Asetek A/S (A31.F) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to Asetek Q2 2020 presentation conference call. [Operator Instructions] I must advise you that this conference is being recorded today. I would now like to hand the conference over to your first speaker today, Peter Madsen. Please go ahead.

Thank you, Angelica. Thank you, thank you, and welcome to this Asetek Q2 and Half Year 2020 Results Presentation. My name is Peter Madsen. I'm the CFO. I have here with me our CEO and Founder, André Eriksen. Good morning, André.

Hello.

We're coming to you from a very sunny Aalborg, Denmark today, where our Board met just a couple of hours ago and discussed and then approved the half year and quarterly report, which we're now going to present to you. These meetings happens via web. That is due to the COVID-19 situation, of course. So the way, Angelica, the operator just spelled it out, the way we're going to run this is that we will do the presentation. We will then have a Q&A session where you can either follow the instructions that she will provide and then verbally speak to us or you can, during the presentation, go to the web presentation here with the app and type in your questions in this section, direct from app. Those questions, we will see as they pop up but we will -- and we will then address them at the proper time. With that, André, I'll hand it over to you.

Yes. So looking at the highlights for the quarter, it was a revenue of $14.1 million compared to $17.1 million. And our gross margin increased quite a bit, actually 9 points from 42% to 51%. And our EBITDA is more or less the same as last year, $3.1 million versus $3.3 million. But the interesting thing is last year included almost $1 million in litigation settlement. So quite a strong EBITDA. And first half, $23.3 million versus $28.3 million. We have announced our collaboration with HPE, and we have raised our expectation to our revenue and profits for the full year. I will get back to all of this. If we just start with perhaps a little bit more sad and boring part, COVID-19. Let me just spell out how we are doing, as a whole company, not just us, but of our suppliers, et cetera. In terms of our contracted manufacturing, we had a little bit in early Q1, and our employees in China, were sent home. But other than that, we've not really seen any big impact from it. In-house, we are obviously doing the necessary safety precautions and we have not really done anything special. Other than that, we have not laid off people. We have not hired people. It has been pretty steady, I would say. And in terms of our OEMs and end users, I will get back to that a little bit. But let's just put it like this, demand is actually pretty crazy right now. And we cannot really hide that. We are pretty enthused about that, but I will come back to that also. If we look at the revenue, what we said earlier in the year was that we saw a 5% to 10% decline. Keep in mind, we had the tariff situation. We still have that, by the way. We have COVID-19. We have our biggest customer, more or less, leaving us. So our hopes were and what we could see were that, if we could do a 5% to 10% decline and still have positive numbers on the bottom line, we would be happy and thought that we would have coped really well with the situation. And then fast forward, what we have guided is actually now a 5% to 15% growth compared to last year. And on top of that, income before tax between $4 million and $5 million. So it has been a pretty strong development and it's still -- yes, I would say, again, I'll get back to that. Looking a little bit from the top-down on our business, we have the Gaming and Enthusiast division, if we should call it that. That's again, divided into 2, it's divided into the enthusiast and do-it-yourself users where people are going to a store or online, buying our customers' product and go home and build their own gaming PC. And just to name a few, you can see here, ADATA; ASUS; EVGA; Fractal; GIGABYTE; NZXT; and Thermaltake, and that's just a few of them. And then on the PC side where end users are actually buying a complete gaming PC, we have, among others, Alienware and MSI. And then the other side of our business, the Data center business, we are only selling OEMs. We are not selling to any end users, where we have Fujitsu; HPE; Intect; XENON; Supermicro; and Intel and others. I know there are some new investors on the call. So although this may be repetitive for some of you in the way we are organized, I would say, thanks, God, right now, because we are not able to fly. We fortunately have people more or less all over the relevant places. We have our sales and marketing in the U.S., in California. We have people very close to our biggest -- our big customer, Dell and HPE in Texas. We have salespeople in London. Here, in Denmark, where I am, we obviously have management, R&D. We have some sourcing; in-house manufacturing; quality; order management and so forth. And then we have a rather big site in China, where we also have R&D; sourcing; all our outsourced manufacturing; quality; order management, et cetera. Although I'm not necessarily a big fan of spreading a relatively small company all over the globe, I have to say, it's really a big force right now. And of course, our traveling budget has been pretty light this year, but we are actually functioning really well the way it is right now. If we look at the quarterly revenue development, I think this is a beautiful picture of why we are no longer guiding on quarterly levels because it's fluctuating up and down, as it always had been and as it probably will also continue. But I think the most interesting in this slide is really the EBITDA margin of 22.1%. I don't -- is that a record, Peter?

I believe it is.

Yes. It's probably the highest EBITDA margin we have ever had. So that's something I'm really happy about, of course. Diving a little bit into the segments. If we look at the Gaming and Enthusiast segment, the goal has, of course, been and still is to widen and diversify our base of customers. And right now, we are currently shipping to more than 20. Top 5 of them represent 79% of the revenue. It was 81% a year ago. And we're obviously trying to, all the time, improve this picture. As always, we look and monitor our IP situation and we are still moving ahead with our business model transition. I mentioned it quite a few times, so I'm not going to spend a lot of time on it other than, instead of supplying our direct customers with fully fledged products, we are giving them now our core technology and then they're doing the customization on their path. That means our revenue per unit is going down, but our margin per unit is going up. And that's obviously also why we had guided a decline in revenue. So it's actually pretty strong that we are able to both increase our margins and our revenue because it's kind of counterintuitive. If we look at the whole innovation part of the business that we talked to you about a year ago or so, we have just launched with Alienware, what we call the Rad Card GPU Cooler. I will not spend a lot of time on the mechanics of it but the point is that instead of having a radiator in a fan space, in your PC chassis, we now use a PCI Express port, which allows, let's call it, very powerful GPUs in a very small form factor. It just started to ship. So we'll see how it goes. But so far, it has been received pretty well. We have gotten good reviews. If any of you are interested, you could go to a YouTube channel called Linus Tech Tips. They just made a review of it. We have started shipping 2 new products for ASUS Republic of Gamers. We are powering a whole new series of coolers for Fractal Design, and we have a magic pipeline of new products to start shipping in the second half of this year. I don't remember the exact number, but I believe it's more than 20. A parallel to the innovation side was also this, building our own brand in the channel without compromising our direct customers. So we are executing this dual branding or brand-behind-the-brand strategy. So now, when we are launching new products with our customers, we are actually on the box and as you can see, our Enthusiast brand is on this beautiful picture, is holding a cooler from ASUS. And as you will see, there is this Asetek logo on the box. So people actually know that they get the real deal and not some cheap copy from China. On the strategic development in the Gaming and Enthusiast, our goal, as always, of course, is to continue to dominate the market. And we have different handles we can pull. And the key one, of course, is R&D and innovation. It's also the branding and the marketing, and it's obviously also widening our customer base. And I think personally, I think we're doing pretty well on all of these. We are quite busy. Where we have perhaps not succeeded a lot is on reducing single customer dependency. What you cannot see from the slide is that we still have one big, large customer that we are depending on. But within a very few months, we have actually swapped from one customer to another. So it's actually a big success story. And the reason why this customer is so big is actually because they're just selling like crazy out there. So from that perspective, I'm obviously happy that we have lost a significant portion of our revenue to one customer, but we've been able in no time to swap it over. If we look at the Data center side, the most exciting for now, of course, is our collaboration with HP; HPE to be precise. Our announcement was a little bit, what you would call it, timed in a weird way. Because the plan was to announce it later in the year when HPE is actually launching products but because HPE wanted to mention this in a conference in Asia somewhere, we obviously also had to announce it so it will not come to the back door, so to speak. So that's why it just came out of nowhere. But the thing is, our solution is incorporated into the Apollo server platform. And yes, it's running on track. We have started to ship in small volumes, preproduction units for qualification on their production side. And we announced it in January, and a server platform typically lasts between 18 and 24 months. And so far, we have nothing else to say than the estimates indicate a revenue between $4 million and $5 million for this program. If we look at the Data center business, although that we stopped guiding on them specifically, and just to refresh your memory, the reason is that as long as one business is 5% of the rest, then there's no point in guiding on them individually. When and if that will happen, we will change as we see fit. But for now, we shipped just shy of $1 million order that we announced in April. We have announced additional orders in Q2 of $1.2 million, $1.1 million. And what we see is still an increased pipeline of potential projects. And I would say that the higher activity and increased sales prices have resulted in the quite good financial performance at least compared to last year. On the more strategic side of the Data center business. There, our goal is, and still will be, to obviously create a meaningful and big and profitable business over time. And the strategy is that we need to influence the influencers, be it politicians or press or whatever; obviously, increase end user adoption with existing and new OEMs; take advantage of the leadership we already have; and explore growth opportunities beyond HPC. I would say that our work in the European Union is obviously a little bit handicapped by the fact that it's really difficult to set up meetings and travel there, et cetera. But I actually just got a sales report this morning and we actually believe that we have come pretty far. As you all remember, it's not an easy task to go to Brussels and ask them to implement liquid cooling data centers. But nevertheless, there are many initiatives in that direction. And I do believe we will end up there where it will simply be legislation at some point that, if you have a data center of a certain size, you simply need to reuse the wastings. So that's an ongoing thing. With that said, I will leave it to Peter.

Yes. Thank you. I'll go through the financials, and I'll start out with the income statement. I'll simply start from the top and then work my way through towards the bottom. Revenues this first half year was $23 million versus $28 million last year, indicating, of course, a reduction both in decline, both in sales volumes, but also a small decrease in our average sales prices due to this new model -- business model that André, he was talking about. So a reduction in revenue, of course, is never fun to report but take into consideration, please, that we are now guiding towards an increase for the full year in revenue between 5% and 15%, meaning that for the second half year, we are looking at $36 million of revenue as it stands right now compared to this $23 million we made in the first half year. So we're going to be quite busy, as André also alluded to. Gross profits, I'll save my talking here to the next slide. Suffice just to say that we showed a gross profit in the first half of 51% this year versus 42%. And last year, quite an impressive, I believe, increase also as we had hoped for and planned for because it's coming from the business plan -- business model trend. Then directing the attention to the operating expenses. In total, $10.7 million for the half -- first half year versus $10.8 million. On the surface, that's a pretty flat development, but please look at the income we had last year of $750,000, which came from a -- it was a settlement payment we received last year. So if I take the liberty of adjusting for those, when comparing the 2 numbers, then it's actually a reduction of $900,000 in operating expenses between the 2 years. We are running a tighter ship. We have been more frugal. If some of it has -- and of course, we're not traveling as much, and as André also said, that does help us some. I wouldn't say we have ever had an outrageous travel budget but of course, it helps then when everybody is sitting at their desks at home. But we -- also on other lines -- line items, we have had significant reductions in overhead expenses between the 2 years. Around 2/3 of our total expenses are denominated in Danish krone. And of course, it helps when the Danish krone goes down by -- in cost, about 3%. But it's not all of it, we have been more frugal, we have been running a tighter ship. We are loosening up a little bit now when we can see that the COVID-19 situation is not as harmful to us as we may had feared earlier. I would say this is not a result of a planned cost savings exercise. It is more how the money -- how the things have been falling throughout the period. All in all, we have an operating income for the half year of $1.1 million compared to $1.1 million also last year. The percentages are a little bit better because this year, it's on a lower revenue. So we have a total operating income ratio of 5% versus 4% last year. If we then take the liberty of comparing our first half year here, the $1.1 million operating income; with the full year of last year where it was a little bit less, and that's interesting in the sense that it shows that last year, the second half year of last year was a zero-sum game. We didn't make any money at all in the second half of 2019. With the increased revenue expectations and the $36 million we're expecting in revenue, that is not what we're looking into in the second half year. We are looking into quite an interesting second half year. We are planning, as André said, for -- or showing right now an income before tax projection of between $4 million and $5 million. Gross margins are interesting for a lot of reasons. In this particular case, it's interesting because they have actually always been fairly high. And a couple of years ago, we managed to increase our gross margins from the 30 -- high 30s level to the low 40s level, and that was actually -- I was quite happy to report that at that point. And this year, we are now showing 49% gross margin in Q1 and 51% gross margin in Q2. Quite a significant increase. And the -- this is caused by a mix of a lot of different components. The new business model, which is a high gross margin model, we've increased late last year, our Data center prices quite significantly. We have been helped by a stronger U.S. dollar. We have also a general product mix that has [ self-closed ]. And then, of course, we have our good sourcing people and good engineers, et cetera, working on lower cost prices for our products, which also helps our gross margins. I remember a quarter ago, 3 months ago, being asked if we could maintain -- if I thought we could maintain these higher gross margins, and I believe I said no. So it's actually been a positive surprise that we have been able to pull off yet another quarter at these very high gross margins. I do believe that we have to see and look into, that we are looking into a second half with somewhat lower gross margins. And that is -- there are different components playing in their product mix changes and also additional cost. We are a little bit more uncertain about the exchange rates. The dollar has been, if not collapsing, then at least, reducing in price, thereby driving up the Chinese renminbi cost of that. And then we also see the U.S. tariffs being a little bit more aggressive on us in the second half in the year. So all in all, at this point, we're expecting a level, and let me stress that it's a level, it's not an exact science here, of around 47% for the year as a whole.

But when we are stressing anything, let's just stress that 47% is still very high compared to our around 40 number, which we used to report.

Absolutely, absolutely. Balance sheets. You who have been following us have been seeing these graphics for a long time. We are a cash-rich company and a very solid company. At the end of the second quarter 2020, we had $24.8 million to be exact in the bank. That's cash. And 36% -- 76% on our balance sheet was actually booked equity. So we are quite solid, which creates an exceptional partner when we discuss new customer relationships. And hopefully, it also shows we have a solid balance sheet towards the people out there who might be tempted to, yes, honestly, steal our IP. We are ready and we are able to defend our IP from a financial standpoint. And that has always been important to us. An update on the ongoing share buyback program. We initiated a share buyback program back in May. At this point in time, as of yesterday, we have spent $0.9 million out of the framework, which is $4.5 million, so we're still working on it. It's to be completed by September of this year. The goal was to buy up to 1 million shares. We are a little bit more than -- we are almost about halfway through that number. The idea here, of course, is to build up a buffer -- or no, that's a wrong word for it, build up a quantity of shares on -- our treasury shares to back up our option programs that are outstanding. Talking about options and warrants. When we arrive in October, then there will be a big chunk of warrants -- employee warrants that will expire. They have a lifetime of 7 years, and there was a bunch that was granted in 2013. They will expire in October 2020. And to the extent, of course, that they are not exercised, and that means that in this window -- open window where we are allowed to exercise warrants, there will be quite hefty activity, I expect, on the exercising of warranty that's ongoing right now. I know some has exercised this morning and probably we'll see further exercises from other employees throughout the month of August. And on that note here, when these are exercised and/or canceled, then we will have around just shy of 10% of our share capital outstanding in terms of options and warrants. Half of it is options and half of it is warrant. And a final note here, which is important, a group of our employee -- management team members, André and myself included, amongst these employees who have warrants from 2013 that will expire, if they are not exercised, so because the share is -- or these warrants are in the money, at this time, of course, we have used our right to exercise, and that is happening as we speak. That is the stock exchange release that went out just an hour ago or so, that pertains to a group of management members. So that's -- you're going to see further communication via the stock exchange on these transactions. Very finally here, a few words on our financial priorities. On the Gaming and Enthusiast side, it's about us. In finance, we would say, supporting our business model and drive competitiveness and profitability. It's very much these days about innovation and rebranding over on the -- and thereby, of course, increasing revenue makes sense. On the Data center side of things, from my point of view, it's more running -- about running the ship as efficiently as possible. It's about operational discipline, you could say. The same goes for our cost base, our overheads. We are frugal, yes, and we are running the ship tightly. But of course, we are also very observant to the fact that there needs to be money to support R&D efforts and marketing efforts. And we -- even though we have been spending less money as a total, you will -- you should know that our R&D focus is actually -- on spend has actually increased. That was that from my side. And then over to you, André, for the summary and outlook.

Yes. Let me just follow-up on the exercising of warrants, to be proactive. I have, as Peter said, exercised 325,000 and some warrants today. And at the same time, and that's already a done deal by now, I have sold 260,000 shares at 62,000. And for those of you who should care, that's a net 0 deal where I don't make any money when the Danish tax authorities have been paid income tax. So out of the 325,000 shares, I'm left with 62,000 shares that is now in my deposit. So that's the deal, if you wonder. Going to the summary and outlook. We are seeing a strong demand for the Gaming and Enthusiast products. In fact, we are seeing a much stronger demand than we have guided for. Then, some of you may ask why you not then increasing your guidance, that's because we are now facing another issue that we've not really seen before, and that is we have to make sure that our supply chain can actually cope with it. And when I say supply chain, one thing is the manufacturing. But during these COVID-19 situations, we need to make sure we can get the components for it. But we are in the luxury situation that the demand is strong and of course, we are following the supply side closely and we'll, of course, keep you abreast of any developments in that direction. I would like to stress, though, a guidance that we have given you, we are certain that we can supply that. There are several risks from a supply chain perspective in that. And on the duties of business model transition and higher Data center, we obviously -- yes, the outlook is also that if the top is going up, the bottom is going up as well. So that's nice. As I already said, a substantial pipeline of new products that will start shipping soon. And we also see an increased pipeline of the Data center projects. So all in all, despite the situation out there in the world, we have no reason to complain here. That being said, all the information that we have given you that goes into the future. And what I have just said is obviously not taking any COVID-19 disasters into account because trying to guess for that would be impossible. So what I've been saying here, and what we've been saying today, is under the assumption that the world will at least continue as we know it today.

Very good. And with that, we will open up the floor for questions, and we'll call on operator. Angelica, will you help us with that?

[Operator Instructions] There are no questions at the moment. Maybe I can, once again, [Operator Instructions]

That's fine, Angelica. Maybe it's the heat. We have 2 questions coming in via the web here and André, you can read as I can. Maybe you can address the first one.

Yes. So the question was, which market did you describe as crazy in the start of the presentation? I cannot see when the question came in, whether it came in before my summary and outlook. But in any event, that was what I described in the summary and outlook, that there is -- the market is hot in the sense that there is a lot of demand. We can all guess or try to guess why. I don't want to do that. I would say that apparently, a lot of people are building PCs and gaming right now and for whatever reason, but that's how it is. And I think it's a well-known phenomenon, not just for Asetek. And then, of course, also the fact that we are launching so many new products at the same time, obviously, also creates a demand.

Very good. And there's a question from Germany. For you, André. Can you give us some additional information on the new Rad Card GPU Coolers. How big is the additional business potential of this product? Could you use it for laptops? Any remarks about other product pipelines and the business opportunities that they could offer?

Yes. And then it says any update on the legal action against the CoolIT? And -- yes, so on the Rad Card cooler, it will -- let me start about what it is not. It's not something that will fit into a laptop for the very reason that the graphics card itself is bigger than the laptop. And so is the cooler and the laptop does also not have a PCI Express slot. So it's not a laptop product, it's a desktop PC product. And I mean, I don't want to mix up what potential is and what I believe. So let's just answer your question without any weighting from my side. And potentially, it could fit into any gaming PC, where there is a need for it, meaning a small form factor PC. And then on top of that, there is also a possibility for an end-user game where the end user would go and mount it himself. There is at least one challenge with that, and that is when you buy a graphics card, unlike a CPU, when you buy a graphics card, the cooler is already attached to your graphics card. And typically, if you remove it, then you will lose your warranty. And I don't think a lot of customers have appetite for that when they just paid $1,000 for a graphics card and then to remove the cooler. But there are opportunities there for sure. In terms of our legal action, I think for obvious reasons, I don't think this is the time and place to say the comment too much on that. What I can say from a process perspective is that again, because of COVID-19, I have not been able to travel to the U.S. I have specifically been asked by the court in San Francisco to participate in the mediation negotiations. So it's actually scheduled for later this month, and it will be a Teams meeting instead of me being there physically. So I would say that the process has been standing still, and that's probably also why we see it in the numbers.

Very good. Then there's a question here from Denmark. Congrats on your strong profitability. Thank you. Can you elaborate more on the increased pipeline of Data center projects statement?

No.

Very good. Good. Question -- I think we are in France right now, how much of your former large client is represented in Q2 revenue? And how much would we expect in the second half? I can address that.

We don't want to address...

That's a good...

For competitive reasons, we don't want to address it.

Okay. Very good. Then let me hit the refresh button. There seems to be no further questions. Let me do that again. And there are no further questions coming up. That means that we just have left here to point your attention to our e-mail address, which is [email protected]. If you write to us there, we'll do our utmost to provide your information and answers to your questions. With that, thank you for your interest in Asetek.

Thank you.

Thank you. That does conclude our conference for today. Thank you for participating. You may all disconnect. Speakers, please stand by.