ANNUAL REPORT 2006 PRECISE BIOMETRICS AB (PUBL)

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ANNUAL REPORT 2006

PRECISE BIOMETRICS AB (PUBL)

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The passion for biometric technology and the enthusi- asm in the organization have contributed towards Pre- cise Biometrics’ becoming one of the leading biometrics companies in the world. All of us have a strong belief in the market potential and in our own technology, which is typical of a company penetrating new markets with the joy of innovation and bold technological ideas. One of my greatest challenges is to support this innovative joy, and also to guide it so that future development work prioritizes our customers and our profitability.

This is a sub-strategy in a new business plan for Precise Biometrics, where the objective is, in the space of a few years, to deliver a positive cash flow and an essential improvement in profits.

It was of course not satisfactory that Precise Bio- metrics failed to achieve better sales and profit targets in 2006, but on the other hand the objectives formula- ted in the past year were based on an estimated in- crease in market developments and sales volumes.

Towards the end of 2005 there were clear signals from the market to indicate major expectations for 2006, but as it turned out I can now confirm that actual develop- ments failed to materialize in several respects. The biometrics market is a tough one in the sense that it is difficult to predict, and this has been the case for many years now.

MARKET PRESENCE OUR MOST IMPORTANT ASSET Factors that Precise Biometrics cannot influence may have both a driving and in some respects a breaking effect in the field of national ID cards and electronic passports with biometrics. Political considerations and financial reassessments are difficult to predict. This has led to many countries departing from the timetables they set several years ago, and on which Precise Biome- trics based its own forecasts. Nevertheless, the process of introducing national ID cards and electronic passports with biometrics is in full swing, but we will have to be more careful in our attempts to predict when the intro- duction is actually made in the different countries.

The good news in 2006 is a follow-up order from Thailand and a few orders from other countries concer- ning electronic passports and national ID cards with biometrics. Thailand is the first country in the world to implement a full-scale solution for national ID cards with Match-on-Card as the biometric solution.

The project has given Precise Biometrics a unique experience as one of the world’s leading biometrics companies. There is no longer any need for any country to doubt our technology or our capacity as a partner to participate in projects of this magnitude, which assures us a strong position in relation to future demand.

Another important confirmation was an order from

PRESIDENT´S REPORT

The journey towards a market-oriented and proﬁtable business has begun.

In a few years, when we look back on the development of Precise Biometrics, the latter part of 2006 will stand out as a turning point. Many measures were initiated in the fall as a first

step towards generating a positive cash flow and a significant improvement in

earnings. The entire organization and all the markets where we are active have

been analyzed as part of a process that demands, and will continue to demand,

tough but unavoidable decisions.

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the US Department of State in September. This order, for over 2,000 combined fingerprint and smart card readers, which among other things will be used at con- sulates around the world, demonstrates that confidence remains strong in Precise Biometrics. So far, more than 30,000 of our fingerprint readers have been installed at the US Department of State. We will continue to utilize this inspiring confidence in relation to the extensive programs for enhanced security being introduced by the American Federal authorities.

VOLUME MARKETS IN FOCUS

Precise Biometrics continues to aspire to be a strong in- ternational player and our investments in the market will focus on geographical markets and business areas where there are extensive volumes and an imminently pending commercialization. The development of bio- metrics is undergoing rapid expansion in Asia today and the acceptance of the technology means that com- pletely new applications can be a reality in just a few years.

Two events in 2006 gave Precise Biometrics a po- werful platform for the future. A joint venture was launched in February with Smart Unicorn Group in China for the purpose of integrating Precise Biome- trics’ technology as part of new solutions for mobile telephones and mobile terminals.

Another important event was the license agreement with the large Japanese group OKI Electric Industry, which was signed in July. I see this agreement with OKI as strategically important because in the long term coo- peration can lead to significant increases in sales volu- mes. It also forms the basis for a new and prioritized business area – Biometric Embedded Solutions. I am firmly convinced that this business area will be of great importance in our work with radically increasing Pre- cise Biometrics’ sales and profits. The fact that a global group like OKI has chosen to collaborate with us sends a clear signal to the market that our technology and the competence and experience that exists in the group are at the cutting edge.

One priority in the immediate future will be to identify, in a global perspective, additional potential partners, and new applications with opportunities to integrate Precise Biometrics’ technology. This is a

long-term work where we focus on finding both app- lications and partners that can generate significant volume sales. I believe that the business area Biome- tric Embedded Solutions in the next 2-3 years will ac- count for an important part of the group’s total sales.

EXPANSION OF MARKET ROLE

As the new CEO, I am particularly impressed by our collaboration with Scandinavian Airlines (SAS) and the great interest subsequently expressed by the media.

It has been gratifying to see the far-reaching enthusi- asm and acceptance that our biometrics technology has experienced in the airline and the positive response of passengers, airports and the authorities to the biome- tric solution. The introduction of the technology took place at an impressive tempo, encouraged by rapid de- cisions and a powerful motivation for the renewal of traditional routines.

The SAS project confirms that biometrics offers mul- tiple advantages over and above strict concerns with se- curity, and this is something we have been careful to incorporate in our further developments in this area. To- gether with SAS we have had the opportunity to analyze customer requirements in great detail and, on this basis, to create a flexible and solution-oriented biometric con- cept that offers benefits to customers in terms of enhan- ced security, more rapid passenger flows, and more sa- tisfied customers through easier baggage handling.

The solution incorporates a combination of biome- trics and cutting-edge competence in this technological field. We received the overall responsibility for the im- plementation of this successful project, which was then extended to cover a large number of airports, and this means we will continue to clarify the role we are going to play as a company that generates value.

The new business area Biometric Aviation Solutions, now being established, has a unique reference in SAS.

Because there is extensive interest in a global perspec-

tive for these types of solutions it is important that we

can quickly adapt to specific solutions and do this with

an expansion of our sales resources. Another priority is

to create synergies on the basis of the technological core

concept developed for SAS, and which with the requi-

site modifications can be adapted to the requirements of

other airlines or airports.

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BALANCE BETWEEN PRODUCT DEVELOPMENT AND MARKET INVESTMENTS

For a technological company focused on development, its own products can actually constitute its core activi- ties. However, we cannot constrain ourselves to this perspective if we are to transform Precise Biometrics into a profitable and expanding company. Precise Bio- metrics must be a company that achieves a good ba- lance between research and development that stems from demand, and extensive investment in the market.

One of my first measures when I took over as CEO in November was therefore to initiate work with a new business orientation. Instead of assigning major re- sources for the development of new products that may be expected of having a market, we ought to assimilate our strength around key concepts such as the analysis of customer requirements, identification of profitable business areas, more powerful sales efforts in relation to prioritized market segments, and competitive solu- tions for applications similar to the one for SAS.

Evaluations have shown that the biometrics market can increase twofold by 2011 (Source IBG). With a strong trademark, leading technology, a large number of refe- rence projects and committed staff and owners, we have every reason to see the future in a positive light.

The successful new issue of shares implemented in the latter part of 2006 was especially pleasing in that it de- monstrated that our shareholders still experience strong confidence in us. The infusion of capital has enabled us to acquire the requisite resources to increase our sales and marketing activities. Nevertheless this must take place in combination with a process of orga-

nizational change, the improvement of cost-efficiency, a renewal of priorities and the implementation of a new business plan that will have consequences in several different areas. In 2007, for example, we will assess and develop our partner relations with the objective of ta- king a more active role and delivering added value to prioritized partners in the form of biometric compe- tence and consultancy resources, experience and sales support. We will be focusing on partners who see coo- peration with Precise Biometrics as a valuable business relationship and where we consider there are excellent prerequisites for profitable transactions.

In 2007 we will be building up a segment-focused and further refined organization in the business areas Biometric Smart Card Solutions, Biometric Embedded Solutions, Biometric Aviation Solutions and Biometric Readers & Systems Integration. It is of strategic impor- tance to examine new opportunities for commerciali- zation and the packaging of our solutions. I am convin- ced that in time Precise Biometrics will have completely new alternative earnings and this is partly a target on the journey we have begun towards market orientation, increased sales and profitability.

2007 will be a tough year and will demand a lot of hard work from all our staff, and patience from our ow- ners. All the efforts that have been made, however, have been made on the basis of a profitability strategy that we are all convinced will result in a positive turning point for Precise Biometrics.

Thomas Marschall, President and CEO of Precise Biometrics

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TURNOVER GROSS MARGIN EMPLOYEES

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Operations and Business Concept

Precise Biometrics develops and markets biometric se- curity solutions focusing in particular on the use of fingerprints in combination with smart cards. With the in-house developed and patented technology Precise Match-on-Card

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, the company has a leading position in the field of smart ID cards.

The company’s solutions replace keys, PIN codes and passwords, and improve both security and func- tionality in ID cards and electronic passports with bio- metrics. Precise Biometrics’ solutions enable public aut- horities, companies and organizations, in addition to enhanced security and user-friendliness, to benefit from the advantages of increased cost-efficiency and market-leading performance.

Precise Biometrics’ business concept is, together with partners and system integrators in a global net- work, to offer countries, authorities, companies and or- ganizations user-friendly and interoperable biometric solutions that also protect user identity.

A GROWING WORLD MARKET

Precise Biometrics operates in a world market which according to IBG’s Biometrics Market and Industry Re- port 2006 - 2010 amounted to approximately 2.1 billion US dollars in 2006. The market is expected to expe- rience a strong rate of growth between 2007 and 2012.

The largest market segment of the total biometrics

market is verification via fingerprints. This segment accounts for almost 45 per cent of the market, and it is in this area that Precise Biometrics has chosen to focus its development, manufacturing and marketing. The Match-on-Card technology is expected to account for more than 25% of the market for verification via finger- prints.

Objectives

OPERATIONAL OBJECTIVES

Precise Biometrics’ operational objectives have in simi- larity with its business strategy undergone a review and reformulation in the latter part of 2006. Some of the most important operational objectives for the future are that, in the critical segment for national ID cards, the group will establish further relations and sign ad- ditional agreements with smart card companies and chip manufacturers. The global coverage of the market will also be reinforced through a new sales organiza- tion with sales teams responsible at a local level. One priority objective is also to develop supplementary applications for the aftermarket that emerges in countries issuing national ID cards.

The most important operational objectives include expanding sales activities in relation to the authorities in the US, Europe, the Middle East and Asia. An impor- tant operational objective is also that Precise Biome- trics’ profile as a competent system integrator will be clearly defined in relation to the market segments that demand conceptual solutions, and in relation to custo- mers that give Precise Biometrics total responsibility similar to that given in the SAS project. This market profile will be implemented in parallel with Precise Biometrics’ participation in consortiums, where diffe- rent partners have a prime responsibility for the imple- mentation of projects.

FINANCIAL OBJECTIVES

2006 was a disappointing year in terms of growth and profitability. Precise Biometrics’ financial objectives in-

A REVIEW OF THE GROUP

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3,013 3,836

4,634

5,634

2007 2008 2009 2010 2011

7,408

2012

EXPECTED SALES FOR

BIOMETRICS MARKET 2007–2012

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clude achieving a positive cash flow at some point in 2008 and ensuring that the group will report a profit wit- hin two to three years. Towards this end, as of the latter part of 2006, the company´s operations have begun to fo- cus on specific sub-areas and market segments where the prerequisites for significant volume and license sales are considered to be satisfactory. Examples of such areas are national ID cards and biometric solutions for public aut- horities and the aviation and travel industry.

Through growth, profitability and a stable financial base, the company will achieve a long-term increase in value for its shareholders. Dividends and dividend po- licies have not as yet been determined, since, as so far, the company has not achieved positive earnings.

Strategy

BUSINESS STRATEGY

Precise Biometrics markets software and hardware so- lutions, including consultancy services, through the direct processing of several different customer seg- ments in Europe, the US, the Middle East & Africa and Asia. Complete biometric solutions are offered together

with partners, system integrators, smart card compa- nies and chip manufacturers, primarily in IT security, transport and travel, as well as integrated systems. The focus of operations is on the Precise Match-on-Card

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technology and Precise BioMatch

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, and the develop- ment of supplementary applications and services to ge- nerate a large aftermarket.

Precise Biometrics’ business strategy has been rene- wed in 2006, with the objective of allowing the group to achieve a more prominent position in the world chain and to obtain a more distinct role as a strategic partner for smart card companies and chip manufacturers. An-

other important aspect of this new business strategy is that Precise Biometrics to a greater extent will focus on the marketing of custom-designed solutions and in conjunction with this also increase its marketing of consultancy services.

PARTNER STRATEGY

Precise Biometrics’ partner strategy is to build up rela- tions with selected partners, who are considered to be able to effectively contribute towards the group achie- ving operational and financial objectives. The global network of partners creates important openings in the market, while at the same time Precise Biometrics’ tra- demark becomes more quickly established in the most interesting markets in Europe, the US, Asia and the Middle East.

Partners

STMicroelectronics and Gemalto are two of the part- ners that Precise Biometrics has conducted important business with in relation to the national ID card pro- jects in Thailand and Qatar.

NATIONAL ID CARD PROJECT IN THAILAND

The importance of strong partner relations is illustra- ted by Precise Biometrics’ major reference project in Thailand. The Thailand project provides a good illus- tration of how the requirements for biometric solutions successively increase in relation to performance, tech- nical reliability, compatibility and cost-efficiency. Well- developed partner relations are becoming increasingly important for Precise Biometrics to respond to the new and tougher customer requirements that follow on from an expanding global market.

In April 2005, Precise Biometrics received a break- through order in Thailand for licenses for 12 million national ID cards. STMicroelectronics was the smart card partner Precise Biometrics collaborated with for this order. STMicroelectronics is the world’s leading chip manufacturer for smart cards. They have an inte- grated product line with chips, operative systems, Card Management Systems and applications. Precise Biome- trics delivers Precise BioMatch

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J as a Match-on-Card

CUSTOMERS

PARTNERS AND SELECTED DISTRIBUTORS

PRECISE BIOMETRICS

Information Flow

Sales

A REVIEW OF THE GROUP

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applet to the Thai authorities, and STMicroelectronics delivers the smart cards.

THE NATIONAL ID CARD PROJECT IN QATAR

In 2006 Precise Biometrics, together with Gemalto, was awarded a procurement for national ID cards in Qatar.

The project includes licensing of the Precise Match-on- Card

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technology, which will be integrated in the na- tional ID cards.

Gemalto is the world’s leading manufacturer of smart cards. The company is a merger of the former companies Axalto and Gemplus. Gemalto has a fully integrated product line consisting of an operative sys- tem, Card Management System, applications, readers and consulting operations. Biometrics is an important part of their total offering.

Gemalto offers a smart card which integrates the Precise Match-on-Card

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technology. Precise Biome- trics has worked together with Gemalto in the Qatar project, where approximately one million citizens will be provided with national ID cards with biometrics.

Precise Biometrics was part of the consortium that re- ceived the order and where Gemalto was included as the smart card supplier. In addition to the Match-on- Card technology, Precise Biometrics will be offering readers, terminals and specific developments for the consortium in the Qatar project.

Competitors

The biometrics industry is a complex industry and the- re are a large number of companies in active competi- tion with each other. It is not uncommon for competi- tors to be, or become, partners of Precise Biometrics.

There are competitors at different levels, for example, in terms of smart card solutions, and hardware and software. Precise Biometrics’ broad product portfolio will be reduced in 2007 and there will be more explicit focus on four prioritized business areas (see page 22- 29).

PRECISE BIOMETRICS’ UNIQUE POSITION WITHIN MATCH-ON-CARD

What gives Precise Biometrics a unique position on the market in comparison with its competitors is the core

technology Precise BioMatch

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and the company’s tech- nology for storage and matching of fingerprints on smart card - Precise Match-on-Card

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. The company’s Precise Match-on-Card

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technology is currently a de facto standard and is, for example, the only biometric Match-on-Card solution that is supplied as a Java app- let, which among other things gives customers exten- sive flexibility in their choice of smart cards. This solu- tion has been delivered in the national ID card projects in Thailand and Qatar. Of all the biometric companies in the world, Precise Biometrics is the only company that has delivered a solution like the one for Thailand’s national ID card project with such a large number of users.

Precise Biometrics’ competitors often have a more extensive range of biometric solutions. For example, two of the company’s largest competitors, Sagem Mor- pho and L-1 Identity Solutions, also offer AFIS solutions used by the police, customs and other public authoriti- es. L-1 Identity Solutions is one of Precise Biometrics’

main competitors and has a large range of multi-bio- metric products that target the American federal aut- horities. Sagem Morpho is the main competitor in na- tional ID cards, but biometrics only consists of a small part of the total project range for Sagem Morpho. Other competitors of interest include Cogent Systems, NEC and Bioscrypt.

Some competitors also work to a certain extent with the development of Match-on-Card solutions, but the few companies that work with this technology do not have the same scope as the Precise Match-on-Card

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. Most of the solutions of these competitors have not been commercialized either. In addition to its unsur- passed performance, Precise Biometrics is the only supplier of Match-on-Card that has a technology that is so widely dispersed and has such a large number of excellent references.

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Business Areas 2006

AMERICAS

PRECISE MATCH-ON-CARD

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A WELL-ESTABLISHED TRADEMARK IN THE AMERICAN MARKET

In the first quarter of the year a follow-up order was received concerning both hardware and licenses for the US Department of State. Several pilot tests were also initiated early on in the year on the basis of require- ments from the security directive HSPD-12*.

The establishment of the trademarks Precise Bio- metrics and Precise Match-on-Card

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in the US market has demanded extensive resources in recent years, both in terms of personnel and financing. Despite the fact that Precise Biometrics has achieved a strong position in the market in 2006, sales have not performed as ex- pected. The assessment has therefore been made that further marketing and monitoring of the market can be carried out with smaller subsidiary operations in the US. These operations will receive strong sales support from a new regional and global sales organization with its headquarters in Lund, Sweden. The work of redu- cing the number of employees has therefore commen- ced in the last quarter of the year.

REINFORCED MARKET POSITION

One positive event in the US market was that Precise Biometrics, at the end of the second quarter, was cho- sen as a member of the HSPD-12 Interoperability Con- sortium, established by the partner SafeNet. The con- sortium will guarantee that solutions which can be delivered to the American federal authorities comply with the directives in HSPD-12. Since the federal autho- rities initiated the issue of ID cards based on smart cards towards the end of 2006 (known as PIV cards), an active participation in the consortium has had a high priority. The objective of the consortium is to show the American authorities that supplementary solutions of the participants in the consortium can be integrated and function well together.

The position of Precise Biometrics in the market

was further reinforced in the third quarter when the combined fingerprint and smart card reader Precise 250 MC was approved and placed on the US General Services Administrations Approved Products List (GSA APL). The fact that a product is approved for this list, which can be compared with a purchasing guide, means that it complies with the specifications of the authorities for use in the HSPD-12 program.

An important factor for Precise Biometrics to ac- hieve its objective of volume sales in the next few years, is also that several American consortiums have previ- ously installed Precise 250 MC in their test systems. An additional factor that paves the way for a positive deve- lopment in sales is that Precise 250 MC is the only com- bined fingerprint and smart card reader on the GSA APL list.

The rapid issue of PIV cards will also be encoura- ged by the fact that there are sanctions linked to the directive, which will affect those authorities who fail to

• The national security directive HSPD-12 makes it compulsory for American federal authorities to issue smart card based ID cards (known as PIV, or Personal Identity Verification Cards) to employees and consultants. A national PIV card means that a uniform security level is established and that security routines can be simplified when an employee with a PIV card can obtain access to several official places.

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live up to requirements and issue them according to the established timetables. An interesting potential ef- fect that HSPD-12* could have on the market is that American organizations, e.g., in the health care sector and large companies with a large number of regional units throughout the US, have shown an increasing in- terest in utilizing the biometric infrastructure being built up for the PIV cards.

EMEA

NEW MARKET STRATEGY FOR EMEA

Even though sales were unsatisfactory during the year there was a lot of market activity in the EMEA market (Europe, Middle East and Africa) and there was sharp interest in biometric technology in several different applications. The failure to achieve good sales results demonstrates the difficulties of making correct judg- ments about when a strong interest in the market is converted into tangible orders. This is particularly true of large-scale biometrics projects, where several Euro- pean countries have been forced for various reasons to postpone earlier timetables for national ID cards and electronic passports with biometrics.

The development of biometrics in the geographical markets of Europe, the Middle East and Africa point to relatively large differences in terms of the scope of the use of the technology, applications, and degree of ma- turity. Many countries in Europe are approaching an implementation phase for national ID cards with smart card technology and electronic passports with biome- trics. IT security and entrance control systems with a high level of security account for a good deal of the in- terest expressed in biometrics in the Middle East. In the last few years sales activities in the business area EMEA have to a large extent been focused on these market segments.

The monitoring of market and project developments in the business areas National ID Cards and ICAO has also had a high priority for sales work in EMEA during most of 2006. Deliveries of the order Precise Biometrics received from one of Israel’s largest banks in the last quarter of 2005 were also implemented during the first months of the year.

Interest in the use of smart card solutions with Match-on-Card technology is very positive for Precise

Biometrics and has during the latter part of the year led to the formation of a new market strategy for the EMEA markets. The objective is that Precise Biometrics will have more efficient sales, more end-user contacts, rein- forced partner relations, and better market coverage.

Much of the sales work in 2007 will be directed towards public authorities, not least in Europe, and towards enabling additional agreements with leading smart card manufacturers and system integrators.

NATIONAL ID CARDS

PRECISE MATCH-ON-CARD

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SETS THE STANDARD

When Precise Biometrics’ business area National ID Card was formed in 2005 one of the main objectives of the sales work was to influence the market so that Pre- cise Match-on-Card

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would be established as a stan- dard for, in the first instance, national ID card projects.

Precise Biometrics received several confirmations in 2006 that this objective was well on its way to being realized. A follow-up order from the Thai authorities towards the end of the first quarter is expected to result in additional earnings during a three-year period. The Thailand project means in its entirety, that Precise Bio- metrics, together with the partner Smart Card Systems International Co, Ltd (SSI), will be responsible for the delivery of the biometric solution for a national ID card, which during a period of several years will be issued to all of Thailand’s 64 million citizens. The project is the largest of its kind in the world and assumes a unique position as a reference project for Precise Biometrics, and will be of great importance in all negotiations con- cerning national ID cards and electronic passports with biometrics.

Precise Biometrics’ strategy to promote Precise Match-on-Card

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as a standard technology in this type of projects has led to successful achievements in the market in 2006. Early on in the year one of Precise Biometrics’s smart card partners, Gemalto, was cont- racted by the authorities in Qatar for the introduction of national ID cards for the country’s one million citi- zens. These cards will also be equipped with Precise Match-on-Card

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technology. In terms of volume this order is smaller than the Thailand project, but it does demonstrate the strong position the Precise Match-on- Card

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technology has assumed on the market.

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INTERESTING AFTERMARKET FOR NATIONAL ID CARDS Precise Biometrics has a dominant share in the world market of national ID card projects which are in an im- plementation phase. In both Thailand and Qatar there are also excellent prerequisites to obtain follow-up or- ders for maintenance services, hardware and software.

In countries that issue national ID cards with Precise Match-on-Card

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, there will also be opportunities for interesting aftermarkets. In the long term it is possible that smart cards will have additional functions and, for example, be used for identification during payment transactions in health care and insurance.

There were no new orders in the second half of 2006 for this business area. Nevertheless, Precise Biometrics has been working intensively with partners and sys- tems integrators to participate in and monitor develop- ments around the world in countries facing decisions on the procurement of solutions for national ID cards and electronic passports with biometrics. With Thai- land as a reference project, Precise Biometrics can de- monstrate that Precise Match-on-Card

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is a stable tech- nology with superior performance in comparison with competing solutions. The technology is also ready for full-scale national roll-out. The fact that no orders were signed in the latter half of 2006 does not mean that the company’s market position has weakened, but rather that the procurement processes in a large number of countries have been delayed as a result of political and economic considerations.

Experiences from sales work in the business area in 2006 demonstrate that relations with partners, systems integrators and chip manufacturers ought to be further reinforced. An important reason for this is that many countries give a very high priority to Match-on-Card solutions. One result of this is that manufacturers of smart cards obtain an advanced position in the market and establish dialogues with customers at a very early stage of the procurement processes, which can extend over several years. The large smart card companies es- tablish themselves today in local activities in a large number of countries so that they can take part when procurement processes get under way, and this means that Precise Biometrics must have the resources to esta- blish good partner relations at many different places around the world. A similar requirement exists in

terms of having close cooperation with systems inte- grators firmly established on a regional basis.

NEW STRATEGY AND CHANGE OF NAME

The global development of the market for national ID cards and electronic passports with biometrics led to Precise Biometrics establishing a new strategy for this business area at the end of the fourth quarter, with the introduction of a new name – Biometric Smart Card So- lutions (see also page 22-23). An enhanced focus on sig- ning additional agreements with smart card and chip manufacturers, and through regional sales organiza- tions, to achieve a more efficient and global coverage of the market is part of this strategy. The development of extras and applications for the aftermarket, expected to emerge in the countries that have initiated the issue of national ID cards is also a prioritized incentive.

ICAO SYSTEMS

ORDER FROM SAS IMPORTANT REFERENCE PROJECT For the business area ICAO Systems (passport projects and projects in the travel industry) 2006 was a very suc- cessful year in terms of sales, but it was also a year that saw a delay in the expected penetration of the segment for electronic passports and travel documents with bio-

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metrics. The deadline set (August 28), when EU countries were to commence the issue of electronic passports with biometrics and travel documents, could not be met by many of these countries. This clearly de- monstrates how difficult it is to predict the develop- ment of sales even in this area. A rapid development in the standardization area (see page 15-16) is expected, ho- wever, to have a positive effect on the development of the market in the next few years.

An important event during the year for the busi- ness area ICAO Systems was when Scandinavian Airli- nes (SAS) initiated a test period for the use of Precise Biometrics’ technology on domestic flights from Kallax Airport outside Luleå. The very successful test project led to SAS making the decision in the fourth quarter to install Precise Biometrics’ biometric system at all the airports in Sweden. Fingerprint reading will in time take place on all flights in Scandinavia and the techno- logy will affect some 10 million passengers a year on its expansion. In 2006 the biometric system for baggage security was installed at 11 airports in Sweden. SAS is the first airline in the world to introduce biometric se- curity checks to guarantee that passengers who hand in baggage are identical to those on the flight.

The fact that Precise Biometrics was chosen as the overall supplier by SAS means that the company has a very strong reference for the projects in the transporta- tion and travel industry that are entering the procure- ment phase in Europe.

FYRPLUS TEKNIK AB

GREATER FOCUS ON BIOMETRIC SERVICES AND INTEGRATION OF BIOMETRIC SOLUTIONS

With more than five years experience in biometric app- lications the staff at the subsidiary has unique compe- tence in the field of biometrics. Precise Biometrics’ ac- quisition of the company at the beginning of 2005 was for the purpose of acquiring Fyrplus Tekniks cutting- edge competence, which in combination with Precise Biometrics’ technology would be able to meet a gro- wing demand for fully comprehensive biometric sys- tem solutions. In 2006 this combination of technology and cutting-edge competence has been decisive for Scandinavian Airlines’ (SAS) choice of Precise Biome- trics as its overall supplier of a biometric security solu-

tion on all its domestic flights.

Fyrplus Teknik is active in biometrics, communica- tions, pharmaceuticals and the defense industry. The emphasis of the company’s operations focuses on a complete system development concept that extends from pilot studies to analysis and design, development, implementation, testing and support.

Traditionally the subsidiary has received many consulting and development assignments from the de- fense, pharmaceuticals and communications industry.

Increased cooperation within the group has, however, led to more and more assignments in the field of bio- metrics. Of Fyrplus Teknik’s total turnover in 2006, 40 per cent accounted for assignments related to biome- trics as compared with only 20 per cent in 2005. In 2007 there is reason to believe that 70 per cent of turnover will be accounted for by biometric assignments.

This greater focus on the biometrics sector is taking place in parallel with ever sharper price competition in other areas of operations, and there is also a decline in the long-term nature of assignments. A clear trend, re- inforced in 2006, is that many large clients in need of consulting services are attempting to quickly cut down and adapt the volume of external consulting services, depending on the requirements in question. New play- ers in the market for volume-intensive consulting as- signments in the form of manpower companies have also contributed to intensive price competition.

The future strategy for Fyrplus Teknik means that the company should avoid entering this price competi- tion and instead concentrate activities in the field of biometrics. As part of this consolidation the subsidiary has reduced its staff by four persons in 2006, who had specialist competence in other areas. These persons will, however, remain available on a consultancy basis if necessary. The corporate management has also prio- ritized an optimization of the cost structure, and as part of this work the office in Linköping was closed in the second quarter of the year.

UNIQUE CUTTING-EDGE COMPETENCE ENSURES SPECIAL POSITION IN SCANDINAVIAN BIOMETRICS MARKET The biometrics system Fyrplus Teknik previously de- veloped for Astra Zeneca proceeds, and in 2006 an agreement spanning several years was signed for

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further maintenance and support. This biometric sys- tem, where personnel who work with the production of pharmaceuticals are identified via iris recognition, is considered to be one of the largest for industrial appli- cations in Europe. As a spin-off from this project Fyr- plus Teknik sees interesting opportunities in the future in projects where companies can improve the efficiency of manually demanding document handling via elec- tronic signing. This signing can take place through further development of the biometric concept develo- ped for Astra Zeneca, and which also includes docu- ment handling in conjunction with the production of pharmaceuticals.

The most positive event for the subsidiary in 2006 was Precise Biometrics’ order from SAS. The order is of great importance for the subsidiary since the com- pany is responsible for all the integration work and has also had a key role as a consultant during the entire project period.

The cutting-edge competence of the staff at Fyrplus Teknik in the field of biometrics has placed the compa- ny in a special position in the Scandinavian biometrics market. At the present time there are no other players with a corresponding profile and therefore there are excellent prospects for strong expansion in 2007 in terms of sales of consultancy services related to biome- trics.

LOQWARE SWEDEN AB

INVESTMENTS IN CHINA - COMMISSIONING IN JOINT VENTURE COMPANY

The subsidiary Loqware Sweden was acquired in the fall of 2005 so that Precise Biometrics would obtain ac- cess to supplementary basic technology and products in specialist biometric areas, and also gain a foothold in the Chinese market. Loqware’s processing of market channels in China in 2006 formed the basis for the joint venture company Smart Unicorn Solutions, which in the first quarter was established together with Smart Unicorn Group in Shanghai.

This establishment in China means that Precise Biometrics owns 30% of Smart Unicorn Solutions, with an option to acquire an additional 10%. The remaining shares are owned by the Chinese company Smart Uni- corn Group, which among other things develops solu-

tions for mobile phones, mobile terminals and compu- ters.

In 2006 the work has mainly been focused on the strategic orientation of the joint venture company. The transfer of technology and training of personnel in China provided by personnel from Precise Biometrics in Lund is also under way. Nevertheless, the original timetable for the launch of new biometric solutions in the market has been delayed as a result of discussions and to some extent uncertainty about the business ven- ture. The company’s investment in China, in conjunc- tion with the requisite evaluation test, has been reas- sessed in the fourth quarter. As a result of these delays and the negotiations in progress with Smart Unicorn Group on the interpretation of the undertakings in the joint venture agreement, a write-down has been imple- mented for a total of SEK 25.2 million. In spite of this the management of Precise Biometrics continues to see the joint venture project as attractive.

To improve the efficiency of the work and cost structure in Loqware’s Swedish operations, the Loq- ware office in Gothenburg has been closed during the year and the product and development work for Loqware’s products have been integrated with the de- velopment department at Precise Biometrics’ headqu- arters in Lund.

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PRODUCT OFFERING FOR THE CHINESE MARKET

The joint venture initially resulted in a large order for LoqFlash

^™

licenses. LoqFlash

^™

is a USB memory with an integrated fingerprint reader developed by Loqwa- re. As part of the business venture one of Loqware’s patents has been transferred to the joint venture com- pany so that the company can develop products and solutions specifically adapted to the Chinese market.

The joint venture company Smart Unicorn Solu- tions has prepared a plan of action that will lead to the development of a product range for the expanding Chi- nese market. The training conducted during the year has primarily focused on Precise Match-on-Card

^™

technology, and the interest in this technology has also progressively grown within different market segments.

In China, for example, there is a great demand for mo- bile phone security. Smart Unicorn Solutions conducts very active development work with new mobile servi- ces. These services, in combination with biometrics, will, for example, be able to contribute towards more secure payment transactions via mobile phones and mobile terminals in the future.

Research, Development and Patents

STRONG PATENT PORTFOLIO IN STRATEGICALLY IMPORTANT TECHNOLOGICAL FIELD MATCH-ON-CARD Precise Biometrics invests extensive resources every year in research and development. The objective of the research is to maintain and develop Precise Biometrics’

position, to offer biometric solutions at the absolute le- ading edge on the biometrics market. By participating and taking effective action in different standardization organs, Precise Biometrics also monitors the standardi- zation process and ensures that the group’s technology Precise Match-on-Card

^™

has a prominent position in future standardization.

More than 20 per cent of the employees at Precise Biometrics are active in research and development. The objective of the group’s research and development stra- tegy is to secure and reinforce Precise Biometrics’ posi- tion in the market. The penetration of the market achie- ved by biometrics technology means that significant parts of the group’s research and development focus

will be shifted towards a more customer and segment oriented development. One example of this in 2006 was the solution developed for Scandinavian Airlines (SAS), which in turn opens new windows of opportunities in the newly established business area Biometric Aviation Solutions.

Precise Biometrics has for several years now acti- vely participated in the standardization work in pro- gress around the world, which in the last five years has had an ever-increasing importance for developments in the field of biometrics. Greater demands for integrated system solutions, where the technology of different suppliers can be coordinated, increase the need for standardization.

One example of how standardization contributes to a beneficial development of biometrics is the interna- tionally determined ISO standard 19794, where Precise Biometrics has contributed by working in various sub- committees. The importance of ISO 19794 is that the standard determines a uniform data format, e.g., for the storage of fingerprint data and electronic signatures.

An important advance made by Precise Biometrics’

R&D department during the year was that Precise Match-on-Card

^™

was developed to comply with the re- quirements in the ISO 19794 standard. The standard means that the Match-on-Card technology is interope- rable with other manufacturers, which is of great im- portance for national ID cards and the European Citi- zen Card. In the American market the company has been approved as per the ANSI 378 standard, which is of significant importance for the PIV cards.

A process of global standardization is conducted in ISO, and Precise Biometrics is also active in similar work at European and national level, for example in the US. CEN (Comité Européen de Normalisation) is a Eu- ropean standardization organization with 28 member countries. In the US, Precise Biometrics participates in standardization work at the national level through ANSI/INCITS and through a dialogue with NIST (National Institute for Standardization of Technology), which is directly responsible to the American govern- ment. Precise Biometrics therefore has the opportunity to clarify issues and technological advantages that are of essential importance for sales in the expanding American market.

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In 2006 Precise Biometrics presented technical advanc- es in line with the preferences of the American authori- ties, also including standardization work in America.

The smart card solution Precise Match-on-Card

^™

has been launched in a version adapted for the American standard ANSI 378 minutiae template (the format for the PIV card). In addition the fingerprint readers Pre- cise 250 MC and Precise 200 MC have been approved for purchase by the US Federal Government, since the products are listed on the US General Services Administration’s (GSA) Approved Products List (APL).

LONG-TERM PATENT STRATEGY WITH PRECISE MATCH-ON-CARD

^™

IN FOCUS

The group’s long-term patent strategy focuses on esta- blishing a strong protection around the Precise Match- on-Card

^™

technology. The patents portfolio has been successively expanded since 2001 and at the end of 2006 included 47 different patents and 36 applications for patents in 21 different product families. Precise Biome- trics has twelve different patent families just for the Match-on-Card technology.

Approved patents in 2006 are:

Verification algorithm with pattern matching technique (approved, May 2006 in Israel)

Match-on-Card with pattern matching technique (approved, September 2006 in France, Germany, the UK and Italy) Detection of latent fingerprints (approved, April 2006 in the US, France, Germany, the UK and Italy)

Match-on-Card with spiral matching (approved, August 2006 in France, Germany, the UK and Italy)

Match-on-Card with minutia points (2) (approved, August 2006 in France, Germany, the UK and Italy)

As part of the establishment of a joint venture company in China, Precise Biometrics has in 2006 transferred th- ree nationally approved patents and one patent appli- cation to the jointly owned company Smart Unicorn Solutions. One of these patent rights was obtained by Precise Biometrics through the acquisition of Loqware Sweden AB in 2005. The transfer of the rights means

that the joint venture company can develop biometric solutions and products covered by the patent for mar- keting in the Chinese market.

In 2006 the group continued to actively apply the patent strategy that has the objective of securing the rights for its in-house technology, to create value for fu- ture business, and to make it more difficult for compe- titors to infringe the group’s different patents. As an important part of the protection of patents and techno- logy there are also well-developed routines for the mo- nitoring of markets and competitors. No change has taken place during the year for the two patent issues that concern the Swedish market and which Precise Biometrics has previously appealed to the Court of Pa- tent Appeals.

Technology and Products

UNIQUE CORE TECHNOLOGY IMPORTANT PRODUCT PLATFORM

Precise Biometrics’ product program has in recent years been developed and adapted to satisfy both the more extensive demands of the market as well as the more specific demands of customers in individual pro- jects. Developments in the field of biometrics will in all probability lead to further adaptation and focusing of the product range. One important reason is to concen- trate on specific customer solutions, and thereby also to reduce the need to stock standard products.

The global penetration for biometric technology in- creases the demands for a flexible product strategy that follows developments in the market.

PRECISE BIOMATCH

^™

The strength of Precise Biometrics is that the group’s products and solutions are based on the company’s unique core technology, the algorithm Precise Bio- Match

^™

, on which all the company’s products are ba- sed.

PRECISE MATCH-ON-CARD

^™

Precise Match-on-Card

^™

is the group’s software tech- nology, where Precise BioMatch

^™

is optimized for fing- erprint recognition on smart cards. In smart card solu- tions the software make sure of matching the reference

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image stored on the card with the incoming biometric image when a person uses a fingerprint reader. The sto- red information never leaves the smart card’s secure environment, which reinforces the personal privacy.

PRECISE BIOCORE

^®

Precise BioCore

^®

is a module of Precise BioMatch

^™

which is programmed on a chip. This type of circuit solution is used for integration in mobile and stationa- ry units to enable the use of biometrics. Precise BioCo- re

^®

is sold as license, and together with Precise Bio- Match

^™

Embedded this product range constitutes the investment initiated during the year in relation to the business area Biometric Embedded Solutions.

SUCCESSFUL PRODUCT ADAPTATION

Precise Biometrics’ product strategy is to optimize the utilization of its core technology in combination with the core competence that exists within the group.

A central aspect of this strategy is to continuously as- sess the group’s product program on the basis of custo- mer and market requirements, including profitability requirements. The rapid developments in the field of biometrics have led to price competition, which is ex- pected to increase in the next few years. One such ex- ample is in the home electronics sector, where biome- tric solutions are used to enhance PC security. A central part of the company’s future product strategy is to fo- cus instead on less price-sensitive technological areas and applications. Precise Biometrics’ competitiveness is based on a combination of products, software solu- tions and biometric cutting-edge competence.

One example of successful technical product adap- tation is that Precise Biometrics, through an intensive development work in 2006 had the combined finger- print and smart card readers Precise 200 MC and Pre- cise 250 MC placed on the US General Services Administration’s (GSA) Approved Products List (APL).

The fingerprint reader Precise 100 XS was launched in 2006. This reader is assessed to have extensive sales po- tential since it satisfies the strong demands that exist in many companies, organizations and authorities through- out the world for a simple, fast and above all cost- effective method of improving IT security.

All the manufacturing of Precise Biometrics’ pro-

ducts takes place at carefully selected subcontractors.

Product development and the production of prototypes take place in Sweden, including also a certain degree of manufacturing, while a significant part of the final as- sembly and volume production take place at the facto- ries of subcontractors. All subcontractors responsible for delivery of Precise Biometrics’ end products are cer- tified in accordance with ISO 9000 and our main supp- liers are also environmentally certified in accordance with ISO 14000. New regulations have come into force during the year concerning lead-free manufacturing.

Both Precise Biometrics and its subcontractors have adapted their products and production processes to current regulations.

Precise Biometrics actively participates in work with the environment and a prioritized objective is, to- gether with its subcontractors, to comply with the re- quirements in different EU directives.

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Employees

COMMITTED EMPLOYEES WITH CUTTING-EDGE COMPETENCE

Precise Biometrics is a knowledge-based and global group. The company is active in an expanding techno- logical sector, where many challenges and the opportu- nity for personal development for the staff working in the group is offered . Precise Biometrics’ future growth and competitiveness depend on its ability to attract, de- velop and retain committed staff with cutting-edge competence in biometrics, consultancy assignments, marketing and sales.

The number of employees at the end of the year was 49, in comparison with 69 in 2005. This reduction is a re- sult of a program of organizational changes and cost-ef- ficiency introduced in the fourth quarter of the year.

These changes also reflect the adjustment from a busi- ness focusing on technology and development to one characterized by a greater focus on marketing and sales.

26 per cent of the employees in the group worked with research and development during the year, 24 per cent with sales and marketing, 28 per cent with consul- tancy assignments, and 22 per cent with finance and administration. Thirty persons were working at the end of the year at the headquarters in Lund of the pa- rent company Precise Biometrics AB, and four at the subsidiary Precise Biometrics Inc. in Washington, DC,

USA. Fifteen persons were working at the subsidiary Fyrplus Teknik AB’s office in Karlstad, Sweden. During the year Fyrplus Teknik’s sales office in Linköping and Loqware’s office in Gothenburg have been closed. Ope- rations in London have also been discontinued.

Of the total number of employees at the end of the year 35 (54) were men and 14 (15) were women, and more than 70 per cent of the employees in the group are under 40 years old. Approximately nine out of ten have an academic education. Precise Biometrics works acti- vely to achieve gender equality in accordance with an equality plan. The work that has been initiated to shift the focus from technology to marketing can be expec- ted to result in a more uniform gender balance in the next few years.

Sick leave remained at a low level, 1.2 per cent (1.1), in 2006 and the turnover of personnel was 38.7 per cent (16.7). The work with organizational changes and the shift of focus from technology to marketing initiated in 2006 means that the turnover of personnel can be ex- pected to remain at a relatively high level even in the future. This is because the need for new competence arise in line with rapid developments in the biometrics sector.

NEW CHALLENGES

Precise Biometrics operates in an international arena

and is characterized by several deeply rooted essential

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staff values. These values include commitment, open- ness, lack of prestige, and the encouragement of perso- nal initiative. In the latter part of the year work has commenced to clarify and adapt these values to the re- quirements set in more market-oriented operations.

Greater focus on marketing and sales has resulted in a new sales organization based on regional responsi- bility. The new organization will involve new challen- ges for the employees in the group who are engaged in sales and marketing. Part of this challenge is to ensure that Precise Biometrics achieves a more prominent po- sition in the market as a supplier of solutions, which means that it will offer, to a greater degree than before, sales of consulting and technical services in combina- tion with different technological biometric solutions.

The group’s assessment of leadership is based on in- formal dialogue with the staff. The leadership aims to encourage personal initiative and personal responsibi- lity for the development of competence and issues of self-development. The leadership of Precise Biometrics has a key role in the changes that have been initiated towards a greater focus on marketing.

Education

Other education, 14%

Master of Business Administration, 10%

Age

< 30 years, 16%

30–39 years, 61%

> 40 years, 23%

Function

Finance and administration, 22%

Sales and marketing, 24%

Consulting, 28% Research and

development, 26%

Other academic education, 40%

Master of Engineering, 36%

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NEW TRENDS IN THE MARKET AND TECHNOLOGY REQUIRE A NEW

CORPORATE STRUCTURE

The global market for biometric solutions and biometric products was

estimated in 2006 to amount to some 2 billion US dollars. The predicted rate of growth up to 2010 is estimated to be around 30 per cent per year. Of the total biometrics market, solutions and techniques for verification with

fingerprints account for approximately 45 per cent, and it is in this segment that Precise Biometrics is active.

As this segment has acquired a greater degree of maturity and commercial penetration, new trends in marketing and technology emerge. These trends are powerful dri- ving forces in the high rate of growth predicted in the co- ming years, and for Precise Biometrics it is essential to adapt its organization to these trends to retain a strong position in the market and to capture new market shares.

At the same time, as the biometrics market deve- lops, it is highly probable that it will continue to be ne- cessary in the future to implement additional organiza- tional adjustments at regular intervals. Such adjustments should be seen as quite natural and neces- sary for a company operating in a new and rapidly emerging technological sector.

Towards the end of 2006, Precise Biometrics presented a new allocation of business areas, with four divisions:

• Biometric Smart Card Solutions

• Biometric Aviation Solutions

• Biometric Embedded Solutions

• Biometric Readers & Systems Integration

On the basis of these four business areas (which are pre- sented in more detail on page 22-29), it has been possible to create an opportunity to control the group’s sales and marketing resources so that they can be dimensioned in line with the specific market demands set in each business area.

THE MOST IMPORTANT TRENDS IN MARKET AND TECHNOLOGY

Interest in smart card solutions based on Match-on- Card technology is growing in an increasing number of markets. Many countries want to use the opportuni- ties to combine requirements for strong personal pri- vacy and secure identification. In addition to national ID cards there is, for example, growing interest in smart card based healthcare cards, driver’s licenses, and ID cards for different organizations and companies.

As the market for smart cards expands, there is a clear trend where global manufacturers of smart cards and chip manufacturers diversify their regional plat- forms in many countries to increase the contact inter- face with national authorities.

A prioritized objective for Precise Biometrics’ new business areas is to follow this development and to es- tablish close relations and partner alliances with the players in different markets.

In the aviation sector there are rapid developments to achieve enhanced security for travelers through im- proved and more flexible ID checks around the world.

In addition to demands for greater security, develop- ments are driven by the need for improved and simpli- fied travel services, as well as better logistics and cost- efficiency. Through the establishment of the business area, Biometric Aviation Solutions, Precise Biometrics will position itself as a competent supplier of biometric

NEW ORGANIZATION

ANNUAL REPORT 2006 PRECISE BIOMETRICS AB (PUBL)