Fractal Gaming Group AB

STO:FRACTL

Earnings Call Transcript 2024-Q3

[Jonas Holst, executive]

Hi, everyone, and welcome to today's presentation of the Q3 report for Fractal Gaming Group. Today, we will be presenting the key highlights from our just released Q3 quarterly report, focusing both on the headwinds that we have been facing and the positive outlook that we see ahead for our company and industry. We are, of course, happy to answer any questions that you might have either in the end of the call or if you reach out to us individually.

We will start with some general comments from Q3 and the changes in the headwinds that we are facing and the long-term positive outlook that we believe can take us back to growth already by end of year.

Our net sales for the quarter was SEK 157 million, representing a decrease of 17.5% in SEK, but 13.9% organically. This development is in line with our expectations following the high comparative numbers that we are facing from Q3 2023, a quarter where we saw a very strong growth of 45% year-on-year.

We are seeing a gradual improvement in the market compared to the first half of 2024. The restraint in retailer purchases that we observed earlier in the year have eased towards the end of the quarter as freight costs have started to come down and many partners are looking to increase their stock levels ahead of the crucial sales period in the fourth quarter. This is also positively affected by our successful product launch program that we activated during the summer.

Sales out in the quarter declined 16.5%, primarily due to reduced consumer purchasing behavior following long-term high inflation and interest rates. We also understand that many end consumers are postponing purchases in anticipation of new graphic cards and other component releases that are expected in early 2025. Our sales out in the quarter benefited positively from our new product categories, which are less reliant on the component upgrade cycle. We believe this trend will continue to benefit us moving forward.

Our EBITDA for the quarter was SEK 12 million, down from SEK 35 million last year, with an EBITDA margin of 7.4% compared to 18.5% last year. The lower result is mainly due to the decrease in net sales in combination with the lower product margin. The product margin decreased to 37.8% from 41.8% last year, primarily driven by increased general discount levels in the market. Additionally, our net cash position continued to be at good level with SEK 30 million at the end of the quarter.

On another positive note, the reception of our new product categories continues to be very encouraging. Our new Refine computer and gaming chair launched with strong sales following very positive reviews from end consumers and media. Additionally, Era 2 was introduced during the quarter and received a strong reception from the market. We also see that the interest in Scape, our upcoming gaming headset, is increasing further as the success of Refine is proving that we are making impactful entries also into new categories.

So in conclusion, while we are still facing some short-term challenges, our long-term outlooks remain strong following the gradual market improvements and the positive reception of new products.

During the quarter, Fractal reached significant milestones through the introduction of the new products as part of our extensive launch program that was presented in Computex in June. We have proudly launched our first computer and gaming chair, the Refine, as well as the next-generation small form factor case, the Era 2. With the introduction of the Refine gaming chair, Fractal has made a significant entry into the gaming furniture market, and the chair has been celebrated for its ergonomic designs combined with Scandinavian aesthetics. The initial sales has exceeded our expectations, and we are confident in the positive future contribution of our new product categories.

Refine has received strong positive reviews, both from gamers and media, getting praise for its adjustability, premium materials and seamless integration into home environments. It is proving that our combination of design and high performance is successful also for new categories.

In September, we also launched the Era 2 small form factor case, which received glowing feedback for its enhanced cooling, innovative design, strong compatibility and premium materials. These new product launches continue to solidify Fractal's position as a leader in the gaming hardware market, meeting the needs of the modern gamers around the world.

Now let's look at the current trends and future outlook of the gaming market in general. 2024 is proving to be a transitional year for the gaming market. We are witnessing weaker demand and delays in component launches. However, there is a positive aspect as strong consumer engagement and upcoming PC upgrade cycles suggest a promising rebound in 2025. So despite the temporary stagnation in 2024, consumer behavior shows resilience and pent-up demand.

This is also supported by the development of the global games market, where we are seeing a growth rate of about 6% during 2024, primarily driven by engaged gamers spending more time and money, not just on playing games, but also on other gaming community activities. A remarkable 80% of consumers below 18 identify as gamers today with increasing time spent in gaming environments.

Furthermore, the importance of streaming is growing with more and more consumers buying a product based on recommendations by a streamer. This highlights our own ambassador network called Fractal Creator Program that daily promotes our products and brand. This is currently the fastest-growing team in our industry on Twitch.

Looking ahead to 2025, the gaming hardware market is set for growth. This will be driven by components like NVIDIA's RTX 50 series and advancements from AMD and Intel. The demand for high-performance versatile gaming setups is further reinforced by the growth of more advanced game titles, also driven by AI.

In conclusion, while 2024 presents some challenges, the future of the gaming industry looks bright. With strong consumer engagement and technological advancements on the horizon, we can expect both significant growth and innovation in the coming years. Fractal's growing product portfolio, which now includes gaming headsets and gaming chairs, fits well into these market needs and offers opportunity for us to capture a broader audience.

And with that, I'm giving the word to Karin that will take us through the financials for the quarter.

[Karin Ingemarson, executive]

Thank you, Jonas. So the graph at the top illustrates the quarterly development in net sales. In the third quarter, net sales amounted to SEK 157 million, reflecting a 17.5% year-over-year decrease. We also measure our sales in U.S. dollars since we sell exclusively in dollars regardless of the end market. Net sales were $15 million, representing an organic decrease of 13.9%.

Last year, we had strong comparative numbers with 45% organic growth in Q3, but we still see a slower market compared to last year. In Q3, freight prices remained high and resellers continued to be more restrictive with their purchases as they are responsible for covering the shipping expenses. However, compared to the first half of 2024, we see a gradual improvement in the market. Resellers are increasing their stock levels ahead of the holidays and the important sales period in the fourth quarter.

The graph at the bottom shows our quarterly development in sales out reported by tracked partner and measured in dollars. In Q3, sales out amounted to $15 million, reflecting a 16.5% year-over-year decline.

In the last quarter, we discussed Fractal's upgrade cycle, which typically spans 3 to 5 years, but is highly dependent on consumer sentiment, purchasing power and the timing of new components such as graphics cards. We experienced weaker consumer sentiment in the third quarter as well, but there was a gradual improvement. This sentiment was a market-wide issue affecting not only Fractal, of course, but also our competitors. Due to these market-related issues, we anticipate the upgrade cycle to occur in 2025.

Moving on to the next slide and segment development. Sales of cases accounted for 91% of total sales. This was approximately 1 percentage point higher year-over-year. Other products have decreased compared to the previous year due to lower sales and higher discounts on water cooling and power supplies. However, the sales of our new product category, chairs, contributed positively to other sales and is expected to increase in the latter part of 2024 and have full effect in 2025.

Total net sales of cases in Q3 amounted to SEK 142 million, which is a decrease of SEK 29 million year-over-year. The decrease year-over-year was primarily driven by increased channel inventory at our customers. The strongest region in the quarter was EMEA with net sales of SEK 80 million, a decrease of circa 15%. EMEA's share of total sales was 51%, which was 2 percentage points higher compared to last year.

Americas net sales amounted to SEK 57 million, which was a decrease of approximately 17% year-over-year, of which the main part was related to cases. Americas' shares of total sales was 36%, which was in line with last year. Net sales in APAC were SEK 20 million, and their share of total sales was 13%, which was a decrease of 2 percentage points compared to last year.

Moving on to the next slide and product margin development. In the third quarter, the product results amounted to SEK 59 million compared to SEK 79 million last year, and the product margin was 37.8%, which was a decrease of 4 percentage points year-over-year. The main driver for the changes had to do with sales discounts, which affected the product margin negatively by approximately 3 percentage points.

The damp demand in the market has led to more campaigns and discounts to drive sales across the industry. However, Fractal's core philosophy as a premium brand is to be restrictive with the discounts, and we closely monitor market developments. As the market strengthens, we expect to return to a more normal level of campaign activity going forward.

Shipping costs slightly affected the product margin positively by approximately 0.2 percentage points. During the third quarter, shipping prices were higher compared to the same period last year, which was expected. However, this was offset by significantly lower handling costs during the quarter.

FX impacted the product margin negatively by 1 percentage point due to a weaker U.S. dollar rate compared to last year.

During the third quarter, EBITDA reached SEK 12 million with a margin of 7.4%, reflecting a decline compared to last year primarily due to lower sales. We can see that several cost items have decreased compared to the previous year, such as inventory costs and consultants.

During the quarter, we have continued to focus on streamlining our operations and ensuring good cost control. Operating cash flow in the third quarter was SEK 15 million with a cash conversion of 127%. The change in net working capital was positively affected by decreased inventory and accounts receivable and negatively affected by decreased accounts payable due to lower purchases. The lower inventory was mainly due to cautious purchasing because of a weaker market and also because Fractal is adjusting inventory levels to better match demand.

Cash flow from investing activities amounted to SEK 4 million and was related to the development of new products. With SEK 30 million in net cash and no use of the overdraft facility, Fractal demonstrates strong financial stability and flexibility. Cash conversion cycle amounted to 29 days, which was an improvement versus last year by 14 days, mainly related to improved days of inventory and days payables outstanding.

Moving on to the next slide and the income statement. As previously presented, net sales in the third quarter amounted to SEK 157 million, a decrease of 17.5% year-over-year, mainly related to higher comparative numbers and the weaker market. Capitalized development increased by SEK 0.7 million related to the increased number of hours spent on development. Total revenue amounted to SEK 159 million.

Goods for resale amounted to SEK 99 million and were in percentage of sales, positively affected by a slightly favorable product mix and freight costs, however, negatively affected by FX.

Other external expenses amounted to SEK 26 million, a decrease from last year, primarily due to reduced warehouse costs, but also due to the transition of some long-term consultants to full-time employees.

Personnel expenses amounted to SEK 23 million, an increase of SEK 5 million year-over-year, and the increase was mainly due to new hirings in 2024 and the full year effect of hirings from last year, but also the movement of some consultants. This is in line with our hiring plan to be able to meet our mid- to long-term growth targets.

Finance net was lower due to negative FX when recalculating from U.S. dollar to SEK. However, lower interest costs due to a net cash position.

With that, we have walked through the financials, and I hand over to Jonas again.

[Jonas Holst, executive]

Thank you, Karin. So to summarize the quarterly report, our net sales in SEK decreased 18% compared to high figures in Q3 2023, where we achieved a 45% increase year-over-year. However, compared to the half -- first half of 2024, we are witnessing a gradual improvement in the market as partners look to increase their stock levels ahead of the sales season by end of year.

Our product margins decreased to 37.8%, down 4 percentage points year-over-year, as we're faced with negative FX effects and higher sales discounts in the market. The EBITDA margin stands at 7.4%, down about 11 percentage points year-over-year as a result of the lower net sales and product margin.

During the quarter, we have received very positive reception for our Refine computer and gaming chair as well as our new case Era 2. We've also seen big interest for the Scape gaming headset, and this supports the shift in Fractal's global brand and market position.

Our strong financial position gives us the opportunity to pursue our strategic initiatives and further advance our position in the market. We are committed to expanding our presence in both existing and new product categories, and we are continuing to invest in the long-term growth strategy.

Additionally, we are observing a trend where gamers are spending more time and money on gaming. This behavior aligns with our positioning and vision, and we believe it will continue to support our growth. The upgrade cycle for gaming hardware has been pushed forward with stronger industry performance expected in 2025, supported by key PC component launches.

To summarize, we are still facing some short-term headwinds, but we believe in a strong long-term outlook and foresee a stronger sales development already in the fourth quarter of 2024, where we again can show growth supported by our new product launches, expansion into new product categories and increased marketing and channel initiatives.

And with that, we have taken you through the Q3 report, and we open up for questions.

[Operator]

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

[Simon Granath, analyst]

I was initially wondering if it would be possible for you to give any more color on the sales impact from the new product categories or rather the gaming chair here in Q3, particularly in light of the flat sequential sales growth for your other segment sales here.

[Jonas Holst, executive]

Yes. Thank you, Simon. First of all, the other categories here, as we talked about before, includes all other categories for Fractal then that we are including water coolers and power supplies, et cetera, that we are not moving out of, but reducing our inventory or lineup of. And the impact that you're seeing in the other categories, meaning that it is not positive here is also related to that sell-out of these products. So, lower sales of water coolers and power suppliers started to outweigh sort of the increased sales that we see in chairs.

So we have had a positive impact both from a sales out, sell-in and margin perspective by the chairs in Q3, but it's something that will have full effect now during Q4 and as we move into 2025.

[Simon Granath, analyst]

Very good. And on the customer discounts, you mentioned that you expect these to normalize going forward. Should this be the case already in Q4? Or is it more so a gradual normalization as we enter 2025?

[Jonas Holst, executive]

It's likely going to be a gradual normalization. We believe Q4 will be a big step in the right direction there. That's the direction we are working on. Q3 was more abnormal in that sense. We believe market coming back and the changes now with also the campaign season here that we have a better position in the market.

[Simon Granath, analyst]

That's crystal clear. And as mentioned, your resellers are currently increasing stock levels ahead of Q4 and on the solid 2025 outlook. Would you expect this trend to continue in Q4, i.e., that they might end up with some excessive inventories or would you expect sales in and sales out for you to match one another relatively well?

[Jonas Holst, executive]

No, we would expect them to match relatively well. And as always, continuously monitoring and making sure that we close the year and every period on as good channel inventory situation as possible. But at the same time, we are expecting the market to, just as we said, come back also with the new releases and components coming in the beginning of 2025. So we might have a slightly different baseline compared to where we have been in the last few months.

[Simon Granath, analyst]

Another very clear answer. Finally, on the demand situation in 2025, perhaps it's a difficult question to answer, but how important would you say that the anticipated GPU launches from NVIDIA are to the demand for your PC cases sales to improve? Would you expect a negative impact if this were to be pushed towards the latter part of 2025? Or is the current pent-up demand combined with recent product releases simply too strong near-term forces?

[Jonas Holst, executive]

We believe that the -- our own roadmaps definitely have a positive impact on the sales development also for 2025 and definitely so with our other categories and then with the chairs and with headsets, that is not as reliant or dependent on the component upgrade cycle, which we believe is very good to decrease the volatility. However, for the impact of case sales in particular, the component cycle is important and the release of particularly NVIDIA's next series will have impact. So delaying that later into '25 could have impact definitely on the numbers, especially for cases.

[Operator]

There are no more phone questions at this time. So I hand the conference back to the speakers for any written questions or closing comments.

[Karin Ingemarson, executive]

Yes. So the first written question as we have is, as of today, 4 out of the 12 best-selling gaming chairs on [ UEG ] are Fractal chairs. Can you comment on how you think you can achieve this considering that your pricing point is 3 to 4x as high as the other best-selling chairs?

[Jonas Holst, executive]

Well, we believe it's the combination of the ingredients, so to say, for our product development and product success, the combination of the design direction that we're moving with the performance of the products that we are delivering. Of course, that is something that we believe is attractive and is meeting the demands of the consumers.

It's correct that there is big differences in prices in the gaming chair category, but the products that would be competing with Refine could probably rather be on a higher price point than on a lower. So we believe that the value for money that you also have on the Fractal Refine is very, very strong. So that's a strong selling point for the Refine gaming chair.

[Karin Ingemarson, executive]

Yes. Your other category, where the Refine chair is included, had negative sales development quarter-over-quarter. Can you put some color on why, given that sales of Refine have exceeded your expectations?

[Jonas Holst, executive]

Just as I tried to explain, the other categories includes also sales of other, other categories, so to say, and the sales have dropped significantly compared to especially last year, which is planned and moving and [indiscernible] giving room for both chairs and headsets for the future. But it outweighs, so to say, the sales of Refine that is a positive contribution, both from a sales out and gross margin perspective.

[Karin Ingemarson, executive]

Any update on the release date of Scape?

[Jonas Holst, executive]

We're moving closer. But as Fractal usually does, we don't go out in advance with too much information on release dates and these things. But we're still looking at the effect of Scape in Q4 revenue as we have been saying before. And more information will come during the next few weeks and months.

[Karin Ingemarson, executive]

How high are your expectations on the release of Scape given that the release of Refine had such a good reception from both customers and reviewers?

[Jonas Holst, executive]

I think I would be too modest if I would say that our expectation of Refine have -- sorry, of Scape has increased now after the launch of Refine. It is a feeling we have, a sentiment in the market with the relation with our partners, customers and also end users that people are even more interested in the Scape now after the Refine launch as it sort of proves that the products we're coming also within new categories are really strong compared to competition that's out there.

So we have very high expectations on Scape. But still, we are, of course, modest in saying this we're moving into a new product category, and we are taking it as a gradual launch just as for Refine, we're taking it step by step, making sure that we do things right here. So Scape will have a good impact for us in 2025, just as Refine will be having.

[Karin Ingemarson, executive]

Can you comment on your recent partnership with Best Buy? Does it differ from your partnership from other resellers? And if so, how?

[Jonas Holst, executive]

Correct. Now in the beginning of Q4, we have shared the information that we have moved into a relationship -- a partnership with Best Buy in the U.S. It's a big step forward for Fractal as well, especially with the new product categories as well to be available to more customers in other platforms. The partnership per se doesn't differ materially from any of the other big partnerships that we might have, but it's a good step forward for Fractal to make our products available for a bigger audience also on the American market.

[Karin Ingemarson, executive]

Will Fractal's cases be sold only online through Best Buy or in Best Buy's physical stores as well?

[Jonas Holst, executive]

At the moment, we are available in the online channel. But of course, long term, it's a broader strategy.

[Karin Ingemarson, executive]

Does the collaboration only include cases? Why not chairs?

[Jonas Holst, executive]

As with every product that we launch, we have launch partners that are set and involved in that product launch process since quite long before the actual launch happens. And here, Best Buy wasn't one of the launch partners, that the case wasn't -- or the product wasn't released when we went into those negotiations.

[Karin Ingemarson, executive]

Can you elaborate on markedly lower processing costs during the quarter? Was this a one-off? Or did you change your way of working? Well, we have not changed our accounting processes. It's the same as before. However, last year, there were exceptionally high container costs in Q3. So that's why we have that offset now this year.

What did chassis grow in sales out?

[Jonas Holst, executive]

I don't have the exact number in my head right now, but we would say that we see that the new categories [ that will ] Refine had a positive impact on the sales out numbers. So -- but it's in line with the overall development of the business -- overall portfolio.

[Karin Ingemarson, executive]

Yes. Thank you. Is it fair to assume 40% gross margins on your 2 new product categories?

[Jonas Holst, executive]

Do you want to answer it or me?

[Karin Ingemarson, executive]

Yes. I have the same answer as always. Well, the margin on our new 2 product categories, chair and headset, will be in our span, so to say, with current product margins as we have. So yes, they will.

Can you explain the lower gross margin in the quarter? Are you seeing the margin going back to normal levels ahead?

[Jonas Holst, executive]

The lower gross margins is -- I mean, the lower margins that we are seeing overall is affected by the discount situation that we are having in the market, driven by the market itself, not primarily driven by us. So it is our expectation that, that will come down and the impact from the product mix and so on will be continuously positive as we have seen in the past. So it's -- as long as discounts move in the right direction, margins will as well.

[Karin Ingemarson, executive]

Can you talk about when your new product categories will be available on Amazon?

[Jonas Holst, executive]

Amazon, of course, as a global player, we will have different availability in different markets around the world from Japan, Europe and also America. It will -- we will have our chairs available there in not-too-distant future. So you can keep your eyes out for that. But it's related to what I talked about before with launch partners and activations of our new product categories and how we are activating sales.

[Karin Ingemarson, executive]

You expect a stronger sales trend already in the closing quarter of 2024. Could you expand on that? It's measured on net sales. That is not saying much, because net sales Q4 2023 was very weak. Can you comment on sales to end customers? That was many questions in one, but...

[Jonas Holst, executive]

No, it is correct. And we were not facing as strong comparative numbers in Q4 '23, at least not in comparison with the previous quarter during that year that was very strong in contrary. But we believe that the market is moving in the right direction. That is related to the changes in the freight cost, for example. That is a barrier that is going to be reducing or decreasing, but also that we are moving into high sales season and that component launches in the beginning of '25 will also have a positive effect.

[Karin Ingemarson, executive]

Yes. Could you update us on your thoughts and progress with the distribution through Amazon, especially in the U.S.?

[Jonas Holst, executive]

So on the American side, correct, Amazon is now -- we've been working on that during 2024 as one of our key objectives and initiatives that we are exploring and developing. We are having good progress with Amazon, exploring different routes of distribution, expanding our portfolio, but it's a gradual work as well and not something that will go from 1 to -- 0 to 100 in a day. But we are pleased with the development as where we are heading right now.

So the overall development of the distribution network in U.S. is progressing according to plan with the involvement of Amazon in combination with the existing network and then the addition of new players such as Best Buy.

[Karin Ingemarson, executive]

Any production bottlenecks for Fractal Refine? Or can you meet the high demand?

[Jonas Holst, executive]

That's a good question. Not to say that it's a bottleneck, but of course, we -- as we talked about with our new product categories, we do ramp up production and we do ramp up supply of this product. We have a good approach to that from -- in our plan to see that we will have a long-term best effect. So the ramp-up of Refine is not an issue. But of course, we would have loved to have more products available in the market already now. We have been out of stock for a month or 2 in some markets, which was not expected, but it's due to a significantly higher demand initially from these products than what we could expect. So it will be a bit of catch-up here in Q4, but by end of the year, we would be in a bit better position.

[Karin Ingemarson, executive]

Do you think you will have growth also in sales out?

[Jonas Holst, executive]

In Q4, we believe we will move in the right direction also in sales out. We're moving in -- closing in already in Q3, and it's moving in the right direction for us.

[Karin Ingemarson, executive]

And that was it.

[Jonas Holst, executive]

I think there is one more from Thomas.

[Karin Ingemarson, executive]

Did I miss that?

[Jonas Holst, executive]

So the question is, could you talk about discounting and how you share some of the distributors' discounts? Or was that very visible in your gross margin this quarter? So essentially on discounts, of course, it's a constant planning with our partners and distribution channels on how the cost is shared between us and them. So, either, we would initiate depending on activities and campaigns that would be initiated by Fractal, or by the partner. And how they are split depends on what type of activity it is that we are running. It was very visible in the quarter, and it is due to the channel or the industry driving high discount levels at the moment.

[Karin Ingemarson, executive]

Great. Thank you.

[Jonas Holst, executive]

Very good. Thank you all for the questions and participation. And as usual, please reach out if you have any further questions, and we are available for you.