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

Very good. It's 4:30 p.m. here in Aalborg, where we are coming to you from today. Welcome to this Asetek update to our full year 2021 guidance call. We issued a stock exchange release earlier via the stock exchange in Oslo, and we have developed a couple of slides, a few slides that we would want to develop on with some commentary now. My name is Peter Madsen, I'm the CFO. I'm joined here in this room by John Hamill, our COO; and then on a different line, we have our CEO, Andre Sloth Eriksen. Andre, he will walk us through the slides and explain what happened and our future plans. And we will then take questions. [Operator Instructions] With that, Andre, the floor is yours. And moderator, if you can flip 2 slides forward, please.

Yes. Good afternoon. So let's jump right into it and look only 5, 6 weeks back and look at our Q2 report, what was said and what was guided back then. I think that's useful to see where we are going. So we expected our revenue to increase between 20% and 30% over last year, and that would give us a revenue in the range of $87 million to $95 million. Our pipeline is -- was and is still record high, but we're also seeing customers getting nervous by increasing shipping rates, component shortage in the channel, and there was a lot of moving and pushing orders around, and that's still going on. And as such, we maintained our guidance because of the very low visibility, it was our best assumption at the time. We expected our gross margins to normalize, and we basically thought that we would look at something above 40%, and that's always been our goal. But of course, substantially above 40%, if we can. That's always what we're trying. And we were looking at an operating income of between $8 million and $12 million, compared to $11 million last year. And yes, we were looking into uncertainty related to the COVID-19 situation and shortage of semiconductor chips. That was, basically, the situation only a few weeks back. So moderator, please change the slide. So here we are today, September 22. And a few thing has happened within the last 2 or 3 days. I would say that 3 days ago, we saw the first, what should we call it, warning signs that something may happen in China. And then during the last few days, and especially, during today, it has developed in the sense that the Tongan district in China, which is just north of where we have our factory, we have a lot of sub-suppliers there, and that area has simply been shutdown completely. Public transport is shutdown. People are sent home. They cannot go outside. Factories are shutdown. And that means that in our own factory, the only components we have, and I think it's important to stress here that when I say components, it's not IC, it's not semiconductors like the global shortage of components, these are basically subcomponents to our products, we cannot get them. So beyond what we may or may not have in inventory, we cannot get it. And on top of that, in Xiamen, where we have our factory, the COVID situation is getting worse, apparently, every day. Also, I think there was 300 or 400 new yesterday. So that also means that our own employees are limited in traveling to the office, limited in working, and the same with the factories. And of course, that means we cannot get products or parts in, and we cannot get products out. So that's a brand-new development. But on top of that, and also triggering this update, we, of course, still have the wider supply chain challenges with a continued increased component cost and shortage. And again, I would like to say the shortage here, as I also said at our last conference call, is primarily with our -- with the customers. So other than the COVID-19 situation, we actually do have the components we need. I think I can disclose that, just on the cost side of components, it has cost us $1 million more to get our components, but we've gotten them. And of course, also the increase in logistics cost. So since our last call only 6 weeks ago, we are looking into added shipping cost on our side of $2 million. And keep in mind, we are only selling a little bit -- or sorry, shipping a little bit. It's our customers who are typically buying from our factory, and then they take care of shipping. But just on our side, it's an extra cost of $2 million right off the bottom line. And that's, of course, also why it's hurting our customers. And of course, this is all leading to increased uncertainty, both related to the sales and the cost for the remainder of the year. Just as the shutdown, we have no way of looking into what the Chinese government is doing. But talking to our own employees, which is not an indicator of anything that people who lives there, what they say is that when they do these quick shutdowns, typically, we get up again within a couple of weeks. But at this point, it's only guesswork. On top of that, our expected data center revenue is not materializing. And that's just dragging down our margins and our profits big time. And that's, of course, because we have a fixed cost base. We have a certain number of engineers. And when the revenue is high, then the margins are better. But when the revenue is low, the data center revenue, that is, then, of course, it's a big drag. And this update, of course, also reflects the fact that we have decided to sharpen our data center focus and get out of HPC. And of course, there are some costs associated with that. So what that means is that based on what we can see today, our full year expectations are now 10% to 20% growth compared with 2020 and an operating income of between $0 million and $2 million compared to $11 million last year. And that's, of course, a dramatic decrease unfortunately, I would say. It's pretty easy to explain and understand. So we are losing revenue in the millions because of this shutdown. As I just said, we have just a component cost and increased shipping on our side, $3.5 million in total. We have the missing margin that we expected from the data center revenue. And then we have a write-off of IP inventory equipment, et cetera, that's associated with the HPC decision. So that's why we are where we are. To give you a little bit more color on why we guide 10% to 20%. What I would say is that it's still a guesstimate because we don't know how the situation in China will look like. The reason why we still guide 10% to 20% is because we still see a strong demand in Q4. So are we able to supply, we will also have a strong quarter and vice versa, of course. But instead of trying to guess, I'm laying out the facts here. We have a strong demand, we have a critical situation in China, and we just have to wait it out. Next slide, please. So if we look at the current situation, coinciding with these COVID-19 effects in China and the wider supply challenges, we have decided to sharpen the data center business segment, and basically, exit the HPC space. The reason I say coinciding is because this HPC decision is, of course, something that we have spent some time on developing, and then, basically, in the midst of it within the last few days, we get this critical message from China. So that's why the two of them are actually mixed together in this update. But some background about why we are pulling out of HPC. I can say already now we are not pulling out of data center, but we are pulling out of HPC. And the reason is that we are seeing an increased complexity and demands in the architecture for high-performance computing, that's driven by more powerful GPU and DIMMs, so memory modules. And I could say that this is really moving away from data center. I would say HPC servers are moving away from data center servers, general purpose data center servers. So this development, in the first place, is kind of counter-constructive to what we want to achieve. But on top of that, we can see that compared to where we are now, we would need to increase our investments even further. We can see our customers. They want even higher engineering support, which they are not paying for. And we have been able to look into the revenue expectations for the next 24 to 36 months. And they are actually low, significantly lower than today, which means that our burn rate would accelerate like crazy. So if we stayed in this market, we would be looking at significant losses. And HPC is a niche that has nothing to do with our success in the more general data center market. That's something we entered, of course, to keep the lights on basically to get some revenue and because we thought we could use HPC as a stepping stone into the more general data center, but that turns out not to be the case. So the rationale behind the decision was really to protect our future profitability from increasing losses, lacking revenue from this area. And then I think it's also important to let you know that the reason this decision comes now, it could have been perhaps more logic to talk about this at our annual investors meeting. But the fact is, we have a customer that we have committed to, and we needed to give a binding committed -- or commitment within the next few days. And if we commit to that, we would commit to the losses that I just explained to you about. So therefore, we needed to get out of it. And as we needed to get out of it, then, of course, we need to let the stock market know, and that's what we are doing. And then, yes, the perfect storm, the COVID situation in China on top. Our goal for the data center market is basically the same as it's been all along, that is, to create a sustainable and profitable business. And I would say that the short-term tactics and strategy has, of course, changed. We are exiting the HPC space. That means that we will have a reduction in our staff of between 15 and 18 full-time employees. It will be primarily R&D and operations. We will have the nonrecurring cost of $2.5 million, as I explained before. And the whole goal, of course, is to improve our profitability going forward but also to avoid increased losses. It would not be realistic to keep that business going at the current levels, unfortunately. What we are not going to cut down is, of course, our work in the EU in terms of the legislation and to get the waste heat and everything put into hard legislation from the good intentions that we're seeing in the EU. And once legislation is adopted, then, of course, we want to capitalize on and make money and sell. And I think from the longer-term outlook, I think the global sustainability agenda is still there. Nothing has changed. I think the rationale for what we are doing has not changed. We are seeing a positive impact from the Green Deal with the EU, that's favoring liquid cooling. But as I have also said and realized during, I think, 2 or 3 years now, I do not believe the market will take off before we get hard legislation. And then the rationale of getting out of HPC is whether we lose $7 million or $10 million a year going forward will not change it. So therefore, there is no reason to lose that amount of money while we are getting ready and while we are trying to influence it. And I think it's also important to stress that in terms of products, in terms of technology, in terms of manufacturing equipment, of course, we are keeping that around. And I think it's also important to stress that we, of course, also -- we are still maintaining and developing the technology. There will still be a small group of people inside Asetek doing data center stuff. We will just not be selling to HPC anymore. Next slide. So just to sum it up, we are still banking on and hoping for a record revenue. I think that's also important to understand that. If we go out with any growth, basically, it will still be a record revenue year compared to 2020, which is driven by the strong underlying demand that the irony of the situation, we could call it, is that it's not really a lack of demand that we are seeing, fortunately, I would say. The new expectations are really triggered by the effects of new and also ongoing COVID-19 shutdowns in China. As I repeated a couple of times, it also includes the -- let's call it, the supply chain challenges that we have seen all year, and partly, also last year that's accelerating. And then, yes, we are expecting an operating income between $0 million and $2 million. And of course, that is heavily relying on the situation in China. And then as such, we have updated our expectation based on new and available -- the best available information we have today. And should anything change, we will, of course, let you know, and of course, update you via our normal reporting. We are sharpening the data center segment. Let me just stress here. Apparently, there's some confusion what HPC is. I can tell you what HPC is not. It's not our core business. Although we are selling to high-performance gaming PCs, it has nothing to do with HPC. What we are looking at right now is getting rid of our loss-making 5% to 10% of our revenue and that's it, with the intent, of course, to improve our profitability while we maintain our long-term commitment to the area. And I think it's also important just to remind ourselves that we have a strong balance sheet that's supporting a long-term growth overall. And with that being said, I will jump to the questions.

So I will start with some questions. So number one, does the step back from HPC mean that you have -- you do not have the right products for this market? Does other have better cooling solution for this market is the reason that the HPC market is moving towards GPUs? I think the best way to answer is there is no such thing as the right product. You have to develop new products for every generation, and that's the problem. 2 years ago, roughly, we developed new products for Fujitsu, Supermicro and HPE. Now they have been selling them for a couple of years. And now we can start all over again because now Intel and NVIDIA and so forth is coming with new form factors, and then we can do all of this design work all over again. So I don't think it's a question about having the right products or not. I think the question is, does it make sense for Asetek to employ 30 engineers to support a revenue between $3 million and $5 million annually. And in my book, the answer is clearly no. So that's the answer to that. In terms of -- so next question, what is the expectations for guidance when the shutdown in China will ease again? Well, that's impossible to answer because we don't know when it will ease. If it will ease in 2 weeks, it will be one question. If the shutdown in China will drag out for 2 months, it's a different question. So we cannot say at this point. I would love to give you an answer, but I have no privilege into when the Chinese government will open. And then another question -- or third question, did we get that right that you don't give up on the general data center market? Given the fast-growing importance of ESG, this would be totally wrong timing. A lot of investors have been in the stock due to the data center business. I don't know what else to say than just repeat what I just said 3 times. We are not going out of the data center market. We are leaving a highly unprofitable HPC market. And I think it's fair to say that there is a fair amount of investors who is also getting sick and tired of watching a loss of $4 million, $5 million a year just for the sake of HPC. So I think with the moves we have done here, in my opinion, it's diligent management. We are minimizing the losses, but still optimizing the opportunity. Can you try to quantify the one-off cost for '21 versus the ongoing effects for '22 on cost and EBIT, please? I think that's perhaps a question to you, Peter.

Yes, sure. I can try. The one-off cost which you said was around $2.5 million consists of several components. About $2 million of those $2.5 million is IP and equipment. And that equipment would be written off and the IP would be written off now in the anticipation that we cannot, for example, realize or sell the equipment off to other avenues. That -- those $2 million would have to be written off over time over typically 3 years, that was another data point. So combining that with the effect on the EBIT in 2022 and onwards, the effect of this cost savings exercise as -- is one word for it from the CFO desk here, of course, is around $3.5 million effectively in 2022. And those $3.5 million include, of course, the amortization of those fixed assets that I -- and the IP that I mentioned before. So the one who asked here, I think, there would be -- in what I just said, there would be a few data points where you can calculate.

All right. Thank you. So what would have been the cost of the milestone with the HPC partner? So what we can say is I would think we would have to hire in the vicinity of 5 to 7 more people to support this, and we were looking into a total revenue over the next 24 months of $5 million, that's what we got. So that would be a significant 2-digit million dollar loss to support this. Then there is a question about to what extent, we can move production from China to the U.S. and Europe over the long term? I think there are a lot of possibilities. And I think it's easy to be clever in the hindsight. The possibilities right now are, of course, 0 because there's a lot of subcomponents from China. And assembly in Europe makes not a whole lot of sense if you cannot get the components. So I think that's not something we have covered on this call, but I think there are many opportunities to reduce the dependency. I think there are many opportunities to optimizing the whole logistics setup in terms of shipping and in terms of also the tariffs. And that is something we are looking into, of course. But I also think it's important to understand that we are not a huge international giant that can set up 5 manufacturing places around the world, that's not who we are. It would be nice if we could, but we don't have that flexibility. But I think the double whammy here is that even if we had a production or assembly in Europe, it will not have changed the situation because, and I think that's true for many companies in Europe, a lot of the subcomponents are from China. And if you cannot get them or they're really expensive to get, well, it doesn't really make sense that you have anything in Europe. So it's definitely not something we fix overnight, but also something that's really high on our agenda, of course. In terms of sim racing, whether the cost to develop this business is higher than originally planned? There are no change compared to our last quarterly update. Can you say something about when sales have stopped? I calculate an implicit H2 revenue decline of 20% to 35%. If revenue has been normal in July to mid-September, we must be seeing into a full stop in the remaining period of '21. I don't really know how to answer that. There's no sales that has stopped. We are still selling, of course, and we are still getting revenue. What we can say is China has been shut down, and we still don't know what the impact is. In terms of HPC, we will be taking orders, of course, to support the customers until the end of the year with the last shipment possibility of end of Q1. Is HP cooperation for HPC or general data centers? That is for HPC only. We don't have any general data center customers. And that's the whole point that the HPC customers we have, they do not really, let's say, have a spillover effect on general data centers. Can you give more color on the geographical extent? Not other than the province I mentioned is where we have our sub-suppliers. And GN is also having production in Xiamen. Well, if they keep up their production, they may be -- or they have to be able to withstand their supply base that's kind of a given. We don't. And what will be the savings from not investing in HPC anymore on an annual base? I don't know if you have anything to say about that, Peter. I think it's worth noting that this is something that's, let's say, developing as we speak. We are still talking to employees in other rooms just next to me. So this is very much new. But what I can say, and then I'll give you the chance to answer also, Peter. What I can say is that I believe that we were looking into $2 million, $3 million, $4 million more a year than where we currently are, if we continue. It's an unfair assumption to look at last year and say what happened if we continue and what will we save? I think it's -- I cannot stress enough, that's not an option. The option is whether we would like to increase our investments to support it or not. So with that said, Peter, is there anything you will say there?

I mentioned the amount $3.5 million before, but that is with all the caveats and assumptions that you just listed there.

Yes. So there is an investor asking that the share price has fallen dramatically, and that's probably because of lost confidence to the company and the management and whether that gets any consequences. I'm probably not the right guy to ask that. That will probably be a question for our Chairman. But what I can say is that if this get on us and believes that I'm in control -- or the company is in control of COVID, then I think it's perhaps a little bit unrealistic expectations to any management. And in terms of the shutting down the HPC, my job is to do what I believe is best for the company. That's what I'm hired to do. And of course, in the long run, that should also be what's best for the investors. I do believe it's the right choice we are making. I do not believe that at this point in time, we have invested almost $100 million and keeping investing between $5 million and $10 million a year in a niche space that does not bring us to the end goal, I do not believe it's the right choice. But of course, there may be disagreement with that. And if there is, then for sure, it will be another CEO than me because I don't see it, and I don't see the point. So there's a question here. You state that component costs are up $1 million and shipping $2 million. How much is this in total percent of cost of the 2 items, respectively, in the period? Do you want to answer that, Peter? I...

Yes, let me focus on shipping. And normally, our shipping bill is just shy of $3 million and not -- just shy of $1 million, and now it appears to be summing up to $3 million. And just one comment on this shipping. We will, of course, do our utmost to see what we can do to fight that. It is still out in future. But I read news just like everybody else, and I do not see the shipping rates coming down. But of course, we're working on it.

Yes. Will the HPC decision burden your relationship with AP as a server supplier partner for the general data center market? That's a question for HP. I cannot speak on their behalf. But I think it's important to note that we are not selling or supplying HPE on the general data center division. We are supplying their HPC division. Because of this, is it a risk that you will need more equity financing? I cannot imagine that would be the case. I believe we will save money from doing what we are doing. Then there's a question about what improvement in profitability we expect to see by exiting the HPC business? I think you answered that to the best way you could, Peter. Then there's a question about gross margin level. What's included in your new EBIT guidance? There's nothing included as of right now. We have guided on the top line and on the bottom line. Can you comment on the growth beyond '21? Where is the growth coming from? How should we think about the income in the next years? Some light at the end of the tunnel should be good for the stock market. I completely agree, but I also think we need to look at the facts. If we manage to get out with the 10% to 20% growth this year over at -- in same record year last year, I think growth is not the issue. The demand is not the issue. But when a region in China shuts down and we cannot manufacture our products, when people are bidding on containers out of China, when containers are increasing 300% in rates, to me, I cannot answer that question. What I can say is when the market normalizes, I think growth is my least concern. Lost revenue for '21, do you think that's pushed into '22? And further, how does this affect your record-high product launches? In terms of revenue, it's speculation because keep in mind that what our customers are seeing is that when people cannot get graphics cards, they cannot build computers. And when they cannot build computers, they don't buy PC peripherals, coolers, keyboards, chasses, et cetera. So we will have to wait and see. And in terms of our product launches, I'm not 100% sure how that will affect. Do you have any comment on that John, if the shutdown in China has affected that?

It may temporarily delay the availability of some of those products. But as far as our customers' commitment to launching those, absolutely not.

Okay. Buyback at those levels? We completed our buyback program, and there's not a new one coming up. What were the historical recurring losses of HPC? Can you answer that, Peter?

I know the historical recurring loss or total accumulated loss of the entire data center business and that's around $60 million. And maybe, Andre, you can qualify how much of that is HPC and how much is general or so?

Well, everything we sell is HPC.

Good. Yes. So $60 million.

Yes. And then how much will you reduce the running cost due to the shutdown of HPC? I think it will be fair to say that we are saying goodbye to between 15 and 18 employees, including whatever cost is associated with that, and of course, also included the investments in HPC, specifically. I cannot give you a total number today because, as I said, we are still effectuating these layoffs. What profitability do you expect for the G&E business longer term? I think the picture is the same as it was prior to COVID-19. I don't see any change in our underlying business or how we are going to conduct business. We expect to have a plus-40% gross margins, as we already -- always had, and we are going to improve the profitability by getting out of HPC. So I don't see any change. Then again, there is a question about whether we are going to issue new shares. No, we are not going to issue new shares. And then there's a question whether we generate revenue today from the general data center market? We do not. And if we did, we would probably not have shut it down. Do you today generate revenue -- so that was the one. Should we see an increase of $4 million to $5 million next year? I think we already answered that. Then we have a question that if we scale down the data center business now, if I see a risk that we will permanently lose your OEM customers? No, I don't see that. We have had OEM customers coming and going over 20 years. And keep in mind that what we are trying to do here is we are trying to stop a highly unprofitable business. We are not in the business of buying loss-giving revenue. And what we expect and what we all hope is that the legislation from the EU will kind of -- they will have to adopt something like this. So I don't see that as an issue. And the second question is when we will have a new strategy to address the sustainable data center market? I think I already addressed that by saying that we will continue what we have been doing so far. And I think from the perspective of being a company our size, I think we have done pretty well in actually affecting the Green Deal and the whole proposals around sustainable data centers, and that's what we intend to continue doing. Outlook for '22? That will be a Q1 discussion. The cash effect on the lower OP guidance. Do you want to answer that -- the question? And then Peter, I think it's implicit in the presentation, but...

Yes. We have -- our operating income pretty much equates the cash effect. We are capitalizing some, yes, but we're depreciating with pretty much the same amount. So the P&L effect is the same as the cash effect.

Yes. And then there's a question if I could give some specifics in terms of what kind of components are particularly scarce? I think from our perspective, IC is, of course, like everybody else, is the scarce component. That's why we have to pay more for it. But in general, what we are hit by right now is the lockdown in China where we just cannot get regular components for building our products in. Given the attractive medium-term growth opportunities, would the price level now be a chance to increase the stake in Asetek, and thus, express your own outlook and confidence? I'm not really going to guide on the share price, or what I believe, what I can say for myself is I have not sold and I have bought, I think, 3x over the last year, even when the stock price was lower than it is right now. So for me, personally, nothing has changed. Sim race, when will this business be profitable? It's too early to answer. We're not in the market yet. Then we have someone saying, thank you for being brave enough to take a tough decision. It gives me confidence to know that you have your own personal money at stake. I can say thank you very much. I have lost today, if I sold a significant portion of my own savings. So I do what I believe is right. What is the long-term target for gross margin? No change. Can you please confirm your cash position as of today? What's that, Peter?

We'll come back to that when we report our numbers in October. I could give you a number, but that would be -- that will be changed at the end of September anyway. So it's not meaningful at this point.

No. Given that the stock price has already lost 40% over the last month, some investors appear to have been in the loop, have insider sold. There should be an investigation by the Oslo Stock Exchange. I think whoever wrote this is more than welcome to contact the Oslo Stock Exchange. I don't know any insiders have sold, not that I believe. If they have, there would obviously be a stock exchange release about it. So it's relatively easy to go in and see if there are any issues or not. Given the attractive medium-term growth opportunities, would the price level now be a chance to increase the stake in Asetek? So that's a second time. Are there relevant insurance policies that the company can invoke in the wake of these disruptions? I guess, it's a force majeure or something like that, it's been referred to. Do you know that, Peter?

We do not have insurances to cover our operations supply chain like this, no.

Okay. So let me just do a refresh here. Okay. It seems as that's the last question. So by this, thank you for listening in.