Fractal Gaming Group AB

STO:FRACTL

Earnings Call Transcript 2023-Q3

[Operator]

Welcome to the Fractal Gaming Group Q3 2023 Report Presentation. [Operator Instructions] Now I will hand the conference over to the speakers, CEO, Hannes Wallin; and CFO, Karin Ingemarson. Please go ahead.

[Hannes Wallin, executive]

Hello, everyone, and welcome to today's presentation of our Q3 report. We are very excited to present our latest quarter report to you today, which is yet another very strong quarter with impressive growth and profitability. We're going to walk you through the latest developments within Fractal and our industry. And we're, of course, happy to answer any questions you may have.

We will start with some highlights from the Q3 report. Our sales increased by 45% year-over-year measured in SEK and increased by 41% measuring U.S. dollars. We are, of course, very proud that we're continuing to show strong growth and growing much faster than the market. Year-to-date, our revenues in SEK have grown by an impressive 83%.

Our sales out revenue increased by 56% year-over-year, which is another important testament to the very strong demand for our products. We now believe that the required stock filing to match higher run rates in early quarters is completed for now and that revenue in coming quarters will be more in tune with sales out.

With the continued strong growth, we are cementing our strong market position, which is driven by our very successful product releases but also from our expanded efforts in sales and marketing such as increased sales on Amazon and our Fractal Content Creator Program. And the market overall is back to show some growth, but it is clear that we are growing significantly faster than the market.

EBITDA increased to SEK 35 million compared to SEK 13 million a year ago with an EBITDA margin of 19% compared to 10% last year. Our product margin improved year-over-year to roughly 42% compared with 38% last year, which was primarily driven by a positive impact from shipping rates coming back to normal but also from great results in reducing our COGS and purchase prices. We had a very strong operating cash flow in the quarter. And we now have a net cash position of SEK 76 million.

Looking at the general market development and demand. In the third quarter, we saw a strong consumer sentiment in gaming with high engagement, thanks to several successful big game launches such as Starfield, Baldur's Gate 3 and Diablo IV.

During the pandemic in 2020/2021, there was a surge of new gamers and upgrades. And it is believed that many of those consumers will need to upgrade sometime between 2023 and '25, further driving the growth. We also see the market data that young generations are allocating more and more of their leisure time to gaming, which further reinforces the long-term positive future for the industry.

And with that, I leave over to you, Karin.

[Karin Ingemarson, executive]

Thank you. So moving on to the financials. And as Hannes said, the third quarter was another strong quarter. And net sales increased by 45% to SEK 190 million. All our sales are in U.S. dollars, regardless of the end market. And the organic increase was 41% and amounted to $18 million. Year-to-date, net sales had a growth of 83% and amounted to SEK 631 million.

In the third quarter, sales out increased by 56% organically with an increase in the case category of 69%, which was mainly due to a strong demand for Fractal's products. We have made several successful product launches in the past 2 years. And we now have the strongest product portfolio ever, which has contributed to the increased sales. Case series North, Pop and Torrent were among the best-selling products during the third quarter.

During the first 2 quarters, the stock levels in the sales channels were low and the increased demand from end customers led to retailers replenishing their stock to be able to meet the increased sales growth. However, we believe that the stock buildup at the retailers is at healthy levels. And net sales are now more in line with sales out, which we also expect in the coming quarters.

In the graph at the bottom, you can see our quarterly development in sales out that distributors and resellers report to us measured in dollars. In the third quarter of 2023, sales out amounted to $17 million, which is an increase of 56% compared to last year. Sales out has been on a high level during the last 4 quarters and the level is the highest in over 2 years, which again shows the great interest in our products.

Moving on to the next slide and segment development. The strongest region in the quarter was Europe with net sales of SEK 94 million, an increase of 44% compared to last year. The share of total sales corresponded to 49% and was at a similar level last year. The net sales growth in Europe was mainly driven by a demand from end customers due to several successful product launches and a strong product portfolio but also a pent-up demand due to EU being weaker last year.

Americas net sales amounted to SEK 69 million, an increase of 49% year-over-year. The share of total sales corresponded to 35%, which is in line with last year. APAC & Other amounted to SEK 28 million, which is 15% of total net sales. Sales of cases was 90% of total net sales compared to 83% in the same period last year.

Moving on to the product margin development. In the third quarter, product margin was 42%, which is 4 percentage points higher year-over-year. Year-to-date, product margin was at 41% compared to 37% last year. Lower shipping costs affected the product margin by 4 percentage points due to lower shipping prices.

Current prices remained around USD 2,000 per container compared to the peak of prices in early 2022 of approximately USD 20,000 per container. Favorable product mix positively affected the product margin by 2 percentage points, which is due to a higher share of cases sold but also increased margins within the case category.

During 2023, we have taken margin-strengthening initiatives, which have given effect during the third quarter. Due to lower raw material prices and positive currency effects, we have been able to negotiate our purchase prices. We have also been able to make some price increases for many of our products, mainly due to lower freight costs.

And for the main part of these price increases, they do not affect the end customers. Currency effects affected the product margin negatively by nearly 4 percentage points due to high comparison figures in the third quarter 2022, when the dollar strengthened against the SEK.

Let's have a look at the next slide on earnings. In the third quarter 2023, EBITDA was strong and amounted to SEK 35 million and the margin was 19% compared to SEK 13 million and 10% margin last year. The increase in EBITDA was mainly due to higher sales, lower freight and warehouse costs together with other external costs being scalable. Our personnel cost increased according to expectations.

Operating cash flow was strong and amounted to SEK 65 million compared to SEK 12 million in the same period last year, positively impacted by higher EBITDA. The change in net working capital was mainly related to decreased account receivables, slightly increased accounts payables and inventory. Cash flow from investing activities amounted to SEK 4 million compared to SEK 6 million and was related to development of new products.

We are very satisfied with the development of the cash flow, which has been strong for several quarters now. And this is a receipt of hard efforts. And the strong cash flow will enable us to invest in our continued growth. When closing the third quarter, the bank overdraft facility amounted to 0 compared to SEK 124 million year-over-year. We had net cash of SEK 76 million compared to net debt of SEK 116 million last year.

Moving on to the next slide and the income statement. As previously presented, we had another really strong quarter with a net sales of SEK 190 million, corresponding to an increase of 45% year-over-year, mainly due to our strong product portfolio and increased demand in the market. Total revenue amounted to SEK 192 million.

Goods for resale amounted to SEK 111 million and were in percentage of sales positively affected by lower shipping costs and favorable product mix. Other external expenses amounted to SEK 28 million, SEK 5 million higher than last year, mainly due to increased marketing activities, which is in line with our marketing strategy. Other costs were in line with last year.

Personnel expenses amounted to SEK 18 million. And the increase was mainly due to new hirings, which was in line with our hiring plan to be able to meet our mid- to long-term growth targets. Finance costs were lower due to net cash position and, therefore, lower interest costs compared to the same period in 2022. Profit for the quarter amounted to SEK 24 million, which is SEK 18 million better compared to last year.

With that, we have walked through the financials. And I hand over to Hannes again.

[Hannes Wallin, executive]

Thank you, Karin. So to summarize the quarter report. We continue to report strong sales growth driven by our successful product launches and improved sales and marketing initiatives.

Our net sales in SEK grew by 45% and we have a solid product margin of 42%. EBITDA margin improved significantly and came in at a healthy 19%. We also continue to have very strong cash flow development leading to a net cash position of SEK 76 million, which is very encouraging and would assist our future growth.

The buildup of inventory at the retailers has now caught up. And we expect net sales in the coming quarters to be approximately at the same level of sales out, meaning the sales from our sales channels to end consumers. Net sales in the fourth quarter of 2023 is expected to be lower than in the third quarter due to strong sales so far this year and that there is no certain need to normalize inventory at retailers in the fourth quarter.

And the continued success of our newly launched products, combined with expanded sales and marketing efforts gives us confidence in our ability to drive profitable growth in 2023 and beyond. And this year will most certainly be our most successful year ever. Our assessment is that there is still a pent-up demand among gamers to upgrade their equipment and that the upgrade cycle for 2024 and 2025 should be stronger than 2023.

And with that, we have reached the end of our presentations. And we open up for any questions.

[Operator]

[Operator Instructions] The next question comes from Simon Granath from ABG Sundal Collier.

[Simon Granath, analyst]

Congratulations on the strong numbers. Initially, you mentioned in the report that you have several new product launches planned for 2024 and beyond. Any color that you may provide here? Are they tilted towards the beginning of the year or the second half? And do they have any other characteristics in terms of gross margins against the current product portfolio?

[Hannes Wallin, executive]

Thank you for your question. We are still working to finalize the launches of these two new categories that we expect in 2024. A preliminary guide right now is that it's toward the end of the first half that we expect to launch these products as the schedules are right now.

We see that the product margins of these new categories are relatively strong, especially considering that we are a newcomer in these categories. Most likely, they are slightly lower than the case category, especially considering the recent improvement we've done in the case category. But mid- to long term, we expect these categories to be in par or perhaps even higher than cases.

[Simon Granath, analyst]

That's very clear. And just a housekeeping question on the Q4 outlook of sequentially lower sales, I presume that is a result of both tough comparables and the fact that you will not see as positive tailwind from -- to sales from stockpilings rather than the effects of lower demand or destockings. Here, on the latter, I refer to your wording that there is a need to normalize inventory.

[Hannes Wallin, executive]

Yes, correctly. Yes, we are still seeing a strong demand in the market. So that is unchanged. What we're seeing now is that in the first 3 quarters, we built up inventory in the channel, and we now see a need in the fourth quarter to slightly normalize the inventories to get them to exactly the right levels. And as a result, we see and believe that the net sales in the fourth quarter will be a bit lower than the sales out in order to normalize those inventories, and as a result, and also sequentially lower than the third quarter.

[Simon Granath, analyst]

Very good. And as you highlight, there was a surge of new gamers in 2020, which you are now starting to see the tailwinds from in terms of refreshments. And I understand your wording that the effect from this will be greater in 2024 and 2025 than in the current year. But did you see any impact from this already in Q3?

[Hannes Wallin, executive]

Well, it's hard to trace exactly the sources of the people that are upgrading. But we've seen in several analyst report and market coverage of the general gaming hardware markets that many believe that 2024 and 2025 will be stronger upgrade years as those who were buying their hardwares in 2020/'21 will need to upgrade. Overall, the market in 2023 have seen a return to growth. But we don't see a big growth in the market. And that means as a consequence that we are taking significant market share since we are growing significantly.

[Simon Granath, analyst]

Also very clear. And Karin mentioned that you've made some price increases. Could you give us any ballpark figure on the magnitude of these and also when you did implement those?

[Hannes Wallin, executive]

Yes. We implemented some price increases in the second quarter of the year. It always has some certain lag effects before they take the full effect. And we're also planning some smaller price increases in the beginning of next year. Those price increases have mainly been to adjust for that the shipping cost of the containers have gone down so much.

Back in 2021, where the container prices were extremely high and also into 2022, we had to adjust our pricing for new products in order to accommodate for higher shipping costs for our wholesale channels as mostly our customers are paying the shipping by themselves, which means when we are calculating the kind of margin we expect them to have and the shipping costs they expect to have, we had to take account for that.

But now in this year and including the price increase early next year, we are going back to the normal shipping rates basically. So these price increases are not, in theory at least, leading to increases of MSRPs or market prices of our products.

[Simon Granath, analyst]

And just a final question from me regarding the lower freight rates that we have been seeing, has -- that has, as you pointed out, been a tailwind to the gross margin in recent quarters. Has most of that inventory now been delivered? And should we, therefore, expect a lower sequential effect going forward? And I guess, in addition to that, could you make any outlook on the period after the tariff expansion -- extension expires in December 2023?

[Hannes Wallin, executive]

Yes. So on the lower shipping rates, we have churned through all of the old higher shipping rate costs, which means that what we're seeing right now in terms of the shipping costs affecting our margin is what should be expected going forward, of course, assuming that the shipping rates are staying at these levels.

It looks like that. And they are kind of back to the normal that we saw during many years before the pandemic. So we think that is likely to assume. In terms of the tariffs, I'm not sure what your question was there. Are you asking about what we believe will happen after 1st of January? Or could you explain that a little bit?

[Simon Granath, analyst]

Yes, of course. I was wondering if you would dare to make any outlook for the period after that the extension expires?

[Hannes Wallin, executive]

Right, yes. As with the previous exemption periods, we also at this time believe that there is a good chance that we can get another extension. The visibility and transparency of this is, however, very low. So it's difficult to say, there are no clear signals from the U.S. Trade Representative Office that is managing this in the U.S.

They are doing right now what they call a 4-year review, so 4 years after these tariffs were initially introduced. There are some speculations in the market that some tariffs may be removed. But it's very difficult to say. But we have a good hope that we can continue with the exemptions, given the fact that we've now been granted exemption so many times.

[Operator]

[Operator Instructions] There are no more questions at this time. So I hand the conference back to the speakers for any written questions and closing comments.

[Hannes Wallin, executive]

All right. Thank you. I don't think we have any further questions. So with that, we thank everyone for your time, and wish you a nice day. And by that, we conclude this call. Thank you, everyone.