Fractal Gaming Group AB

STO:FRACTL

Earnings Call Transcript 2022-Q4

[Operator]

Welcome to the Fractal Gaming Group's Q4 2022 Conference Call. [Operator Instructions]

Now I will hand the conference over to the CEO, Hannes Wallin; and CFO, Karin Ingemarson. Please go ahead.

[Hannes Wallin, executive]

Hello, everyone, and welcome to today's presentation of our Q4 report.

We'll start with some highlights from our Q4. In the second half of 2022, we have [ seen growth in ] the gaming hardware market, and this is largely driven by a return to normal graphics cards [indiscernible] and a combination of pent-up demand of Fractal. We launched several new products in the quarter, and one of them have been [ Fractal North ] and have sold out in record time in all [ stores ].

Our sales increased by 17%, measured in Swedish krona, but decreased by 3%, measured in U.S. dollars. This is due to a strong comparison of Q4 2021 and higher discounts in 2022. But more importantly, we're very happy to report an impressive sales out increase of 31%, which proves the return in market demand. Our product margin improved from 32.7% last year to a healthy 37% in this quarter. EBITDA increased from SEK 3 million to SEK 13 million. And towards the end of the quarter, we got a very positive information. There are tariff exemption for cases to the American markets [ extended to ] September 2023.

The leading gaming platforms team set a new record recently with 32 million concurrent players, which is a testament to the still strong gaming interest and activity. The viewership numbers with Twitch have dropped slightly lately, but are still more than double compared to the prepandemic levels. The gaming regulations for China is beginning to loosen up. In the last couple of months, and we've seen positive signs for that market. AMD and NVIDIA introduced graphics cards in the quarter, and all in all, they have been many interesting releases 2022.

Also, gaming was resilient in the past, and we believe it's slowly that gaming will continue to be strong in coming years despite macroeconomical headwinds.

We have launched 3 new case products during the quarter. The most notable is the Fractal North, which you can see here in the center. It's likely one of the most successful product launches in our history. Both media and customer reviews have been very good. We've seen it selling out in record time in all markets. As you can see, we have introduced wood as material to this case, which have been very well received.

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

[Karin Ingemarson, executive]

Yes. Thank you.

So we wrap up the year with a relatively strong quarter. The graph at the top shows the development in net sales. And net sales in the quarter increased by 17% to SEK 142 million compared to Q4 2021. We also measure our sales in U.S. dollar as we sell exclusively in dollars, regardless of the end markets. And the organic net sales decreased by 3% in Q4. During Q4, sales discounts were higher than last year, but also higher on a full-year basis. Sales discounts were back at more normal levels in 2022, being relatively low during 2021.

For the full-year 2022, net sales increased by 2% in SEK and decreased by 14% organically. The second half of 2022 was stronger, with 56% of total net sales. In Q4, the main drivers of net sales were increased demand and healthy stock levels at the sales channels; successful case series, such as Torrent, Pop and the newly launched North, as Hannes just talked about; better availability and prices of graphics cards; strong sales out to end customers, which increased by 31% organically, which means that the underlying consumer demand was strong.

And in the graph at the bottom, you can see our quarterly development in sales out to end customers measured in dollars. Sales out in Q4 with sales of $60 million was the strongest quarter since Q4 2020.

So moving on to the next slide and segment development. The strongest region in the quarter was Americas, with net sales of SEK 73 million, corresponding to 52% of total net sales. The increase was mainly driven by successful sales campaigns, general market growth, low comparison figures and lower inventory levels at the retailers. In EU, net sales amounted to SEK 49 million, which is 34% of total net sales. The decrease in EU versus last year can be explained by a stronger U.S. dollar and high freight prices, which have led to more expensive products to the end customers.

APAC and Other had a net sales of SEK 20 million, 14% of total net sales. Sales of cases was 91% of total net sales, which is an increase of approximately 6 percentage points versus Q4 last year and was related to successful launches of cases during 2022.

Moving on to the next slide and product margin development. In Q4, the product margin was 37%, which is 4 percentage points higher than last year. The increased product margin was mainly driven by favorable currency effect and tariff exemption. But let's have a look at the details on how we get to the 4 percentage points improved product margin versus Q4 last year.

Positive currency effect increased the product margin by approximately 3 percentage points. As said before, we sell exclusively in dollars, and our product purchases are also in dollars. The currency effect comes mainly from selling out from stock with higher FX rate than we bought the stock for. U.S. tariffs exemption improved the product margin by approximately 2 percentage points compared to last year.

Fractal received a renewed tariff exemption for computer cases, and the exemption applied retroactively from 12th of October 2021, through December 31, 2022. We have also received a new exemption from January until September 2023, which will continue to have a positive effect on the product margin also going forward.

Lower freight costs affected the product margin slightly positive by around 0.3 percentage points through lower shipping rates, which was partially offset by a higher share of sales to the U.S. Shipping prices dropped significantly during the quarter, which will have a positive margin impact coming quarters. Lower product costs positively affected the product margin by approximately 1 percentage point. This is due to higher product cost in Q4 2021, that, to some extent, was related to previous quarters.

Sales discounts affected product margin negatively by approximately 3 percentage points, which was due to campaigns related to Black Friday and the holidays. Sales discount is back at normal level, more in line with how it was before COVID.

Let's have a look at the next slide and earnings. Q4 EBITDA was SEK 13 million, and the margin was 9% compared to SEK 2 million and 2% in Q4 last year. Year-to-date, EBITDA was SEK 34 million and the margin was 7%, which is SEK 22 million and 9 percentage points higher compared to the same period last year. The increase in EBITDA was mainly due to higher sales volumes, higher product results and lower warehouse costs due to decreased stock level.

Moving on to the next slide. Operating cash flow was positively impacted by higher EBITDA. During the second half of 2022, we have taken actions to normalize the inventory level, and it was reduced by SEK 34 million. We will continue to focus on the inventory level going forward to ensure additional improvement. Accounts receivables increased by SEK 13 million due to increased sales in the quarter. Investing activities was SEK 6 million and was related to development of new products. The overdraft facility amounted to SEK 110 million and was mainly related to purchases of product in stock. Total credit facility amounted to SEK 180 million.

Moving on to the next slide and the income statement. As previously presented, we had a net sales increase by 17%, mainly due to increased demand, availability and lower prices on graphics cards, successful product launches as well as healthy stock levels at the sales channels. During the year, we have continued to execute on our strategic growth agenda to create profitable growth in the coming years. We have increased our marketing activities, kept a high focus and pace in product development and increase the number of launches.

As said before, we believe that the gaming industry has proven to be relatively recession-resilient in the past, and we believe it's likely that gaming will continue to be strong in coming years despite macroeconomical headwinds. We only sell in U.S. dollars regardless of the end market, and the same goes for purchases of products. Fractal is, in many ways, a dollar company with 100% in dollars down to product margin.

Fractal's reporting currency is SEK and the numbers are affected by fluctuating exchange rates in currencies other than SEK. Q4 had an average U.S. dollar-SEK rate of 10.7 in compared to 8.8 last year, which is positive on our results. As I said earlier in the presentation, positive currency effects as well as tariff exemption improved the product margin in Q4. However, sales discounts decreased the margin.

Other external costs are lower than last year, mainly due to lower warehouse and rework costs. Personnel costs mainly increased due to salary adjustments and higher variable salaries. The financial net is affected by interest expenses related to the overdraft facility and FX translation effects.

With that, I hand over to Hannes again.

[Hannes Wallin, executive]

Thank you.

So a brief summary of our quarterly report and outlook. As mentioned, our sales started increased by 31% in the quarter, which we believe is a fantastic growth level. And it's driven by improved market demand and also our recent successful launches of new products. Our EBITDA margin improved significantly in the quarter and full year. And we will continue to drive our growth promoting initiatives, focused on delivering high-quality products, higher level of service and increased marketing efforts.

Despite high macroeconomic and geopolitical uncertainty, we see good opportunities for growth in this year, which is based on our attractive product portfolio and the increased general market demand.

So with that, we can go over to any questions.

[Operator]

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

[Simon Granath, analyst]

Congrats on the strong Q4 results, and it's great to see further recovery here, particularly positive response in the Fractal North. It's probably partly behind it. Could you talk a little bit about the financial unit economics from -- for when you launch a new product? Initially to give some revenue in the first quarter? But when do you normally see culminating revenue, et cetera? I'm trying to catch whether there was anything unusual boost that was detected in Q4, do you think.

[Hannes Wallin, executive]

The North case has been a big success for us. We launched it on December 7. And we had good hopes, [ but ] we didn't sell that much into the channel. And the very positive reception of the case proved to be much more than we can hope for as we quickly sold out in most markets. So I would say, in Q4, the contribution from North has a relatively modest effect, and we will see more effects of that in the coming quarters.

In terms of the general dynamic of how launches relate to our revenue, there is a certain revenue bump about 1 to 2 months before the launch when we ship the products from China and sell it into the channel, then there will be repeat orders, of course, depending on the success of the products.

[Simon Granath, analyst]

And also, do you expect to launch more products in 2023 versus 2022? I know you mentioned that there were 3 cases launched during H2 here.

[Hannes Wallin, executive]

Yes, I would say that 2022 was a particularly big year for us for launches. We will have launches in this year as well, but not as many as we had in the last year. We're excited to see now the full year effects of the products that we launched in the second half, which are proved to be particularly successful, including the North. But also, the Pop series has become an important revenue contributor for us.

[Simon Granath, analyst]

Great. And on the pent-up demand, do you have any tangible data about the pent-up demand situation that you can perhaps talk about? Or is it more about the general feeling, regardless -- or given the recent softness in the market?

[Hannes Wallin, executive]

Yes. Yes, we have seen a clear return to market demand growth in the second half of the year, which is also in line with what we earlier predicted. And I think it's dependent on several different reasons. But one of the main drivers is likely that both NVIDIA and AMD were launching their graphics cards in September, October, November, which removed this kind of wait-and-see effect that we had earlier when customers, especially during the spring, when the new graphic cards series were around the corner, they wanted to wait and see what that was all about showed.

So [indiscernible] cheaper costs or they can buy the newer one for higher performance but a higher cost. And since we have seen the market demand being depressed for a number of quarters for the second half of this year, we believe that this return to growth will continue in this year.

[Simon Granath, analyst]

That makes a lot of sense. And I know that there have lately been some talks about AMD restricting supply to push up GPU prices. Is that anything that you've noticed in the market that may impact the potential of materializing further pent-up demand?

[Hannes Wallin, executive]

Yes. I mean both NVIDIA and AMD has actually said that in the earnings call that they have, on purpose, kept down the supply of the new graphics cards. So particularly driven by that they had -- and their partners had a lot of inventory over the previous [ years ]. So they want to run through those inventories before releasing further inventory of the newer ones.

We're not particularly worried about that. We think that the prices of the new graphics cards will come down as supply increases, which we will do when the old graphics cards are being sold out. And for us, as a case supplier, it doesn't really matter if the customer is buying previous generation graphics card or one of the newer one, which in either case they will buy the case anyway regardless of the generation.

[Simon Granath, analyst]

Excellent. And then just 2 more questions from me, if I may. On the sales out figures, certainly a very strong figure. How would you say the current inventory levels are at your resellers? And are they talking about anything on how they want to position themselves going into 2023 regarding this?

[Hannes Wallin, executive]

Yes. So inventory levels, they were previously, earlier in 2022, rather on the hard side. And our sales channel had to normalize a little bit during the first half. Towards the end of 2022 when the market demand was picking up significantly, the inventory levels have gone down a lot and were actually below normal levels. So we're now seeing them restocking [ North ].

[Simon Granath, analyst]

And finally, could you mention anything about demand in different geographies? I know that North America has been a strong market for you or a resilient market for you in 2022. Do you expect that to continue in 2023? Or should we see any other trend shift there?

[Hannes Wallin, executive]

Yes, we see the North American market has been very strong lately and continues to be strong. There's a difference between various markets. Europe has been on the weaker side through 2022. And North America has been on the stronger side. Asia has been okay. But especially in Q4, we have seen a rebound on the European markets, not all.

But Germany, for example, has ended the year well. The weakest markets are actually the Nordics and the U.K., which may be because of very poor currency levels in those countries and other macroeconomical uncertainties. But most regions are doing very well, and we're seeing a healthy growth in market demand.

[Simon Granath, analyst]

And congrats once again to the strong results.

[Hannes Wallin, executive]

Thank you.

[Operator]

The next question comes from Amar Galijasevic from Carnegie.

[Amar Galijasevic, analyst]

And a question on the product mix. So strong development for cases, but is there a reason for a bit softer sales in the other category in Q4?

[Hannes Wallin, executive]

I'm sorry, could you repeat that again?

[Amar Galijasevic, analyst]

Yes, sorry. You had strong development for the cases segment, but a bit softer for the other category. Is there a particular reason for that now in Q4?

[Hannes Wallin, executive]

Yes, I would say that our product lineup of cases is stronger than other categories. We're focused more on cases and our product development, especially with a much stronger margin profile the cases provides. So I would say, it's because of our company focus on cases that have driven that and less company focus on power supplies and cooling.

[Amar Galijasevic, analyst]

Okay. I had a question on seasonal patterns. Do you expect the historical pattern of Q1 being a bit weaker than Q4 and perhaps Q2 being the weakest quarter of the year? Or has anything changed that dynamic that we should be aware of?

[Hannes Wallin, executive]

Yes, that's a good question. And in the last couple of years, the seasonal variations have been very hard to predict as the market has been quite volatile. So it doesn't follow the usual patterns. The usual patterns, as you mentioned, is that the Q3 and Q4 are the strongest and Q1 slightly weaker, and Q2 the weakest.

But because of the resurge in market demand in Q4, we believe that Q1 will be a pretty strong quarter still. Q2 is harder to decipher this early. But likely, the seasonal variation will come into play there with a bit lower demand because of the regular season variation.

[Amar Galijasevic, analyst]

That's helpful. And just a final question from me. On personnel expenses in Q4, quite a step-up. Is this a Q4 kind of seasonal phenomenon? Or how should we think about personnel expenses going forward?

[Hannes Wallin, executive]

Yes, we had some annual salary adjustments in Q4 that normally comes a bit earlier in the year, that came a bit later this year. We are hiring staff. So our personnel expenses will increase as we want to expand our business into new product categories, for example.

But -- and we're also actually quite proud of that in this quite volatile year, so 2020, 2021 and 2022. We have not been forced to lay off people as many of our competitors have been forced to do. [ It was weaker in '20 than in '21 ]. But our personnel expenses will rise in 2023 as we are building the company for the future.

[Amar Galijasevic, analyst]

And just a follow-up. Selling inflation, how do you see that affecting you in 2023?

[Hannes Wallin, executive]

Well, it's hard to say yet. We believe that salary increases in 2023 will be higher than [indiscernible] because of the inflationary pressure and expectations from staff in general. We don't believe it will be a dramatic effect on the business. But yes, slightly higher than the median.

[Operator]

There are no more questions from the teleconference lines at this time, so I hand the conference back to the speakers for questions from the chat.

[Hannes Wallin, executive]

Okay. Thank you very much for the questions, Simon and Amar. I don't see any written questions in the chat.

So with that, we want to thank you all for your time, and I hereby conclude the conference. I wish you all the nice day. Thank you.

[Karin Ingemarson, executive]

Thank you.