Rakon Limited (RAK) Earnings Call Transcript

Welcome, everyone, to Rakon's FY '25 Half Year Results And Business Updates. [Operator Instructions]. I must advise that this presentation is being recorded today, Wednesday, the 27th of November 2024. I would now like to hand over to Rakon Investor Relations Manager, Nick Laurent. Thank you, and please go ahead.

Good morning, and welcome to Rakon's HY '25 Financial Results and Business Update. Joining us today are Rakon Chief Executive, Sinan Altug; and Interim CFO, Mark Dunwoodie. In a moment, I will hand over to Sinan and Mark to present the update. But first, a quick reminder that during this presentation, we will make forward-looking statements about Rakon Limited and the environment in which the company operates. Because these statements are forward-looking, Rakon Limited's actual results could differ materially. I encourage you to read the disclaimer on the important notice slide of the presentation for more detail. With that, I will now hand over to Rakon Chief Executive, Sinan Altug.

Good morning, everyone. I'm Sinan Altug, Chief Executive, joined by our CFO, Mark Dunwoodie. Rakon is a global leader in frequency control and timing solutions, which provide the heartbeat for seamless flow of information and data in critical applications. From mobile networks to satellite constellations and AI data centers, we set the global standard for precision, reliability and innovation in our field of technology. Mark and I will walk you through an update on Rakon's performance for the 6 months ending September 30, 2024. We will also share progress in our long-term growth strategy and provide insights into our vision and aspirations extending to the end of the decade. Following the presentation, we will open the floor for a Q&A session to address your questions and share additional context. Let's begin. The first half was among the most challenging periods for Rakon, marked by tough market conditions in Telecommunications and Positioning that more than offset the continued strong performance of our AeroSpace and defence segment. Telco demand remained subdued and lower than our cautious expectations. Still, I'm extremely proud of our team's resilience and dedication through what was quite a distractive environment. Through their exceptional focus, discipline and personal sacrifice, we achieved key strategic milestones, but also laid a solid foundation for future growth. We balanced substantial cost reduction efforts with our growth strategy and we have strengthened the business to grab opportunities in high-growth Space and AI segments. This, along with early signs of stabilization in Telecommunications point to improvement in the second half of the year and into the next fiscal year. Our AeroSpace and defence segment was once again the standout with continued year-on-year revenue growth for the fourth consecutive financial half year and the strong order book into FY '26 and beyond, reaffirming the strength of Rakon in this high-growth market. However, half year total revenue was considerably lower year-on-year. Unsurprisingly, this was primarily driven by reduced demand in Telecommunications and Positioning. Gross margin was also down, affected mainly by loss of efficiencies due to low production levels. We have continued to focus on driving cost reduction and efficiencies, but carefully reallocated the gains from these efforts into investment areas that align with our strategic priorities. This balanced approach ensures we continue to protect Rakon's growth trajectory and technology leadership under these testing conditions. And this is valid particularly in high potential areas like Space subsystems and AI, while we are also prepared for recovery in Telecom. While it's still too early to call it a full recovery yet, the Telecom market is showing early signs of improvement. Our largest Telco infrastructure customers as well as key industry players have reported increased by selective 5G network investment, especially from North American operators. We are now also seeing planned network infrastructure investment in other regions, including India. These are tangible signs that the Telecom market will improve through the second half of the year and into the next fiscal year. Customer demand for our AI and Cloud Infrastructure products has exceeded our expectations. Key design wins from industry leaders position this segment to deliver significant revenues starting from the first quarter of FY '26. This reaffirms our confidence that AI and Cloud Infrastructure will become a core market for Rakon within the next years, further diversifying our revenue streams. We are also on track with the accelerated transfer of key product lines to our Indian facility. As production ramps up in the last quarter of this fiscal year, we will start seeing immediate margin improvements and substantial reduction in overheads. And September was our highest revenue month of the half year. That's encouraging. Looking ahead, we anticipate this momentum to carry through the second half, driven by improving Telecom sector orders and a strong Space demand in Q4. With that said, we expect to remain within the lower half of our FY '25 underlying EBITDA guidance of $5 million to $15 million. And looking into the next fiscal year, we see strong order pipeline and demand in Space and AI and Cloud Infrastructure, and these will be key growth drivers for the company into the next year and beyond. We'll share more on this later. In the first half of the year, we secured 2 major Space subsystem contracts, including our largest to date for $17 million. We continue to compete for additional mega constellation contracts and are seeing strong interest from across the Space industry. As an example, we just announced last week that the German AeroSpace Center selected our master reference oscillator for an in-orbit mission onboard the International Space Station. While this is not a huge contract, it's a real honor for us as a Kiwi company and it speaks volumes about Rakon's IP. In AI, we have hit some important milestones for product designs, and we are securing wins with most of the leading industry players. There are major programs with deliveries starting in the second half of this fiscal year, and we expect significant revenues from the first half of FY '26 onward. In response to the rising demand for our Space and AI products, we are ramping up production capacity to meet current and future order volumes. Rakon's organizational transformation program that we introduced at our ASM is underway. This is a comprehensive program to reconfigure the company in line with our growth strategy. We expect it to catalyze growth while also delivering substantial overhead efficiencies and margin enhancements across Rakon's global operations within the next 2 years. One of the first steps in this program is the accelerated transfer of key products to our India facility. This is on track to deliver improved margins as volume production starts next quarter. All necessary equipment has been transferred. It has been set up and validated at our Indian facility, and we are shortly going to start customer qualifications. We continue to consistently hit the milestones on our technology and product road maps. Most recently, we launched MercuryR, our groundbreaking radiation hardened semiconductor chip that will provide the foundation for Rakon's latest range of miniature Space products. And we are also on track with our critical next-generation semiconductor chip Vulcan. It will be released for select customer testing within this fiscal year. This chip primarily targets the AI and Telecommunications markets, and it will on its own, be also groundbreaking. I will now hand over to Mark to present the financials.

Thank you, Sinan, and good morning to everyone on the call. Just starting with our slide on financial performance for the first half to 30th September 2025, we've reported $41.7 million in total revenue, down 32% from the same period last year. As Sinan mentioned, a key driver in this result is the continued reduction in demand across the Telecom and the Positioning markets. However, we have maintained our market share and September was our highest revenue month for the half year. It was driven by an improvement in Telecom orders towards the end of that period. We anticipate this trend will continue through the second half of FY25 alongside the increased Space business orders that we see. Gross profit is lower at $15.7 million and a margin of 37.8%. This is a direct impact of the reduced sales volumes, but also $1.7 million in increased inventory provisions and one-off adjustments. OpEx was relatively flat at $30 million. Rakon has been successful in reducing run rates, but this is masked by $1.5 million in unfavorable FX movements as well as restructuring and acquisition proposal costs. Half year underlying EBITDA is a negative $7.3 million with a net loss after tax of $10.4 million. It's worth noting the increased inventory provisions and unfavorable FX movements are a significant factor in this result. CapEx has dropped back 6% to $6.3 million as the company continues a very focused approach to delivering on strategic growth initiatives. Our growth investments include research and development. At the half year, we had spent $10.7 million compared to $8.9 million the year before to extend Rakon's technology leadership for securing future design wins and strengthening our position as a technology leader in our respective markets. Alongside the accelerated transition to manufacture in India, we're expanding facilities to ramp up AI chip production and to meet the Space business demand. Operating cash flow was a positive $8.3 million in half year '25 and up 14% on the last year. This reflects our continued focus on working capital management, including an $8.5 million reduction in overall inventory balances. We'll now move on to the performance summaries for each core market. AeroSpace and defence is exciting. We're continuing to see year-on-year growth in this segment with a total half year revenue of $16.8 million, which is up 10% on the same period last year. It's generating $10.7 million in gross margin at 67%, which is good and healthy. High demand for Space subsystem products is a key growth driver here, including the orders from the contracts that Sinan mentioned earlier to supply our subsystems for Low Earth Orbit (LEO) satellite constellations. We move on to the next on the Telecom segment. Total revenue in the Telecoms is down at $16.8 million. It's down 51% on the same period last year with $2.5 million of gross margin at a rate of 25%. This reflects the continued weakness in the Telco market, but also our inefficiencies at lower production levels. These are the key drivers in dropping both the revenue and the gross margin. We have seen order levels improve late in the half year. As we mentioned earlier, we expect this trend to continue into the second half of the year. Importantly, we've maintained market share and design win rates as we target to get a high share of the next-generation orders. Through into Positioning. With Positioning, the half year revenue was $5.5 million, down 23% from the prior year. $2.5 million in gross margin at a gross margin rate of 45%. Similar to Telecommunications, this is reflective of continued market weakness and inventory normalization driving down our order volumes. To a certain degree, we have the same issue around Rakon being able to produce efficiently at this level. We continue to be a strong performer in the precise Positioning part of this market and with a good share of sales and exceptional design win rates there. But overall, the demand in this market remains flat. Move on through to working capital, please. We've got a continued focus on working capital management and driving out the cost savings as well as optimizing the business. At the same time, as Sinan mentioned, we're very targeted on investing in our strategic initiatives and our growth initiatives, and we've been protecting that investment as we go along. We also mentioned a bit earlier, a reduction in inventory balances and that year-on-year reduction of $8.5 million has helped working capital. We'll continue to keep a tight leash on inventory as orders increase and production starts to fire on all cylinders. We're continuing a disciplined approach with CapEx and OpEx as we come out of this part of the cycle and the focus on cost reductions across the business continues, but it's balanced with the investments that we need to meet the business' aspirations. We're continuing to transform our global operations to realize efficiencies, including optimizing manufacturing cost structures, and the accelerated schedule of transitioning the business to India is on track with $2.1 million of CapEx and OpEx invested so far this half year. We expect the manufacturing efficiencies from this to kick off in the latter part of the year as production ramps up. Production utilization is sitting at a good level given the stage we're at across our global locations. Year-on-year, we have reduced workforce by 22% in response to the market environment, and this has allowed us to optimize cost of production while still protecting capacity to ramp up and execute our growth plan. The balance sheet is strong with net assets of $148 million, and we had $15.8 million in net cash at balance date, which was $2.1 million less than the year before. The borrowing facilities that Rakon entered into with HSBC in April 2024 remain undrawn. I'll just circle back to the comment that Sinan made about the people in Rakon and how hard they've worked over the last 12 to 18 months. They've all went into what's going on in the business and reducing costs and doing what they need to get everything across the line, and it's been pretty amazing to see it. Thank you to you man, Sinan.

Thanks Mark. Let me now dive into our strategy and outlook. Next slide. This slide highlights Rakon's aspirational growth trajectory through FY29. While it should not be taken as a definitive indication of future revenue or profitability, it provides insight into how we see the next few years shaping up as we execute on our strategy for growth and importantly diversification of revenue streams. Our strategic road map has already unlocked new addressable market opportunities in high-growth areas like commercial Space and AI and Cloud Infrastructure, which together represent a combined serviceable addressable market for Rakon of over NZD 1.7 billion. These markets are expected to continue driving growth and delivering a greater share of the total revenue with AeroSpace and defence and AI and Cloud Infrastructure projected to account for more than half of our revenue by 2029. The graph also clearly reflects our transition from being exposed to traditional rollout cycles as seen in our reliance on Telecommunications in the prior years to a diversified cycle resilient business model. This transformation has been an important focus area over the last years for us, and it enables us to better weather the market fluctuations, it positions Rakon for sustainable long-term growth. Telecom and Positioning will remain important to our business. These are mature markets with stable growth. We aim to continue to maintain our lead and market share through continued innovation and leverage our technological advantage in parts of these markets. Additionally, the graph highlights the one-off revenue spike during the chip shortage that we had seen in '21 and '22. This was an extraordinary situation as we had emphasized, but we have successfully pivoted from this temporary phase to focus on additional sustained growth drivers of Space and AI. By continuing this strategic focus, we are succeeding in growing multiple strong balanced verticals, again creating resilience for the business long term and diversifying revenue to provide increased protection through the cycles. Based on this diversified portfolio of high-growth verticals, we have set an accelerated 25% compound annual growth rate target from FY26 to FY29. This demonstrates our confidence in the scalability of our growth drivers, particularly in Space and AI. This next slide illustrates how Rakon's Innovate, Capture And Capitalize or ICC strategy enhances the life cycle and profitability of our products while maximizing the value of our global R&D and manufacturing footprint. We talked about this strategic program at our ASM, but the underlying work actually commenced over 2 years ago. ICC redefines how we design, develop, produce and sustain our product pipeline across our global operations which enables Rakon to efficiently develop new products, scale production as demand grows and transfer high-volume manufacturing to cost-efficient facilities. It also ensures long-term competitiveness and extended product life cycles. A central part of this strategy has been the accelerated transfer of products from New Zealand to our India facility. This is expected to deliver improved gross margins, as I mentioned, and substantially reduce overhead costs as we achieve volume production capability in India for these products starting from next quarter. And we are applying the same recipe across all our product lines. We are now starting to work to transfer select commercial Space products from our France to Indian facility. The ICC initiative enhances Rakon's operational scalability and resilience, enabling us to meet customer needs, improve margins and achieve sustainable growth in both mature and high-growth markets. This all goes towards securing our long-term value creation path. Quickly about our growth milestones as we near the conclusion of our current 3-year growth plan that spanned FY '23 to '25, I'm pleased to say that we remain firmly on track to achieve all of our strategic milestones for this year as we have successfully done in the last 2 years. The 4 key investment areas have been vital to driving growth and innovation for Rakon on this slide will continue to play a central role in our strategy moving forward. Looking ahead, our next 3-year plan for FY26 to FY28 will build on this foundation with expanded investment in high-growth areas such as AI and Cloud Infrastructure, AeroSpace and further global organizational transformation to unlock efficiencies and fuel innovation. We'll share more details on our refreshed strategy at our full year results. A quick look at our core markets. Our outlook for our core markets demonstrates the clear growth opportunities across Space, Telecom, Positioning and AI and Cloud Infrastructure. We expect Space business to continue its strong performance and year-on-year growth with revenue in the second half set to substantially benefit from seasonal delivery orders with a robust FY25 and FY26 order book and an active pursuit of game-changing new contracts, and I'm referring to mega constellations with 10x the value potential. We are positioned to capture significant opportunities and lead in Space. The growth potential of this market for Rakon is excellent with industry predictions for up to 20,000 new satellites to be launched in the coming 5 years. Additionally, there are waves of opportunity happening in the Low Earth Orbit satellite constellation segment, as Mark mentioned, where the key players are racing to build, launch and scale commercial Space infrastructure. A major driver for this activity is the lucrative opportunity to provide broadband connectivity from Space. And we also expect a major surge in direct-to-phone satellite technology and commercial constellations enabling this technology. We are very well positioned in this. You may also have noticed new partnerships forming between satellite service providers and mobile network operators, including some New Zealand operators. This is to extend coverage to rural and remote areas and add new customers. Overall, this is a very positive development that is set to increase revenue growth opportunities for Rakon in both Space and Telecom markets. Looking at the Telecommunications market, our assessment of the current conditions remains consistent with what we shared at the FY24 results announcement. The Telecom market has been muted in the first half of FY25, but we anticipate potential stabilization on a year-on-year basis during the second half of the fiscal year. There are positive signs from some of the largest customers that inventory is to normalize by the end of this calendar year. The same customers are also seeing some positive signs from their markets and their sales growth in North America and the network traffic continues to grow at a healthy rate. This is a combination of the underlying traffic growth and the growth of the fixed wireless access demand that is using effectively 5G networks to deliver high-speed home Internet. So there are multiple positive signs and early indications that the market is now stabilizing. In Positioning, as I have shared before, we still maintain a strong foothold in the high-end precise Positioning subsegment, which continues to be a key market segment for us with several new applications enabled by increasingly precise Positioning. However, we are still facing increased competition, price erosion at the commercial end of this market, combined with an inventory correction cycle that is still running its course. Lastly, strong momentum is building for our AI and Cloud Infrastructure business, and we are expecting to deliver significant revenue in the -- starting from the first half of FY26. This segment is on track to become an established vertical on par with our other core markets in the coming years. As many of you know or would have heard, the AI hardware and data center sector has seen a lot of investment already. This is driven by high levels of computing demand from hyperscalers such as Google, Microsoft, Amazon, all public announcements. And because we are being designed into the next-generation products for many major AI hardware players, we expect this investment to come through strongly for Rakon, especially when the AI factory deployment starts to take off. Current market expectations are projecting that AI factory deployments will have a meaningful impact on the sector growth from 2025 onward. Wrapping up, the first half of FY '25 showcased strong performance in AeroSpace and defence, rising demand in AI and Cloud Infrastructure and early signs of stabilization in Telecom. However, substantially lower year-on-year revenues in Telecommunications and Positioning significantly impacted our results. In response, we have accelerated cost reduction efforts and strategically reallocated resources to high-growth areas aligned with our strategy. We have prioritized R&D investments to extend technology leadership and safeguard growth in Space and AI while also Positioning ourselves for Telecom recovery and growth. Despite challenges, we remain on track to deliver within the lower half of our FY25 underlying EBITDA guidance, and we maintain ambitious growth aspirations for FY26 to FY29. In summary, the first half tested us, but we have strengthened our position in core markets and continued our expansion into high-growth verticals, building a diversified and resilient portfolio for the future. These efforts position us firmly to achieve our aspirational growth targets and deliver sustained long-term value. Thanks to our team, we believe Rakon has emerged stronger, more focused and ready to capitalize on clear growth opportunities in front of us. We will continue our targeted investments and operational transformation to ensure we unlock Rakon's full potential in the years ahead. Thank you. And I will now hand back to Nick to begin the Q&A.

Thanks, Sinan. We'll now start the Q&A portion of the presentation. [Operator Instructions] Our first question comes from Will Twist of Forsyth Barr. His question is related to the Telecommunications segment. He points out that gross margins were weaker, and he asks if you can talk about the segment and the second half recovery.

Well, the Telco market has impacted us in that while the sales volumes are as low as they are, it's costing us more to produce what we're producing and our gross margins are lower. So our manufacturing leverage and our operational leverage is lower. As far as the segment itself, it remains a core part of Rakon's business and strategy going forward. And we're geared that, as the volumes increase, we'll be able to pick up and increase and improve our gross margins. Our setup both here and in India and the transition of the business to India also strategically positions us to make the most of it. I guess the analogy that we've talked about around the table here is similar to a falling [ monohole ] in the Americas cap business. You need wind to get up on your foils and Rakon needs sales orders to get up on its foils and go from 7 knots off the foils to 50 knots on the foils.

We have a second question from Will. He's looking at the Telecommunications segment, excluding AI and Positioning, and he is asking, has there been any change in your long-term expectations for either segment?

Sorry, I probably sort of answered that in the first one, but our long-term expectations is, while this is a more mature market and not a growth market as per AI, Cloud, Space and defence, we still expect to have a targeted strategy to do well in this market. So our long-term expectations is Telco and Positioning are very important to us.

Yes. And I would add to that the slide that we had, I believe it was Slide 11, that showed our growth aspirations. You would see there the rate of growth for Telecom. We still expect a healthy and stable growth across the coming years for Telecom. And bit Positioning, it is a bit lower than the Telecom expectation because of the fact that we are going to continue to participate in a subsegment of the precise Positioning subsegment of the Positioning market.

Great. So one moment, we'll bring up the next question. The next question comes from Kevin Ascott, staying with the theme of Rakon's segments, looking this time at AeroSpace and defence. He notes that sales have improved, but they haven't improved perhaps by as much as expected. When are shareholders going to see a bigger increase in sales in the AeroSpace and defence segment?

Yes. Let me take that. The increase in the first half year-on-year was 10% approximately. But as I mentioned, there is some seasonality in that. We expect a bigger number in the second half even year-on-year. But I want to note once again that these sales -- so 2 things. One, for the first half, if you look at our revenue for that segment, it is now equal to our revenue from Telecom and at a 67% margin. So it is -- we find it quite healthy. And now that we are getting economies of scale, it is going straight to the bottom line. I would revisit this question, Kevin, at the end of the fiscal year as well because of the fact that we are expecting a bigger growth as well. But I would not call 10% growth year-on-year on a 67% margin business, chump change.

There's also the aspect to this that the stage of our customers and their life cycle is a factor here, too. Their initial contracts that we currently have are their first and smaller ones, and then they're going to go to larger scale as well. And we're linked in very early to this life cycle. So we would expect to see similar increases as they get more confident in their product and what they're delivering into Space.

We have another question from Kevin. This is relating to the India facility and the product transfers. He would like to know when that facility will get up to 100% of capacity, noting that it's been operating for about a year, and we would like to know a clear indication on when you're expecting to see the benefits from that facility and the transfers?

Right. So there are 3 -- maybe 3 points that I want to make on that. I think the part that we are referring to, as India getting to volume production, is for the portion of the business that we will have in India that was and that is transitioned from New Zealand. Otherwise, we have had India up and running on our traditional Indian business since we flipped the light switch on. So it has been running with all the business that we had in our previous Indian factory. On top of that, what we are transferring is the New Zealand part of our New Zealand business, as I mentioned, through the ICC program. And the third portion of it is going to be our Space business, the commercial Space business that we are starting also to transfer from France into India. So those transitions will continue for a number of years. As I mentioned, we are looking at the transition that will be continuous as it's a part of our ICC strategy, and there will be continuous transitions and transfers for us to extend the product life cycles, achieve competitive margins and be able to reduce our overheads as well.

The next question comes from Eden Bradfield of Blackbull Research. Eden is asking how realistic is the 25% aspirational target given the current results?

Well, I think if -- I mean, I can understand that question. But if -- again, if you were to look at our Slide 11, that does show the picture that we are looking at for the future years, starting from next year onward. So on top of our existing business, which I would call for our Telecom business, it is at a very low point at the moment. And it is going to bounce back to recovery. You're seeing early signs of recovery. So it will recover. So that's Telecom, which has been our largest segment, which is at perhaps its lowest point at the moment. That's one. 2, AI is coming in, in a big way, the AI hardware business, which we have very small quantity of, is going to come in as an additional slice on top of our existing business. That's on its own an entirely new growth driver. And the numbers that we are looking at in our own internal AI projections are very substantial. It's on par with other segments that we are looking at on this Telecom and Space. And coming to Space and new Space, I would still say that although we have been looking at 4 consecutive half years of growth on our Space business, we are still at the start of it. As I mentioned, we are looking at constellation contracts that have even 10x the potential value of what we have addressed thus far. That right now, we are in a position to bid on because of the fact that we are now an established top 3 global player in this. So we have additional -- in short, additional growth drivers that is coming on to a set of numbers that are at a really low point at this point.

And we have a question coming in from [ Brett Asler ]. Brett asks, what currencies are you most exposed to? And what hedging have you in place, particularly with USD to NZD currently below $0.59?

Good question. Our primary exposure is U.S. to NZD and that by far is our largest as we convert our revenue that we receive in U.S. dollars primarily back to fund and pay for our New Zealand dollar cost base here. That will obviously shift as we transition more offshore. But at this stage, that's our dominant hedge. We are well positioned and hedged for the next 12 months and then from 3 months out to '24. Our average rate is not at the 59. We have had hedging in place earlier and some of it is higher than that, but we have been taking advantage of the changes recently in the market, although it's highly volatile. And as we saw yesterday, even though he's not in power yet, his tweets seem to have a lot of impact on the market. But we have a strong hedging policy with external expert advice and we're fairly confident with our position at this stage.

Thank you. So we have the next question. There are questions coming in from Bill Potter. In regards to our Indian operations, do you foresee any geopolitical risks?