7 things I learned from the 2019 Elsoft Research AGM

Elsoft Research Berhad carries out research, design, and the development of test and burn-in systems. These test systems are used by its customers to test their opto-electronic devices such as light-emitting diodes (LEDs), image sensors, and automotive lighting before the products are released into the market. The name of the company is derived from two words, namely electronics and software that symbolise its core competency in electronics design and software innovation. It also operates a butterfly farm through its 30.9%-owned associate, Butterfly House (PG) Sdn. Bhd. (Entopia), which was loss-making in 2018.

As I entered the meeting hall, I was a little surprised by the turnout for the AGM as it was held in the industrial area of Bayan Lepas on Penang Island. Approximately 70 shareholders and proxies turned up for the annual general meeting.

Here are seven things I learned from the 2019 Elsoft Research AGM:

1. Revenue increased 26.5% year-on-year to RM78.2 million and net profit increased by 54.7% year-on-year to RM34.8 million in 2018. Both revenue and net profit bottomed out in 2009 when Elsoft ventured into development of an LED total test solution during the global financial crisis before reaching historical highs in 2018. Meanwhile the improvement in financials in 2018 was due to higher demand from the smartphone segment where LED flash testers were released to cater for a major brand’s new smartphone product line. In 2018, the smart devices and automotive segments accounted for 59% and 27% of total revenue respectively. From 2005 to 2018, revenue has increased at a compound annual growth rate (CAGR) of 6.8% and net profit has increased at a CAGR of 6.3% over the same period.

2. A shareholder raised his concerns that a lighting solutions multinational company along with its suppliers collectively accounted for 75% of Elsoft’s 2018 revenue. CEO Tan Cheik Eaik shared that the customer is one of the top five LED manufacturers in the world. It is an LED conglomerate with a presence in the smartphone, automotive, and general lighting business segments. Tan added that Elsoft has fostered a value-added long-term relationship with the customer for more than 15 years. For instance, Elsoft helps the customer to be more competitive by upgrading its machine speed which differentiates itself from its competitors. However, Elsoft has also invested for more than five years and diversified into the medical devices industry to mitigate customer concentration risk. At the same time, Tan candidly told shareholders that there is a good prospect but not huge potential in the medical devices industry.

3. The same shareholder was interested to know more about the impact of the U.S.-China trade war on Elsoft. In Tan’s opinion, the trade war has turned into a war on business technology.Some of its customers have become more risk-averse and conservative on capital expenditure for existing products. However, some are still aggressively pushing for delivery of new products in 2019 and 2020. Amidst a tough business environment, Tan reckoned that it would not be wise to increase prices to compensate for the potential shortfall in revenue, even though it may see a reduction of about 20-40% in a worst-case scenario. Elsoft would continue to play a supportive role to help customers get through the tough times by launching new products at similar prices.

4. A shareholder noted that other investments surged by 49.9% year-on-year to RM62.3 million in 2018. Tan explained that the company regularly invests its additional cash in unit trusts and bond funds to generate better yields. He added that unit trusts with greater exposure to stocks were affected by a mediocre stock market performance in 2018, but the dividend received from unit trusts and bond funds remained consistent. Elsoft also owns a 0.3% stake (equivalent to about 1.7 million shares) in Aemulus Holdings Berhad, a listed entity that manufactures automated test equipment. Elsoft has been gradually reducing its stake in Aemulus from 3.1 million shares since 2015 and recovered the cost of its initial investment according to Tan.

5. The same shareholder enquired about the increase of RM2.4 million in inventories to RM5.8 million in 2018. Tan answered that the build-up was mainly due to orders of medical devices. The orders were processed initially but had not been delivered as of 1Q 2019. Some other machine orders were piled up too.

6. Tan said that Elsoft will continue to spend about RM8 million on research and development (R&D) annually. The company will not save money on R&D as new products invented would generate revenue in years to come. R&D spending is relatively fixed and accounts for about 15% of Elsoft’s revenue during bad times and about 10% during good times.

7. A subsidiary has been granted pioneer status and its income will be tax exempted between 2015 and 2020. The tax incentive can be extended for another five years. Tax-exempt income under the pioneer status amounted to RM10.0 million in 2018 that translated to 24.9% of 2018 profit before tax.

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