. And the volumes, what I've been boisterous about is that we have multiple pilots running and multiple customers. And we expect those to be, each one being from 10k to 100k, right? So it wasn't everyone's going to be 100k. So we're well into the quarter. We do believe we'll be consistent with that chip on general direction.
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Henrik Knudtzon, Idex ASA - CFO [52]
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Thank you.
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Stanley A. Swearingen, Idex ASA - CEO [53]
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Okay. Thank you, everybody. Thanks for your time.
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