Had a chance to digest the AD8 AGM Preso of 24 Oct 2023 and summarised the takeaways below.

Also read the Audinate Strategy AV Magazine link from @Valueinvestor0909 (many thanks for this!) from 2 days ago which helped sumarise and crystallise what a good and exciting position AD8 in in, both now and whats ahead.

SUMMARY FROM AGM PRESO

• Nothing new in Financials and FY24 outlook/guidance
• TAM revised upwards from previous AUD$1bn to USD$2bn - appprox 2.5x upward increase
• Base audio and video products are scaling nicely, challenges of Covid have now passed, back to BAU
• Well placed to capitalise on external opportunities with the $70m war chest from recent capital raise
• Clearly on the hunt for bolt-on M&A acquisitions to expand and entrench audio and video foothold
• M&A Assessment framework makes sense, AD8 has a good track record of merging acquisitions - Silex, Cambridge 
• The proof will be in the execution pudding ...

Discl: High conviction holding IRL

My notes on digesting AD8's sterling results. Focused more on the operational aspects of the results rather than the financials.

Only thing that surprised me was the headcount changes. Not saying its a bad thing at all (constraining headcount is often an organisational "own goal" if it ends up constraining growth), but rather the fact that it went against what the CFO Rob Goss told us in Feb 2023 where they saw the current headcount as sufficient to support 30% growth and it caused a $5.1m cost increase. Something I noted to myself to keep an eye on in FY24.

Discl: Held IRL

GOOD

Financials

• Sharp increase in revenue despite significant challenges with supply chain issues - 40% YoY to US$46.7 million (A$69.7 million) - AUD revenue grew 50.6% to A$69.7 million aided by favourable A$/US$ currency impacts
• FY23 closes the chapter on a challenging 3-year period in which we delivered US$ revenue growth CAGR over 31% despite COVID induced downturns and chip shortages.
• EBITDA was $11.0 million in the year ended 30 June 2023 compared to $4.3 million in the prior year ended 30 June 2022.
• Milestone net profit before tax of A$1.4 million (vs $4.4m loss in FY22) 

Cash Flow, Cash Position

• Positive free cashflow of $2.5m in 2H23
• >100% cash conversion in FY23
• Well capitalised with cash and term deposits of $40.0 million at 30 June 2023, no debt

Operations

• Covid-Related Supply Chain Impacts are now in the past - Revenue no longer gated by chip supply
• Successful transition of Chips, per plan (1) Last Brooklyn 2 orders - transition to Brooklyn 3 (2) Broadway chip - now end-of-life
• Achieved a record 142 design wins with OEMs, up 12.7% from FY22, 26 were from video 
• Total number of OEM brands shipping and developing Dante-enabled products grew to 538 after accounting for some rationalisation in OEM numbers associated with chip shortages & supply chain challenges - 34 OEM brands now have licensed Dante video products
• OEM customers released another 261 Dante-enabled products taking the total to 3,853 - including 48 products for Dante Video
• Strong Progress on Video Products and Integration of Video into the Dante ecosystem
• Launched Dante AV-H and Dante AV-A - new revenue streams for FY24
• Video support to Dante Domain Manager
• >10,000 video endpoints shipped
• >$3m revenue from video
• 26 of 142 Design Wins were video - 18.3% of Design Wins
• 48 Dante Video products launched in FY23 vs 7 products in FY22
• Video is growing 3x faster than Audio
• Launched Dante Connect - Cloud based solution to deliver audio directly from location to cloud services that enable seamless online production
• Launched Dante Professional Services June 2023
• With the worst of COVID and supply chain pressures receding, the Company anticipates audio OEMs will recommence transitioning products using Dante chips, cards and modules to software Dante implementations. This migration is expected to be relatively neutral for gross profit dollars and result in gradual margin improvement and a slight moderation in headline revenue growth. Irrespective of the pace of this migration, the Company expects % growth in US$ gross profit dollars in FY24 to be consistent with historical performance.
• Backlog at near-record levels - to be fulfilled in 1HFY24

FY24 Outlook

• In our FY21 Annual Report Chairman, David Krall, said “We expect that Audinate will double revenue in the medium term”, and Audinate anticipates achieving this ambitious goal in FY24.
• Growth in USD gross profit consistent with historical performance
• Targeting >30,000 video endpoints from the current ~10,000 end points
• Further growth in uptake of video

NOT SO GOOD

GP Margin Reduction

• GP margin has reduced from 74.7% in FY22 to 72.1% in FY23 as CCM growth outperformed software product and higher priced spot raw material purchases - movement due to product mix (Viper) and temporary Brooklyn III costs
• Gross margin was 71.2% in the first half affected by supply chain impacts, improvement occurred in 1HFY23

Headcount Increases

• Headcount increased 10% (178 to 197), further addition of 15% headcount in 2024 vs "current headcount can support 30% growth" when we spoke to the CFO,Rob Goss in Feb 2023 - a $5.6 million increase in employment costs as headcount grew from 178 to 197 at 30 June 2023. 
• 15% headcount allocated to growth to ensure scalability, mostly to Manilla
• Not an issue if additional headcount is allocated to growth (it is) and if revenue growth can absorb it (it appears so), but this is a clear change in plan

WATCH 

• Higher revenue expected in 1HFY24 as backlogs are cleared, still expect 2HFY24 revenue to be higher
• Cash flow positive 
• Margin to move back to ~75% given Covid issues have subsided
• Headcount movement and costs vs revised plan
• Traction of Dante Connect Cloud Solution
• Traction of Dante Professional Services and contribution to revenue
• Design win growth - this is a leading indicator of future Dante products

RISKS

• M&A opportunities, how they bolt-on to the Dante suite and acquisition cost
• Macro factors, slow global growth, higher interest rates etc - AD8 considers these to be BAU scenarios that needs to be managed

SUMMARY

• Very bullish results
• Continued traction on Audio, good evidence of significant positioning and step uptake of Video from FY22
• Covid Supply Chain issues are over and successfully transitioned to new chips - revenue no longer gated by chip supply, paves way for “unconstrained” growth
• Guiding for same level of revenue growth in FY24

Sharing my notes and takeaways from the very insightful conversation with the AD8 CFO earlier this week. Likely to contain translation accuracy errors, please cross-check before relying on any information.

I walked away with much more operational and opportunity context behind the 1HFY23 preso and a much greater understanding and appreciation of the Video opportunity.

Disclosure: Currently hold AD8 IRL

General

• Digital Audio Network TAM ~A$400m annually - AD8 share is about 7-8%
• 550 OEM manufacturers use Dante in their products, repeat revenue model, similar to Intel - chips, cards, software
• Very sticky customers but the downside is that AD8 is beholden to the manufacturers product rollout plans - impacted by the manufacturers supply chain constraints etc
• Moat is not so much the quality of the technology, but rather the continuous adoption of the Dante technology - 
• Inter-operability across products which are on the Dante platform - “It Always Just Works”
• Transport and synching of audio signals and signal speed is the secret sauce
• IP protection from 50 patents globally, have security measures to detect Dante-clones
• Defacto standard for Audio equipment
• Huge base of passionate Dante-trained professionals ~200k
• A manufacturer will typically make and sell products for a 7-8 year product cycle

Margins

• Chips, cards, modules - 75% revenue, margin is from 80% to sub 50%. Mostly 60-70% - successful passing through of cost of chips
• Software and royalties 25% of revenue, margins are ~100%

Video Opportunity

• At least the same market size as audio
• Not a binary success or fail - key marker is no of products and end points using the Dante video technology - this is an internal short-term performance incentive marker - Red flag if adoption is not gaining traction
• The Dante video technology can be added to existing products
• Video signals are a lot bigger than audio - there is a need to compress the size of video signals to enable transmission through existing audio data pipes - this is achieved by data compression codecs
• Dante (and the opportunity) goes beyond compression - it is about the management of the end-point devices and the inter-operability between/within video and with audio via the Dante platform that is key - use existing codecs, layer on Dante audio system management capabilities
• Customers are currently locked into a single platform for video - Dante enables customers to adopt a best-of-breed audio/video solution, using the Dante technology and platform as the integration base
• Current competitors - NDI Tech/Bird Dog and Crestron, which are single-platform - not a true competitor as the opportunity is to sell Dante Management Control and Audio-related software

Supply Chain Update

• All products require a chip - either a Dante or OEM chip
• Have been using Broadway & Brooklyn 2 modules which have been around 7-8 years, it is not where technology is going and there is only a fixed pool of capacity to produce these older chips - headwinds in 1HFY23, expecting 2HFY23 to improve but it will take all of CY23 to clear the backlog
• Brooklyn 3 module is the de-risking strategy of these constraints
• Anecdotally, shortage impacts exist, volume will come back gradually, overstocking is at play which should progressively normalise
• Manufacturing facilities are in Malaysia and Guangdong, chips are manufactured in Taiwan

Scalability and Financials 

• Well capitalised - $37.9m cash & term deposits, no debt
• In the 12M horizon - 30% annual growth can be achieved without adding further headcount
• $1.5m R&D on “External R&D” was for video-related R&D, ongoing spend is expected to be lumpy, not fixed cost
• Approx 20% of R&D spend is for bug fixes, “sustaining engineering” - rest is mostly on video offering “Dante Studio”

Industry Dynamics/Demand

• Sporting Facilities is a focus
• Higher Education - only part-way through rollout across facilities - Covid online learning was a structural change
• Broadcasting
• Corporate Environments - Work-From-Home is driving requirement for better in-room experience and is a net positive impact
• Adoption of video technology is a key tailwind
• Not focused on the end-user at all

Immediate Focus

• Technology adoption traction focus
• Video traction key markers - technology adoption (1) 30 Manufacturers today and how this expands over time (2) Brand names (3) Product numbers (4) Unit Numbers
• New facilities are driving and adding to demand
• Chase unfulfilled demand from supply chain issues for network audio equipment
• Getting technology built into OEM products
• Grow OEM using the technology

Key Bugbears that Market Does Not Quite Get About AD8

• Under appreciating the opportunity set ahead, especially video
• What the technology actually means to/impacts day-to-day operations and user efficiency - the significant passion around the use of the technology