Good morning, ladies and gentlemen. Thank you for standing by. Welcome to today's Asetek second quarter 2019 conference call. I must advise you the conference is being recorded today, Wednesday the 14th of August, 2019. I would now like to hand the conference over to your first speaker today, Peter Madsen. Thank you, sir. Please go ahead.
Thank you, Rose. Good morning, everybody, welcome to this Asetek A/S Q2 2019 presentation. My name is Peter Madsen, I'm the CFO. I have in the room here with me, André Sloth Eriksen, who is our founder and CEO. Good morning.
Good morning.
Our board, they discussed and approved the presentation and the report last night. That's what we're going to present to you now. We'll do the presentation. We'll pause and take your questions verbally. If you prefer, you're also very welcome to post both your questions online in the web application. I'm sure you'll figure out how that works. Depends on the platform you're on. We'll get the questions in the first one at that point. Anders, with that, let's take it over to you.
Yes. The short highlights for the quarter is revenue of $17.1 million in Q2 versus a record level of $19.5 million same quarter last year. Gross margins up to 42% and for basically both the second quarter and the half year comparing to 36% of last year. Adjusted EBITDA of $3.3 million compared to $2.9 million. We are, as we talked about at the CMD, we have started and we are focused on building an end-user brand and developing some high-end branded products and innovations. As I'm sure most of you know already, our group expectation of the revenue for the group for this year has been decreased to -20% over last year due to the macro conditions and the trade war, to be more specific.
We have two business segments. As we have gotten used to, it's the Gaming and Enthusiast business driving it at the moment, but we still have the Data Center business also. Just looking a little bit more on the numbers themselves. Peter will get back to it, of course. As you can see, the revenue of $16.6, it's still a pretty good quarter for us, or it is a good quarter for us. Of course, we are all looking ahead. I don't think we should be shy to recognize that this is actually the second highest quarter in the history of the company. We are happy with the quarter. We are focusing on profitable growth. What does that mean?
It means that looking backwards, that we are reducing our spend in the data center side and with the year turning out as it is, of course, we have a high focus on remaining profitable even with the downgrade on the revenue side. I think we'll get back to that a little bit later also. Going into the Gaming and Enthusiast segments, we have roughly just shy of 30 Gaming and Enthusiast OEM customers, and altogether they represent 95% of our group revenue. We have our top five Gaming and Enthusiast customers in alphabetic order. It's Alienware, ASUS, Corsair, NZXT, and Thermaltake. These top five customers contributes with roughly 85% of our total Gaming and Enthusiast revenue. U.S. is by far the largest single market with roughly half of our revenue going into the U.S.
The year 2019 is impacted by macro headwinds, and it already started last year for sure. I'm obviously pointing at the trade war where we now have a 25% tariff imposed on U.S. imports from China, and Brexit is not exactly helping us either. Unfortunately, that's impacting our Gaming and Enthusiast segment since we, as we can see on the slide here, we produce and manufacture everything in China. What does this tariff actually mean? For our customers, the OEM, it means that there is a cash flow effect of paying a 25% upfront on all imports from China. That's obviously a big deal. A lot of people are running cash tight, and from one day to the other, they have to manage another 25%.
On top of that, I know for a fact that some of our customers kind of absorbed the tariffs when they were 10%, so that the ultimate retailer and the ultimate end user did not really feel it. Obviously going from 10% to 25%, that's no longer a possibility since 25% is more than several of our customers are actually making of margin. On top of that, their incentive to build inventory is very low to nonexistent because nobody wants to take the risk of having an inventory that has too high of a value. On top of that, going back to the cash flow, they may not even be able to afford it. For sure, inventories are running low. On the end user side, that's obviously more of a guesstimate than an exact science.
For sure, what we can see is that both PC sales and component sales is going down. For us, it obviously means that we get less revenue. Simple as that. That's why we have done the downgrade. I will not try to guess when and if and how this is solved, but for sure, at some point in time, we expect the situation to stabilize. If it doesn't, it's a new world, and we have to reconsider our options. For now, we sit tight, and then we see what happens. Just a brief look at the historical revenue development, where what we are guiding for the year is compared to 2018. Roughly 20% down compared to the $67.3 million.
As I have on this slide here, and as I alluded to before, based on what we can see today, we do expect to be profitable also for this year. I will take the measures if I can and if the timing is there, should things head in a different direction. That's definitely an ultimate goal for this year. If we then look at slide 11, and we look a little bit on our customers. I think some of our investors are still a little bit in doubt about who our customers are, and at one point, we talk about gaming and e-sports, and at some point we talk about enthusiasts, et cetera. I think it's important to mention that Asetek is not a gaming business, and we are also not an e-sport business.
Our main clientele, our main customers are hardware enthusiasts who like to build their own PCs, who like to upgrade their own PCs. A big portion of those, they like to game, therefore they are also gamers. As you can see on our simple graph here, there are a lot of gamers out there who are not hardware savvy. They buy a gaming PC, for example, they don't necessarily know what's inside, they don't necessarily have the interest to take it apart and assemble it again. That's the difference. We are a part of the gaming market, you cannot say that if the gaming market is growing 10%, Asetek is growing 10%, vice versa. If the gaming market is down 10%, Asetek is down 10%. It doesn't work like that.
Our main customers, they upgrade and build new PCs primarily when there are new hardware platforms available from NVIDIA or AMD or Intel that make them excited. For sure, they use them for immersive experiences like virtual reality and eSports. It's the hardware-driven angle, and I think that's important to understand. Just a slide here on our CoolNation Masters, which is an online tournament we are doing later this year. We are also launching, it actually launched yesterday, a CoolNation website, which is going to be an online presence and forum for all our end users, be it gaming, be it overclocking, be it hardware. There will be more about that later, but this is just the beginning. In terms of our rollout of our co-branding strategy, it's not been that many months.
We needed to have the team in place, et cetera. We're already making good progress. Here on page 13, we have the newly launched EVGA GPU cooler and CPU cooler, where you can see on the box and on the marketing material here, we now have a sign that says, "Cooled by Asetek." That was the whole idea to get our brand name out there. We have the Kingpin GPU hybrid cooler on the next slide. We have the ASUS Republic of Gamers, their new Strix series. On the right side, we have Falcon Northwest, who just launched the new Talon PC, where we built the liquid cooling for.
The common denominator for all three is that instead of just being an anonymous cooling vendor, we now have our brand out there in press releases, on the box, and so forth, obviously, this is just the beginning. On the data center side, shifting gear a little bit, we are continuing to receive orders from our existing OEMs. That's good. Of course, we would like them to be bigger and more of them, they are still alive. As I explained in detail at the Capital Markets Day, in order to see wider market adoption, there needs to be legislation and standards around liquid cooling. If we go to slide 16, we have tried to do that lately. I have done it myself quite a bit, actually, been in the front of the bus, being out there in the media, talking to politicians. I still am.
I think the good news is that they are listening, and people are starting to realize that data centers is a really big problem if we don't do anything about it. It's obviously going to take time, and when I say time, it's measured in years and not in quarters. That's for sure. I am actually, let's say, positively surprised about the feedback we are getting. I am going to the European Parliament in October myself to talk to various politicians and people down there because I think one of the eye-openers here in Denmark was we made a study where we looked at the carbon emissions alone. Just forget about power savings for a second and just forget about money savings for a second, just looking at carbon emissions.
In 2030, the Danish government had this vision of driving electrical cars in Denmark instead of gas and diesel cars. I'm just using Denmark as an example. This is obviously global applicable. What we found out is that on Denmark's carbon footprint, you can reduce it by half a % by going to electrical vehicles. Half a %. If the data centers that was projected or is projected and being built in Denmark right now, they reuse the waste heat and they use our liquid cooling, Denmark's total carbon emission reduction would be 4%. That's a factor of eight and according to, let's say, external and independent sources, switching to electrical cars in Denmark would have a cost for the society of DKK 3 billion, where mandating big data centers to have liquid cooling would have no cost for society.
The numbers are real, and they stack up. I remain confident that it's a question about time before somebody wakes up and say, "This is crazy. We have to do something about it." That journey has started, and we're always more clever when we look in the mirror, and looking in the mirror, could we have started this journey on talking to politicians four or five years ago instead of just going after the OEMs? I'm sure we could, but I'm actually not convinced that anyone would have listened four or five years ago. It's just the stage of the journey we are on right now.
We continue pushing, and in the meantime, we obviously take the orders we can get, we take the business we can get, but we are also very observant about the investment into the segment to keep that as low as possible and still keeping the lights on. I think that's what I have for you right now, and then I'll switch over to Peter, who will cover the financials. Thank you.
Yes. Thank you, André. I'll start out on the profit loss side of things, and I'll start at the top line, where we came in at a revenue in this second quarter of 2019 of $17.1 million, which is 9% down versus the same quarter last year. Keep in mind though that Q2 of 2018 was extraordinarily high. I think we saw a 75% increase year-over-year or quarter-over-quarter in 2018. It is a tough comparison this year. 9% down is still a very good quarter. It's the second highest ever on the G&E side there, on the Gaming and Enthusiast side of things. Our ASPs are up a couple of points, there's a lot of good things to talk about and to mention on the revenue side in this quarter.
The gross margins came in at 42% almost versus 36% last year, 5%, 6% up. I'll come back to that on the next slide. Also there it was quite good news. Operating expenses is up a little bit. We have been helped by the FX, the Danish krone is cheaper this year than it was last year. More interesting here on this operating expense line is you can see how we're in this transition phase where we are scaling down the R&D spend on the data center side, and we are scaling up R&D efforts and the marketing efforts and what have you on the gaming enthusiast side of things. There you can see a quite significant decline in overhead costs on data center from last year, and then a similar increase in expenses on the gaming enthusiast side.
All this leads to an EBITDA of 31 points in the Gaming and Enthusiast side this year versus 32 last year. It's quite similar. That's of course a mix of the improved growth margins and then the negative effects of the higher overhead costs on the Gaming and Enthusiast side. All this down into an EBIT margin of 28 in the Gaming and Enthusiast side versus 30 last year. We have earlier talked about how we expect that number to go down from 28 down to maybe 25 or even lower a little bit, simply because we are spending more money on this Gaming and Enthusiast side. It's totally as expected, we are actually doing quite well. Headquarter expenses here, I just want to mention that we had a one-off income of $750,000 roughly from a settlement of a lawsuit that we concluded here in the second quarter.
Of course, that impacts us positively, and that leads us to an EBIT income of $2.1 million versus $1.7 million last year. I just want to call out that the $2.1 million this quarter is the best EBIT ever. Again, here is some cause to talk about. Gross margins, I promised to talk a little bit about that. That is a mixed bag of information here. We are at 42 points in total, 41.8% to be exact, versus 35.8% last year. You can see on the graph on the left-hand side of things here, the black line is the total company. The blue line is the Gaming and Enthusiast, and of course, since that's 95% of the business, that is pretty much similar to the total line. Then the line that is fluctuating quite a lot is the data center gross margin.
Allow me to concentrate on the Gaming and Enthusiast, since it's the bulk of the business. It's a mixed bag. There are many moving parts. On the sales price side of things, we saw, as I mentioned before, an ASP increase of a couple of points. We are, I think, at $58 average sales price these days. Here, it's also a combination of some prices reduced to accommodate our tariff solution towards U.S. customers. Some prices are increased, we've also seen some new products with more complexity, leading to a higher price on these products, more features, et cetera. On the cost of goods side of things, we see a mix here also of the U.S. dollar coming in with an improvement. The total average cost of goods has decreased by, I think, 7%, of which around 5% comes from the FX rates between U.S. dollars and Chinese renminbi.
We also continue to see quite good efforts coming from our R&D and sourcing groups who are optimizing the components towards cheaper components wherever possible, of course. That then leads us to cash flow statement. It has been quite positive. We have almost $26 million in the bank at this point, $7 million up versus January 1st, where in the first quarter, most of the cash inflow came from cashing in, you could say, on the very high sales we had in Q4. Whereas in Q2, most of our cash flow income is coming from inventory reductions on our part, and then optimizations on the accounts payables. All in all, we have had quite good cash flow performance this quarter. The balance sheet as a total, nothing much here to report. It is as it has been for a long time.
A strong cash position, low interest-bearing debt, and very lean balance sheet in total allowing growth and financial flexibility. Also, when the market goes for a curve ball as it has this quarter here going forward. Just a quick update on the financial priorities coming back from the capital markets update in March. Gaming enthusiasts, we talked about rebranding and talking about, hopefully soon again, revenue growth, and we talk about diversification of revenue streams. André mentioned that 85% of our revenue comes from five customers. That is pretty much the same as earlier. However, the split among these five customers is much more even than it used to be. We continue a disciplined effort to launch new products, new exciting products, to get back on a revenue growth path.
On data center side of things, here from my chair, we are focusing on ensuring an efficient operation, that is also very much on discipline and evaluation, foremost on a day-to-day basis on how to allocate our resources. That leads down to the cost-based optimization, where it's also about discipline. We use quite a lot of focus these days on the transition from data center spend to gaming enthusiast spend. Cash flow improvements, I don't need to say much about that. We've been performing well this quarter, we continue, of course, to optimize where we can optimize. With that, André, back to the summary and outlook.
Yes. The gaming and enthusiast market improved in Q1 compared to Q1, as we expected. Unfortunately, the headwinds persist. Our balance sheet remains solid with a strong cash position, and as I already mentioned twice, I will reinforce it, that we expect to deliver profits before tax for 2019 despite the headwinds. We will keep our focus on rebuilding an end-user brand.
Very good. We will call in our operator, Rose, to govern the Q&A session. When we're done with the verbal questions, we'll come back and take your questions that have been posted online also. Rose, please step in and help us.
Thank you, sir. Ladies and gentlemen, if you do wish to ask a question on the telephone line, please press star and one and wait for your name to be announced. If you wish to cancel your request, please press the hash key. That's star and one to ask a question, and the hash key to cancel your request. Your first question comes from the line of Per Paulsen of Danske Bank. Please ask your question.
Yes, good morning, thank you for the presentation. I have one quick question that is about the Gaming and Enthusiast segment. You write you've gotten a new customer. Is it possible for you to provide the name of that one?
No, we shouldn't disclose that here.
Okay. Thank you.
Thank you. Your next question comes from the line of Anders Lundsten of SEB. Please ask your question.
Yeah, good morning, guys. Probably more questions for you, Peter. Could you give us some color on how you see total expenses for the second half? Also, CapEx is very low, which would generate a very strong free cash flow here in this first half. How should we look at CapEx for the second half? Thank you.
Yeah. Thanks, Anders. The way I look at OpEx for the rest of the year is that it's probably going to be stable compared to what you've seen in the second quarter, excluding, of course, the one-off income from the settlement. On CapEx, yeah, you're right that we have reduced our CapEx in Q2. I believe that is also a good picture of what you'll see in Q3 and four.
Okay. Perfect. That's very clear.
Thank you. Once again, ladies and gentlemen, that is star and one if you wish to ask a question. If you wish to cancel the request, please press the hash key. That's star and one to ask a question. There appear to be no further questions at this time, sir. Please continue.
Perfect. Thanks, Rose. We've gotten a couple of questions online, and you are absolutely welcome to post more questions as we go along. The first question here is related to how our two segments operate together, how independent they are. The question is: If a reduction in the data center strategy will imply a reduction in OpEx and CapEx, and if there's an overlap in the resource between the two segments. Yes, there is an overlap. First of all, a reduction in the focus on data center has reduced the spend in the data center business. We do continue to see that. However, there is an overlap, meaning, of course, we share the buildings and we share the infrastructure, et cetera. You will also see the money being sort of moved from one bucket to another, to some extent.
There is certainly a large element, that the biggest element of us actually focusing more on gaming solutions. We do spend more hours, meaning we also do expect to see more outcome in terms of products, et cetera. I hope that was an answer for that question. Otherwise, please specify your question again. André, the question here on data center, is it correct to understand that the data center demand didn't materialize because the cost for customers outweighed the benefits?
No. That's the short answer. That's not correct, but I can elaborate a little bit about it. The cost is not a problem for our liquid cooling. In a worst-case scenario, you have payback within a year, and most of the time it's actually same cost or cheaper to install liquid cooling for the get-go.
I think the reason why the data center market has not materialized, and as I alluded to many times on the Capital Markets Day, we made the assumption that data center operators were interested in saving money and in saving power. As so far, with the exception of data centers, for example, in Japan, where power is extremely expensive and there's not enough of it, then with the exception of supercomputers who use liquid cooling for also performance reasons, the fact is that most data centers, they don't care. I, and we as a company, made the assumption that companies, data centers, were actually proactive and interested in saving power, especially in the world we live in. That was also a wrong assumption. Nobody is doing anything specific to be green unless they have to.
I think that's exactly the reasons why the data center market has not taken off. Now that I'm involved with politicians, it's kind of a rendezvous in the sense that I'm going back now, I'm going back in time, finding some of the material that we used three, four, five years ago. We have solid data from some of the best universities in the world. We have from University of California, Berkeley, who tested our stuff many years ago. We have customer statements. We have the data to support that you will save money, that you will save power, that we can produce hot water. It has nothing to do with how the product works. It's not like if we had a cheaper liquid cooling solution, it will take off.
It's simply because the data center operators have not been interested in changing the way they do it. They still do it the same way as they more or less always did. To provoke that, to have them wake up, we need standards. I think that perhaps the most trustworthy statement I can give you is that Microsoft recently came out and said that in their Asia data centers, they would like to go liquid cooling because they know the benefits both for the environment and financially for liquid cooling. They need standards or legislation to do it, and before that happens, they're not going to do it. It's not actually only Asetek who's claiming this, it's actually some of the potential customers also.
You can always debate about the chicken and the egg, but the fact is, the situation is as it is, and unless we get legislation around it or standardization or requirements or like we have on diesel trucks, for example, with the Euro norms, also on cars, I think we need that for data centers and then I think it will take off.
Very good. Shifting gears totally, we have a question on capital expenditure, how it is being spent today, and what's the split between expansion and maintenance. Then a follow-up here, if we see CapEx levels increasing from here or reducing. I just looked it up. I can see around two-thirds of what we do or what we capitalize these days is on intangibles, meaning R&D projects, and that means that it is new business, it's expansion, and then the rest is actual PP&E fixtures, which of course, a portion of that is maintenance, but the bulk part would be expansion. It works in a way where we generally see the largest CapEx investments when we do new generation, large new generations. We launched the generation six, late last year, I believe it was, and we saw quite a CapEx increase at that point.
At this point, I don't foresee any larger investments in CapEx. To your second part of the question, I think the CapEx levels will remain where they've been about this quarter. A question, totally shifting gear again. We have strong cash position, it's called out a couple of times. That's correct. The question is, when we're going to initiate a share buyback program. The answer to that is that the board, at this point, has not initiated a share buyback program. We actually do have a slide on this. Allow me to find that slide.
While Peter is finding the slide, let me just comment on the share buyback, because we actually have the authorization, I think from the general assembly. From the company's perspective, we would love to buy back shares. It's not like we are holding on the money or holding onto the money. We have been working really hard behind the scenes to make it work. We are in a, let's say, an unfortunate tax situation at the moment between the U.S. and Denmark, and that's actually preventing us from doing it. That's obviously why we have prepared this slide here. I'll let Peter go to the details. Just to call it out, from the company's perspective, we would like to buy back shares, and we would like to kick off the program sooner than later. For tax reasons, we are not able to.
Peter, perhaps you can go to the slide.
Yeah. First of all, it's correct that we have the authorization from the general meeting back in April, I believe it was. It's a fairly standard decision from an AGM to allow for such a buyback, there should be take no signal value out of the fact that it was allowed back in April. The topic of a share buyback comes up once in a while, of course, depending on our cash flow performance and also the revenue guidance. I'm sure nobody will fault us at this point for having a strong cash situation when we're looking into a number of quarters of the year that are more on the negative side of what we've seen recently. The situation is that when we moved the company back from U.S. to Denmark back in 2013, we entered into a double taxation situation.
There's a tax treaty between United States and Denmark, pretty much saying that the company should be only taxed in one place. It's a very standard double taxation treaty. The Americans, who were at that point back in 2012, afraid that everybody and their dog moved their companies out of United States to low tax countries like Ireland. They put in an override to this tax treaty saying that even though a company moves out of U.S., we still, plus the United States, consider the company as a tax citizen in the United States.
That has actually no effects, no significant effect at least, on Asetek as a company because all our income is in the subsidiaries that are not under U.S. tax jurisdiction. It does have the very annoying effect for the shareholders that when we pay back money to the shareholders, that may be considered a dividend, then we have to withhold 30% taxes and pay that off to the United States, and then it's up to the shareholder to file his tax return in the United States. That's what we did in 2017 when we paid out dividends. It was a nightmare, not only for us, but also, and especially for the shareholders who had to file tax returns in the United States. The average Danish, Norwegian, or whatever shareholder over here in Europe does not file tax returns in the United States. It was a nightmare.
At that point, the idea of doing a share buyback came up. A share buyback and dividends are two very different tools, and they have many different traits, but they do share the one trait that it sends money out of the company and back to the shareholders' pockets, and that was seen as a potential good solution. It then turns out that the Americans, the American IRS, for share buyback programs, consider those to be equal to a dividend unless the shareholder and the company can document and prove that this is not a dividend-like transaction. That is very unlike what's done in Scandinavia, where a share buyback program is not considered anything of dividend type. Therefore, it's very unusual for us and anyone over here in Scandinavia to have to work with the idea of withholding any kind of tax on a share buyback program.
We have to do that on share buyback programs unless certain criteria can be met and documented. We are in this awkward situation that we then have to work with the Scandinavian banks, and potentially withdraw or withhold a tax on these transactions. The banking systems over here is simply not set up for that. It's not possible to go through a Scandinavian bank and have this made.
Let's just underline. We have tried.
We have tried for two years. We have worked with the auditors, PwC, other auditors, lots of attorneys, banks on both sides of the pond, et cetera. We are now recently going to the IRS and the Danish tax authorities to have them resolve the situation. They will work on that. We see some positive moves over here on this side of the pond, but it's a long process. It may take a couple of years, and they're actually not obligated to or mandated to find a solution. We are working on it. We're also working on other solutions. Trust me, this is not going to be forgotten. That was a very long discussion. I hope it brings a little bit of clarity, at least underlines that it's a complex issue. Let me just shift back to the questions here.
There seems to be no more questions at this point. Let me just remind you that we do have an email that you are very welcome to pose the question to, investor.relations@asetek.com. With that, André, any closing comments from you?
No.
All righty. We'd like to say thank you to everybody who listened. Thank you for your interest in Asetek.
Excuse me, gentlemen. We do have another question from the telephone line. Would you like to take that question?
Absolutely.
Oh, I'm sorry. The caller has disconnected. Thank you. Please go ahead.
Okay, I'll just repeat and say thank you for your interest in Asetek. Thank you, Rose.
Thank you.
Thank you, ladies and gentlemen. That does conclude our conference for today. Thank you all for participating. You may now disconnect.