Earnings Call: Q2 2019

Aug 14, 2019

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to today's AdaTech Second Quarter twenty nineteen Conference Call. I must advise you the conference is being recorded today, Wednesday, 08/14/2019. 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 AS Q2 twenty nineteen presentation. My name is Peter Madsen. I'm the CFO. I have in the room here with me Andre Sladeerich, who's our founder and CEO. Good morning. Good morning. Our board, they discussed and approved the the presentation and the report last night, and that's what we're gonna send to you now. We'll do the presentation, then we'll pause and take your questions verbally. If you prefer, you're also very welcome to post your post your questions online in in the web application. I'm sure you'll figure out how that works. Depends on the the platform you're on. But we'll we'll get the questions and and the question at that point. Andre, with that, let's let's take it over to you. Yes. The short highlights for the quarter is revenue of 17.1 in q two versus a record level of 19.5 last year, same quarter last year. Gross margins up 42% and for both basically both the second quarter and the half year comparing to 36% of last year. And adjusted EBITDA of 3,300,000.0 compared to 2.9. We are, as we talked about at the CMD, we have started and we are focused on building an an end user brand and developing some high end branded products and and innovations. And as I'm sure most of you know already, our group expectation or the revenue for the group for for this year has been decreased to to minus 20 over last year due to in in last the the macro conditions and and the trade war to be more specific. We have two business segments. And as we have gotten used to, the the gaming enthusiast business driving it at the moment, but we still have the data center business also. Just looking a little bit more on on the numbers themselves, Peter will get back to it, of course. But as you can see, the revenue of of 16.6, it's it's still a pretty good quarter for us, or it is a good quarter for us. Of course, we are all looking ahead, but I don't think we should be shy to recognize that this is actually the second highest, quarter in the history of the company. So we are we are happy with the quarter. We are focusing on profitable growth. And 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 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. And these top five customers contributes with roughly 85% of our total gaming and enthusiast revenue. And US is by far the largest single market with roughly half of our revenue going into The US. The year 2019 is impacted by macro headwinds, and it already started last year for sure. And, I'm obviously pointing at the the trade war where we now have a a 25% tariff imposed on US imports from China, and Brexit is not exactly helping us either. And, unfortunately, that's impacting our gaming and industrial segments since we as we can see on the slide here, we produce and manufacture everything in in China. So what does this tariff actually mean? So for our customers, so 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 a big deal. A lot of people are running cash type. And from one day to the other, they have to to manage another 25%. And on top of that, I know for a fact that some of our customers kind of absorbed the the tariffs when they were 10% so that the the ultimate retailer and the ultimate end user did not really feel it. But, 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 a inventory that has high of a value. And on top of that, going back to the cash flow, they may not even be able to afford it. So so for sure, inventory inventories are running low. On the end user side, that's obviously more of a guesstimate than an exact science. But for sure, what we can see is that both PC sales and and component sales is is going down. And for us, it obviously means that we get less revenue. Simple as that. And that's why we have done the downgrade. And I I will not try to guess when and if and how this is solved, but for sure, at some point in time, we we expect the situation to stabilize. And if it doesn't, it's a new world, and we have to reconsider our options. But for now, we we we sit tight, and then we see what happens. Just a brief look at the historical revenue developments where what we are guiding for the year is compared to 2018, so roughly 20% down compared to the 67,300,000.0. 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. And 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 at one point, we talk about gaming and esports, and at some point, we talk about enthusiasts, etcetera. I I think it's important to mention that AGetech is not a gaming business, and we are also not an esport business. Our main clientele, our main customers are hardware enthusiasts who like to build their own PCs, who like to upgrade their own PCs. However, a big portion of those, they like to game. So therefore, they are also gamers. But 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 a gaming PC, for example, but they don't necessarily know what's inside or they don't necessarily have the interest to take it apart and assemble it again. So that's the difference. We are part of the gaming market, but you cannot say that if the gaming market is growing 10%, then ACTech is growing 10% or vice versa. If the gaming market is down 10%, then ACTech is down 10%. It doesn't work like 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. And for sure, they use them for immersive experiences like virtual reality and esports. But it's the hardware driven angle, and I think that's important to understand. Then just a slide here on our Cool Nation masters, which is an online tournament we are doing later this year, but we are also launching it actually launched yesterday a Cool Nation website, which is going to be an online presence and forum for all our end users being it gaming, being it overclocking, being it hardware. So there will be more about that later, but but this is just the the 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, etcetera, but 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 and on the marketing material here, we now have a a sign set cooled by Asetek, and that was the whole idea to get our brand name out there. We have the the Kingpin GPU hybrid cooler. On the next slide, we have the Asus Republic of Gamers, their new Strix series. And on the right side, we have Falcon Northwest who just launched the new Talon PC where we built the liquid cooling for. And 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 and so forth. And and, 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 often, but but they are still alive. As I explained in in detail at the the Capital Markets Day, in order to see wider market adoption, there needs to be legislation and standards around liquid cooling. So 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. And I 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. But I am actually, let's say, positively surprised about the feedback we are getting. I am going to European Parliament in October myself to talk to to various politicians and and people down there because I I think one of the eye openers here in Denmark was we made a study where we looked at carbon emissions alone. Just forget about power savings for a second and just forget about money savings for a second. Just looking at at carbon emissions. So in 02/1930, the Danish government had this vision of driving electrical cars in Denmark instead of gas and diesel cars. And I'm just using Denmark as an example. This is obviously a global applicable. And what we found out is that on on Denmark's carbon footprint, you can reduce it by half a percent by going to electrical vehicles, Half a percent. 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%. So 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 3,000,000,000 Danish kroner, where mandating big data centers to have liquid cooling would have no cost for society. So the numbers are real, and they stack up. So I 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. And that journey has started. And, you know, we are always more clever when we look in the mirror. And looking in the mirror, should we 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. So it's it's just the stage of the journey we are on right now. But we continue pushing. And in the meantime, we obviously take the orders 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. So I think that's what I have for you right now, and then I'll switch over to Peter who'll cover the financials. Thank you. Yes. Thank you, Margaret. So I'll start out on the profit loss side of things, and I'll start with the top line where we came in at a revenue in this '19 of $7.17100000.0 dollars, which is 9% down versus the same quarter last year. Keep in mind that 2018 was extraordinarily high. Think we saw a 75% increase year over year or quarter over quarter in '18. So so it is a tough comparison this year. But 9% down is still a very good quarter. It's the second highest ever on the on the G and E side, generally, gaming enthusiast side of things. Our ASPs are up a couple of points. So 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 at 42% almost versus 36% than last year, 6% up. I'll come back to that on the on the next slide. But also there, it was quite good news. Operating expenses is up a little bit. We have been helped by by the by the FX. The the Danish kroner is cheaper this year than it was last year. More interesting here on this operating expense line is, you can see how we're we're in this transition phase where we are scaling down the r and d spend on data center side, and then we are scaling up the efforts and the marketing efforts and what have you on the gaming enthusiast side of things. So you can there, you can see a a quite significant decline in overhead cost on data center from last year and then a a similar increase in expenses on the gaming enthusiast side. All this leads to an EBITDA of 31 points in gaming enthusiast side this year versus 32 last year. So it's it's quite similar. And it's, of course, a mix of the improved gross margins and then the negative effects of the of the higher cost of the higher overhead cost on gaming enthusiast side. This all leads down then to an EBIT margin of 28 versus in in the gaming enthusiast side versus 30 last year. We have earlier talked about how we expect that number to go down to from 28, down to maybe 25 or even lower a little bit simply because we are spending more money on on on this gaming enthusiast side. It's totally as expected, and we actually fly 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. And of course, that impacts us positively, and that leads us to an EBIT income of $2,100,000 versus 1,700,000.0 last year. And I just want to call out that the $2,100,000 this quarter is the best EBIT ever. So again, here are costs to talk about. Gross margins, I promise 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 the blue line is the gaming enthusiast. And, of course, since that 95% of the business, that is pretty much similar to to the total line. And then the line that is fluctuating quite a lot is 80% of sales and the gross margin. Allow me to concentrate on the gaming enthusiast since it's 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 and before, an ASP increase of a couple of points. We are, I think, at $58 average sales price these days. And it's here, it's also a combination of some prices reduced to to accommodate our tariff solution towards US customers. Some prices are increased, and we have also see seen some some new products with more complex complexity leading to a higher price on these on these products, more features, etcetera. On the on the cost of goods side of things, we we see a mix here also of the US dollar coming into with an improvement. The total average cost of good goods has decreased by, I think, 7%, of which around 5% comes from the FX rates between US dollars and Chinese memory. But we also see continue to see quite good efforts coming from our R and D and sourcing through through optimizing the components towards cheaper components wherever possible, of course. And that then leads us to cash flow statement. It's been quite positive. We have almost $26,000,000 in the bank at this point, $7,000,000 up versus January 1, 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 in this quarter. The balance sheet as a total, nothing much here to report. It is as it is has been for a long time, a strong cash position, low interest bearing debt, a very lean balance sheet in total and allowed growth and financial flexibility. Also, the market growth was a curveball, as it has, this this quarter here going forward. Just a quick update on the financial priorities coming back from the Capital Markets update in in March. Gaming enthusiasts, we we talked about rebranding and talking about, hopefully, soon again revenue growth, and we talk about diversification of of revenue streams. Andre mentioned that five is that 85% of our revenue comes from five customers. That is pretty much the same as as earlier. However, this the split among these five customers is much more even than it that it used to be. So we continue a a disciplined effort to launch new products, new exciting products to to get back on a revenue growth path. Data center side data center side of things, here, from my chair, we are we are focusing on ensuring an efficient operation, and that is also very much on discipline and the evaluation more and on a day to day basis on how to to allocate our resources. Current that leads down to the cost base optimization where it's also about discipline. We use quite a lot of focus these days on the transition from data center spend to being a through shared spend. Cash flow improvements, I don't need to say much about that. We've been performing well this quarter, and we continue to, of course, to optimize where we where we can optimize. With that, Andre, 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'll reinforce it that we expect to deliver profits before tax for 2019 despite the headwinds, and we'll keep on focusing on on rebuilding an an end user brand. Very good. Then we will call in our operator, Rose, to govern the q and a session. And when we are done with the verbal questions, we'll come back and take your questions that have been posted online also. So, 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 1 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. And your first question comes from the line of Pir Polson of Danske Bank. Please ask your question. Yes. Good morning, and thank you for the presentation. I have one quick question quick question. That is about the gaming and exclusive statement. 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 it here. Okay. Okay. Thank you. Thank you. You. And your next question comes from the line of Anders Lindsden of SEB. Please ask your question. Yes, 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? And also CapEx is very low, which of course means you have generated a very strong free cash flow here in the first half. But how should we look at CapEx for the second half? Thank you. The way I yes, thanks, Anders. The way I look at OpEx for the remainder 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 second quarter. And on CapEx, yes, you're right that we have reduced our CapEx in Q2. And I believe that is also a good picture of what you'll see in Q3 and Q4. Okay. Perfect. That's very clear. 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 hash key. That's star and one to ask a question question. There appear to be no further questions at this time, sir. Please continue. Perfect. Thanks, Rob. So 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, is the reduction in the data center strategy will imply a reduction of OpEx and CapEx and if there's an overlap in the resource between the two two two segments. And, yes, there is an overlap. First of all, a reduction on the in the focus on data center will reduce and has reduced the the spend in the data center business. And we do see we we do see continue to see that. However, there is an overlap, meaning, of course, we share the buildings and we share the datas the infrastructure, etcetera, etcetera. So you you will also see the the money being sort of moved from one bucket to to another to some extent. But there is certainly a large element. That's the biggest element of us actually focusing more on on gaming enthusiast. We do spend more hours, meaning we also do expect to see more outcomes in terms of product. I hope that was a a question to that question an answer to that question. Otherwise, please specify your first name. Andre, the question here on data center, is it correct to understand that the data center market didn't materialize because the cost for customers outweigh 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 market 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. And 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 the fact is that most data centers, they don't care. And I 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. And I think that's exactly the reasons why, you know, the data center market has not taken off. Now that I'm involved with politicians, it's kind of, on the rule 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. And, you know, we have solid data from some of the best universities in the world. We have from Berkeley University in California who tested our stock 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. So it's 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. And to provoke that, to have them wake up, we need standards. And I I think the 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 from the for the environment and financially for liquid cooling, but they need standards or legislation to do it. And before that happens, they're not going to do it. So it it's not actually only Esotec who's claiming this. It's actually some of the potential customers also. You can always debate about the chicken and the egg, but but but the fact is the situation is as it is. And unless we we get legislation around it or standardization or requirements or like we have on diesel trucks, for example, with the euro norm also on cars, I think we need that for data centers, and then I think it will take off. Very good. Shifting here totally. We have a question on capital expenditure. How it is being spent today, and what's the split between expansion and maintenance. And then a follow-up here if we see CapEx levels increasing from here or reducing. I just looked it up. I can see around around two thirds of what we do or what what we capitalize these days is on intangibles, meaning r and d projects, and that means that it is new business. It's it's it's expansion. And then the rest is actual PP and E fixtures, which, of course, a portion of that is maintenance, but the bulk part would be expansion. It it it it works in a way where we we generally see the largest CapEx investments when we do new generation, not large new generations. And we we launched the generation six late last year, I believe it was, and we saw quite a CapEx increase at that point. But at this point, I don't foresee any larger investments in in CapEx. So to your second part of the question, I think the CapEx levels will will remain where where they've been about this point. And then a question totally shifting here again. We have a strong cash position. It's called out a couple of times. That's correct. And the the question is when we're gonna initiate a share buyback program. And the answer to that is that we the board, at this point, has not initiated a share buyback program. And we actually do have a slide on this. Let me just allow me to find that slide. While Peter is finding is the slide, let me just comment on the the share buyback because we actually have the authorization, I think, from the general assembly. And from the company's perspective, we would love to buy back shares. And, it's not like we are holding on the money or holding onto the money. However, we have been working really hard behind the scenes to make it work. However, we are in a, let's say, an unfortunate tax situation at the moment between The US and and Denmark, and that's actually preventing us from doing it. And and that's obviously why we have prepared this slide here. But, you know, I'll I'll let Peter go through the details, but but just to 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. But for tax reasons, we are not able to. So so, Peter, perhaps you can go to the the slide. Yeah. First of all, it is correct that we have the authorization from the general meeting back in in April, I believe it was. It's a it's a fairly standard decision from a from an ATM to to allow for such a buyback, and there should be there should be taking no signal value out of the fact that it was allowed back in in back in April. But and and the the topic of a share buyback comes up once in a while, of course, depending on our cash flow performance and also the also the 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 here that are that are more on the negative side of what we've seen recently. But the situation is that when we moved the company back from United States to Denmark back in in 2013, we we entered into a double taxation situation. There is a there's a tax treaty between United States and Denmark, pretty much saying that own that the company should be only taxed in one place. It's a very standard double taxation treaty. However, the Americans who were at that point back in 2012 afraid that everybody in their dog moved their their companies out of United States to low tax countries like Ireland. So they put in a a a an override to this tax treaty saying that even though a company moves to our US, we still, plus The United States, consider the company as a tax citizen in in The United States. And 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 US tax jurisdiction. But it does have the 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 tax holder to the shareholder to to file this 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. And the average Danish, Norwegian, or whatever shareholder over here in Europe does not file tax returns in The United States, and it's it is it was a nightmare. So at that point, the idea of doing a share buyback came up. The share buyback and dividends are two different very different tools, and they have many different trades, but they do share the one trade that it sends money out of the company and back to the shareholders' pockets. And that was seen as a a a potential good solution. It then turns out that the Americans, the American IRS, for 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. And that is very unlike what's done in Scandinavia where a share buyback program is not considered anything of dividend type. And 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. But we have to do that over we have to do that on share buyback programs unless certain certain criteria can be met and documented. So we are we are in this awkward situation that we then have to work with the Scandinavian banks and and potentially withdraw withhold a tax on these transactions. And the the banking systems over here is simply not set up for that. It's it's not it's not possible to to go through a a Scandinavian bank and have this play. Let's just let's just underline. We have tried We have tried for two years. We have worked with the auditors, PWC, other auditors, other lots of attorneys, banks on both sides of the bond, etcetera. We are now recently going to the IRS and the Danish tax authorities to have them resolve the situation. They and they will work on that. We see some positive moves 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. So we are working on it. We're also working on other solutions. Me. This is not this is not gonna be forgotten. That was a very long discussion. I hope it brings a little bit of clarity, at least underlines that it's a it's a complex issue. 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 post your question to investor.relations@acetech.com. With that, are there any closing comments from me? No. Alrighty. We'd like to say thank you to everybody who listened. Thank you for your interest in Ace Tech. Excuse me, gentlemen. We do have another question from the telephone line. Would you like to take that question that question? Absolutely. Oh, I'm sorry. The the caller has disconnected disconnected. Thank you. Please go ahead go ahead. Okay. Then I'll just repeat and say thank you for your interest in AsiaTech. 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.