Atomos FY Results

Atomos ($AMS) reported their results yesterday. It has been a tough year, so to their credit, CEO & CTO Trevor Elbourne and CFO James Cody fronted two investor calls – one yesterday and one today.

As usual, I’ll outline: 1) reported highlights, 2) key insights from the call and 3) my key take-ways. As part of 1) I will add my own summary of “low-lights”. I conclude by stating how I have assessed value, the decision taken and rationale.

1)   Reported Highlights

• Record revenue of $82.0m, up 4.3% on pcp (previous corresponding period) with a record Q4 result of $37.5m
• Underlying EBITDA of $4.5m (5.5% of revenue)
• Successfully launched Atomos Cloud Studio and new Series 2 ‘connected’ products in Q4
• Executing on strategy of expanding into connected and cloud products and services

The challenges $AMS has faced this last year are well-discussed here on SM, so I wont repeat. For me, the standout “low-light” was that this business has in one year turned from generating a FCF of almost $8m in FY21 to a result of -$32m in FY22.

To management’s credit, there was a fair amount of air time given to this in the presentation and the Q&A.

Key drivers were:

• Inventory build to mitigate pandemic-induced supply chain issues
• A fall in receipts due to a failed sales and marketing strategy in Q3, reported as quickly rectified in Q4
• Margin reduction and inventory write-offs due to Series I models coming to the end of their life cycle and overstocking of models where demand failed to be realised
• Exceptional staff charges due to “unnecessary” hires

(If, I had my way, I would mandate that firms be obliged to communicate at summary level, the 5 most significant things that went well in the year, and the 5 most significant things that didn’t go well.)

2)   Key Insights from the Investor Presentation

Summary, Strategy and Outlook

Trevor began by reminding us of the progress of the company since first sales in 2011 and gave an update of the strategy and the outlook. Slides 8-12 are a very clear summary, so I’ll let them speak for themselves. The big themes are continuing to innovate with new connected products; launch and add services to the Cloud platform; and augment existing sales channels with direct-to-customer sales, including innovative ways for customer to pay for hardware/software bundles.

By 3-5 years they aim to get to an EBITDA margin “towards 20%” getting to “well into the teens” in 2-3 years.

 Financial Review

The bottom left-hand chart below shows part of the issue last year – a collapse in sales in Q3, which was reported in June as due to a “change in marketing approach and lower promotional activity”. I’ll come back to this later. The timing could not have been worse, because inventories has been built to mitigate supply chain issues, including shutdowns in China.

The bursting back to life of revenue in Q4, was as a result of promotional activity and discounting – also foreshadowed in June – rapidly getting the new cloud-enabled products into the market.

Upon further discussion, we learned there had also been discounting and write-down of the old Series I models and clearance of discontinued products.

So, in terms of core operational performance is was a perfect storm: big inventory build + sales shock (quickly corrected) + margin reduction due to discounting and clearances. Ouch.

Consumer electronics are generally not super-high margin products, so that explains a horrible change in cash flow fortunes.

But there’s more.

 Staffing and Organisation

We were told about “significant further headcount added under previous leadership – largely unwound”. When we dug into this in the Q&A, it was stated that a bunch of senior, highly paid sales and marketing personnel has been added in the USA (by you know who). Once Trevor took over, it was decided that these resources were not needed, so they were let go as part of a larger “right-sizing” of the organisation. All of this then also drives an increase in “professional services.

(So this gave us some insights into what happened under the previous CEO, and I speculate, a wider dislocation in organisation performance as these changes took place. I am trying to be measured with my words here.)

Trevor made clear that there is a strong leadership team in place that has a lot of experience in the company. He himself has been there since the early days, and James has been CFO since 2017. However, they are looking to fill several key roles:

• Chief Commercial Officer (they’ll be running direct sales in parallel with the current channel partners. Trevor believes they won’t cannibalise partners, and having AMS being more involved in direct marketing will build the brand. )
• Chief Product Officer (necessary because Trever has stepped up to CEO)
• Head of Manufacturing and Supply Chain (they are diversifying manufacturing from China by adding Malaysian capability).

Supply Chain

In the Q&A we probed on the current supply chain situation. As we have been told earlier, Trevor confirmed that all key products had been engineered/re-engineered to be made of components that are available and for which suppliers will hold suitable stocks. He is confident that FY23 sales will not be constrained by supply chain.

 Cash

As you can tell from other posts on SM, fellow StrawPeople were aghast at the turnaround in the cash position. $5.0m in the kitty at year end, and the $12m debt facility (expanded after the Q3 nightmare) largely drawn. Gulp!

So, on the calls yesterday and today, your faithful fellow Strawpeople asked about the capitalisation of the firm and the need for a capital raise. From the responses on both days, CEO and CFO do not yet see this as necessary. The main reason is that they expect to see a significant improvement in working capital as inventory levels are reduced, and the receivables from the big Q4 sales push are paid.

(In addition to @mushroompanda‘s analysis, I have done some quick and dirty cals, Provided sales continue, if they are able to return the key working capital levers back to the FY21 levels (as a proportion of revenue), I could see them getting to a cash position of $10-$15m by the end of 1Q23. My analysis is very rough, and I haven’t assessed the risks around this. But if the ship is steadied, a highly dilutive raise should be able to be avoided. So, I will give Trevor and Cody the benefit of the doubt. In fact, Cody stated on both days that the cash position has improved since YE22.

3)   My Key Takeaways

I’ll be brief. In my opinion, FY22 is a case study of how quickly fortunes can change when there is a macro-shock combined with leadership misalignment/discontinuity. I’ll leave it at that.

I don’t doubt that the products are great and that customers are going to value enhanced connectivity and functionality enabled via the cloud. At its heart, a core capability of $AMS is product development and delivery. But businesses need much more than that, as we have learned.

The direct-to-customer strategy is unproven, and the vacancy of Chief Commercial Office is a key gap. (I’m not convinced the S&M resources hired in the USA were “unnecessary”. But there are several reasons why they might have been classified so.)

It is certainly a comfort, given everything that has happened, that we have continuity in Trevor and James.

The overstocking and write-downs were perhaps a necessary risk given the information available when key decisions were made in their height of the pandemic. I am not going to be a hindsight hero.

However, the investment thesis has changed, the story revealed today highlights a range of risks going forward. The trials and tribulations of the last 12 months raise real questions in my mind as to whether $AMS has the capability to execute its refined strategy.

 What do I value AMS at?

Tough to do this, so I’ll keep it simple. If we assume ongoing revenue growth of 25% p.a. out to YE 2026, and that EBITDA margin at that time is 20%. I assue some share dilution to 250M SOI. Then using two methods, discounted back to today at 10% discount rate I get.

• Use revenue multiples of 1 and 1.5, reasonable for the sector: $0.55 to $0.82 / share.
• Using EV/2026EBITDA of 7 (again reasonable for the sector), I get $0.77.

But these valuations assume success in implementing the strategy. There has to be a reasonable chance they fall short, so I can't value $AMS today at much more than $0.40 - $0.50/share.

Limitation - I haven't assessed the upside. But even trying to be objective, I can't bring myself to do this today.

In RL, with the SP dropped, I was reduced to a 1.5% holding in $AMS. The paper loss hurts, but this risk profile around the above valuation is too high.

Personal Lesson learned: $AMS was way too high risk to hold a 4.5% position, even though this had run up from an initial investment of 2.0%. And when the short-lived CEO exited, I should then have re-assessed risk and reward. I didn't. I paid for it. But, on a positive note, my maximum position sizing "policy" for high risk firms saved my bacon and I live to fight another day.

Decision: Sell 50% of $AMS holding (Executed). Hold at 0.75%

https://newswire.iguana2.com/af5f4d73c1a54a33/ams.asx/3A600699/AMS_FY22_Results_Investor_Presentation

FY22 results are out for $AMS. There is only one slide and one question for me that matters.

Slide 20 Cashflow

Question: What is your plan to ensure the business remains sufficiently capitalised during FY23?

Disc: Held IRL and SM

https://newswire.iguana2.com/af5f4d73c1a54a33/ams.asx/3A598522/AMS_CEO_Appointment

Trevor Elbourne has been appointed as CEO. I'm relieved and here's why.

Leadership has been one of several drags on $AMS SP, given the reported failed on-boarding of the previous external hire who left after reportedly not being willing to relocate to Australia from USA. We then later find out of a return to strong sales performance under Trevor's leadership on returning to the pre-existing (implied prior to the new CEO) marketing strategy.

Trevor is a tech leader, is one of the original employers, and a member of the team that has developed $AMS great tech portfolio.

External hiring executives is always a risk, particularly for smaller caps who simply often aren't able to attract top talent. Clearly, the Board has decided to give Trevor a go. And I agree.

I believe the downgrade cycle and sell-off in a market unforgiving of tech mis-steps has been over-done. I am patient and am looking forward to $AMS recovering, as the head-winds of tech bear market and chip shortage begin to ease.

Disc: I still hold my full allocation IRL and SM ... although heavily beaten up!

https://newswire.iguana2.com/af5f4d73c1a54a33/announcements/ams.asx/3A595254/AMS_Announcement_3A595254.pdf?download=1

As commented earlier, this is a lot of (coordinated) insider buying. Do any other StrawPeople have any insights? Perhaps the Chairman got beat up by investors due to low insider holding? (I’ve had various interactions with Chris Tait,.. should we invite him to a SM meeting?)

With Jeremy Young leaving, new CEO leaving and miss on guidance plus exposure to global semiconductor crunch, all my analysis has said “sell” over the last year. But I’ve held despite a 60+% paper loss.

While I’m no expert, this company makes great products, in a high growth area, has great ongoing innovation, and a core group of management and board who have been around for a while (e.g. acting CEO, Chair). My gut has told me to hold and I have, despite the analysis. It’s my second largest high risk holding IRL.

This is the first tangible indication in two years that maybe I was not wrong. I can’t buy more (due to personal concentration rules) but I am going to continue to hold.

Disc: Held on SM and IRL

AMS - after a weekend of reflection I conclude the market has provided a buying opportunity

From my straw last week on AMS, I have been doing quite a bit of thinking and analysis. Having recently taken some profts at $1.70 IRL (although I didn't align my SM portfolio), I have today decided to buy back at $1.275, concluding that the market has handed me a valuable opportunity. Here's why.

First the bad news and implicit bear case. In mid-October, when AD8 announced chip supply constraints on its outlook, there was a direct read across to AMS SP. Add to this the sale by Executive Chairman Chris Tate on 18th Oct of 0.419m shares, leaving him with only 0.895m shares. (Albeit partly offset by Sir Hossaine Yassaie making a net increase of 0.12m to take his total holding to 1.955m.) Last week, this was topped off with the "retirement" of Jeremy Young founder, ex-CEO and Executive Director with a mandate to focus on partnerships and the next round of product innovation. This all stacks up to be not a good look, and the SP has reflected that with a fall of almost 30%.

Now the bull case. The market fundamentals of the growth of the high quality video market and the company's positioing are unchanged. The company asserted at the time of the Director share transactions that "Atomos wishes to advise that despite the well-publicised global challenges with component supply, the Board remain comfortable with full year Broker consensus in relation to FY22." A few days later at the Goldman Sachs and Morgan Stanley Conferences the firm gave further detail on the supply chain issue:

• Not a new issue (Managing longer lead times since 2020; Supply situation was factored into our forecast)
• Limited stock outs
• Investing in inventory (Growth in inventory position since June; Major chip supply confirmed for forecast production through Dec-22; Longer term commitment confirmed for a further $20m of chips beyond Dec-22)
• We remain comfortable with consensus forecast

Give the overall profile of the semconductor chip issues, this is a pretty robust statement, and you would think the Board would have stress tested it with the question "what could happen in the next 12-18m that could lead up to have to walk this back with the market?"

Finally, there is the question of leadership. In my straw last week, I overlooked the fact that in September, AMS appointed Estelle McGechie as CEO. She only joined in June, and clearly in stepping up to take the CEO position both she and the Board have had the opportunity to take stock of each other. It is in Estlle's appointment that I gain some comfort that Jeremy moving on might not be a bad thing - in fact, it might be a good thing. Estelle has a track record over 6 years in video at Apple - a key AMS partner. Also, more recent experience in marketing at Logitech and Frame.io, which was acquired earlier this year by Adode for $1.275bn.

Now for the pure speculation bit. Estelle clearly has very strong networks and relationships in US video tech, built over 17 years focused on video in North America. You can have two people in one company responsible for strategic relationship management. As CEO she is clearly going to take that on. So where is the space for Jeremy?

My conclusion: the Board has over the last two years been following a very deliberate strategy of building the management bench to be comensurate with the company's growth ambition. On balance I remain bullish, and this morining re-purchased the 25% of my position I sold at $1.70 for $1.275.

My only remaining slight unease is that I wish the Executive Chairman had more skin in the game, but I respect that as a professional manager, rather than a founder entrepreneur, he is like many others.

(An item to watch going forward is whether Jeremy Young holds his remaining $10m of shares, or sells at or near current market price to fund his next venture.)

Disc: Held IRL and on SM

Founder Jeremy Young to "Retire"

https://cdn-api.markitdigital.com/apiman-gateway/CommSec/commsec-node-api/1.0/event/document/1410-02447658-0AM4JQ8SB34JP898A6OP1MJ0BU/pdf?access_token=00071RSHAyShNDB5S7JbU2PxnvM7

Atomos announcing today that Founder, Exec Director and former CEO Jeremy Young is to retire to pursue personal interests.

Jeremy was the creative/entreprenuerial/technical wizard behind AMS innovations to date, however, the Board has been rapidly building bench strength in the management team over the last year.

At this stage, he remains one of the larger shareholders on the register, so monitoring whether he continues to hold or sell down will in my view give some insight into whether he considers "his" firm has developed sustainable competitive advantages. Jeremy sold down over half his holding earlier this year.

This announcement also perhaps provides a lens on the selldown recently by the Executive Chairman, Chris Tait. Did he see the writing on the wall?

In correspondence I had with Chris earlier in the year, he assured me that the Board was focused on both building a more robust and well-governed company while also retaining the entrepreneurial flair of Jeremy. So there was no foreshadowing at that stage (July) that Jeremy was headed off.

We have had some interesting information about AMS in recent months with which to test the investment thesis:

• A very bullish report and outlook at FY21
• A recent statement that chip shortages are not yet requiring any need to change FY22 outlook (issued on the same day as the next item)
• Significant selldown by Executive Chairman (who doesn't have a very large holding in any case.
• Annoucement of exit of founder

On the one hand if you conclude that 1) chip shortage will bite in time, 2) loss of founder is a blow to innovative capability and 3) Executive Chairman not having much skin in the game indicates lack of confidence, then this seriously undermines the thesis. This is the way the market currently appears to be heading based on my reading of SP progress over recent weeks.

On the other hand, if you conclude that 1) chip shortage is temporary (12-18m) and we are now seeing the worst, 2) that AMS is well-poisitioned as it claims to be with respect to it, 3) that the innovation bench is much stronger than Jeremy (and that perhaps his departure is more an issue of him not growing with a maturing and more professional business), and 4) that the outlook is bright and unchanged, then the next few days and weeks could present an unparalleled buying opportunity.

I'm interested in the views of other SM.

Earlier this year AMS was my largest holding on SM and IRL. I recently trimmed 25% on SP strength on SM and IRL, but it remains my largest holding on SM and a top 5 holding IRL.

Where to next? Options:

• Sell now - thesis broken. (I am not there yet)
• Hold - monitor. See what Jeremy Young does with his holding. By the time he sells, the SP will drop immediately, so this is a risk
• Buy - the "bad news" list above has nothing to do with long terms business. SP has already over-reacted.

Mulling this one over. I'm a hold for now.

Disc. Held on SM and IRL