Fractal Gaming Group AB

STO:FRACTL

Earnings Call Analysis

Earnings Call Transcript 2023-Q4

[Operator]

Welcome to the Fractal Gaming Group Q4 2023 Report Presentation. [Operator Instructions] Now I will hand the conference over to the speakers CEO, Jonas Holst and CFO, Karin Ingemarson. Please go ahead.

[Jonas Holst, executive]

Hello, everyone, and welcome to today's presentation of the Q4 report for Fractal Gaming Group. As newly appointed CEO of Fractal, this is the first time that you meet with me in this forum. However, I've been with the company since June of 2022 as VP Global Sales, so I am well into the operations and business. Today, we are happy to present our latest quarterly report to you, and by that, summing up 2023, the strongest year in Fractal's history, both looking at revenue and profitability.

We're going to walk you through the latest development within Fractal and our industry, and we are, of course, happy to answer any questions that you have after the presentation.

We will start with some highlights from the Q4 report. Sales increased 1% year-over-year measured in both SEK and USD. The lower growth compared to previous quarters are primarily due to higher comparable numbers starting from Q4 in 2022 and our efforts to normalize the channel inventory following the strong previous quarters of last year. With Q4 in the books, we have closed a record year for Fractal with the revenue growth in SEK of plus 59%, 4 percentage points higher product margin and a strong bottom line profitability.

We have seen good results from our strategic growth initiatives and are growing significantly more than the market in all regions. Sales out revenue in Q4 increased by 11% year-over-year, reaching the highest level since 2020. The difference in sales in and sales out growth is explained by channel stock dynamics and we closed the year with channel inventory levels that are in line with our targets.

The strong growth and increased market shares during 2023 is primarily driven by successful product launches such as North, Pop, Ridge and Terra that further cemented our position as the leading brand for the design cautious gamer.

Increased business with key partners such as Amazon and success with our Fractal content creative program are examples of sales and marketing initiatives that have favored us further during the year. EBITDA in Q4 were at the same levels as last year at SEK 13 million with an EBITDA margin of 8.8% compared to 9.4% last year. Our product margin improved year-over-year to almost 41% compared to 37% last year. Despite negative exchange rate impact, and driven by COGS saving initiatives that continue to give us positive effect at the same time as shipping rates continued on a low level.

We had a weaker operating cash flow in the quarter, but closed the year with a net cash position of SEK 8 billion compared to a net debt of SEK 116 million by the end of last year. Now moving over to market development, where we have seen some interesting trends and shifts in the market during Q4. Total PC market saw growth of 5% compared to Q3, and this is breaking a 2-year negative trend. It is now expected that PC deliveries in total will increase 8% compared to 2023 and we see AI computers, for example, making up 19% of the total systems sold and supporting this growth.

This general growth in the PC market is a positive sign for the gaming market in particular. The computer hardware sales in Q4 was also boosted by strong games launches such as Call of Duty: Modern Warfare and Alan Wake 2. Another indicator for market growth is the significant uptick in gaming engagement in Q4, such as viewed hours and active players on Steam. This is despite a slight annual decrease on the Twitch platform. Finally, we see strong growth in the global gaming consumer base with 6.4% growth to now over 3 billion gamers worldwide.

It is believed still that many of these will need to upgrade their systems during the coming 2 years. And now moving over to financials. So Karin, please go ahead.

[Karin Ingemarson, executive]

Thank you, Jonas. The graph at the top shows the development in net sales. The last quarter of the year had as we predicted, significantly lower growth compared to previous quarters during the year and net sales increased by 1% to SEK 143 million. We also measure our sales in U.S. dollar as we sell exclusively in dollars regardless of the end market, and the organic increase in the fourth quarter was 1% to $13 million. The slowdown in net sales growth was a result of the strong sales to our sales channels during the first 9 months of the year. During the fourth quarter, we worked to ensure that inventory levels were at balanced level which will lead to net sales and sales out being more in line in 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. We had a really strong sales out during the year. And in the fourth quarter, sales out increased by 11% organically with an increase in the case category of 18% and amounted to $18 million, which was the strongest sales out number since the fourth quarter 2020. The strong sales out is a result of successful product launches, and we have a really strong product portfolio, case series; North, Pop, Torrent and Terra were among the best-selling products during the quarter.

Sales out has been on a high level during the last 5 quarters, and the level is the highest in over 2 years, which again shows the great interest in our product. Looking at the full year, 2023 was the strongest in Fractal's history with a net sales growth of 59% to SEK 773 million. and an organic growth of 52% to $73 million. The first 3 quarters were particularly high with the second quarter being at an all-time high with a net sales of SEK 245 million. We are growing significantly more than the market and attract new customers, which is a clear proof that we have a strong and distinctive offering to our customers around the world.

Moving on to the next slide and segment development. The strongest region in the quarter was Europe with net sales of SEK 63 million, an increase of 29% compared to last year. Europe's share of total sales corresponded to 44%, which was an increase of 10 percentage points. Net sales growth in Europe was mainly driven by increased demand from end customers due to several successful product launches and a strong product portfolio but also a pent-up demand due to Europe being weaker last year.

For the full year 2023, Europe more than doubled net sales and had a growth of 113%. This can mainly be explained by strong demand at end customers and necessary stock build up at retailers at the beginning of the year and sales initiatives to Amazon Europe have also increased the numbers. Finally, the comparative numbers were low due to high shipping costs during the fourth quarter of 2022, resulting in more restrictive purchases at the distributors.

Americas net sales amounted to SEK 59 million, a decrease of 20%. The main reason for the decrease had to do with strong demand from key partners as well as more campaign activities than usual, in the fourth quarter last year. Americas share of total sales corresponded to 41%, which was a decrease of 10 percentage points. However, the historical number has been around 1/3 of total sales.

Net sales in APAC and other amounted to SEK 21 million, a growth of SEK 1 million and 5%. Their share of total sales was 15%, which was in line with last year. If we look at our product categories, sales of cases were 91% of total net sales, same level as last year. Moving on to the next slide and product margin development. In the fourth quarter, the product result amounted to SEK 58 million compared to SEK 52 million last year. And the product margin was 41%, which is approximately 4 percentage points better year-over-year.

The reason for the improved product margin can mainly be explained by lower shipping costs, which affected the product margin by approximately 5 percentage points, mainly due to lower shipping prices as well as lower share of sales to Americas. It is only freight cost to our regional inventory in Americas that affect the P&L. Sales discounts had a positive effect by 1.5 percentage points. Currency effects had a negative impact on the margin by approximately 2.5 percentage points, mainly due to high comparison figures in the fourth quarter of 2022 when the dollar strengthened against the SEK. The positive margin development during the quarter is also driven by lower purchase prices affected by lower raw material prices and successful negotiations with our suppliers, but we have also been able to make some price increases for many of our products.

Let's have a look at next slide and earnings. In the fourth quarter 2023, EBITDA amounted to SEK 13 million, and the margin was 9%. The slowdown in sales growth led to lower EBITDA compared to previous quarter, 2023, but in line with last year. The strong net sales growth during the year, combined with a higher product margin means that for the full year 2023, we delivered an EBITDA result of SEK 137 million, the strongest in Fractal's history compared to SEK 34 million previous year.

Moving on to the next slide. Operating cash flow in Q4 was minus SEK 56 million, and the decrease compared to previous quarters can mainly be explained by lower EBITDA and decreased account payables related to payments of product purchases made earlier in the year to meet the increased sales. Payment terms to factory suppliers are long and favorable. Cash flow from investing activities amounted to SEK 11 million and was related to the development of new products.

For the full year of 2023, operating cash flow strengthened to SEK 132 million, positively affected by increased EBITDA and net working capital. We are very satisfied with the development of the cash flow, and this is a receipt of hard efforts. The strong cash flow will enable us to invest in our continued growth. When closing the fourth quarter, the utilization of the bank overdraft facility was SEK 3 million compared to SEK 110 million year-over-year. We had net cash of SEK 8 million compared to net debt of SEK 116 million last year.

Moving on to the next slide and the income statement. As previously presented, net sales in the fourth quarter amounted to SEK 143 million, a growth of 1%. The slowdown in growth can mainly be explained by a normalization of stock levels at our resellers. Total revenue amounted to SEK 147 million. Goods for resale amounted to SEK 85 million and were in percentage of sales, positively affected by lower shipping costs. Other external expenses amounted to SEK 25 million, SEK 3 million higher than last year, mainly due to increased warehouse costs explained by higher inventory levels. Personnel expenses amounted to SEK 23 million, an increase of SEK 4 million year-over-year, 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 a net cash position and therefore, lower interest costs compared to the same period in 2022. Profit for the fourth quarter amounted to SEK 3 million, which was in line compared to last year. And with that, we have walked you through the financials, and I hand over to Jonas again.

[Jonas Holst, executive]

Thank you, Karin. So to summarize the quarterly report, we closed a record year for Fractal following our strong product launches and effectful sales and marketing initiatives. Our net sales grew 59% for the full year and 1% in the quarter, following our efforts to normalize stock after 3 strong saving quarters earlier in 2023. Our product margin reached 40.8%, up 3.9 percentage points year-on-year, while EBITDA margin increased 10.7 percentage points to 17.7%. We end the quarter and with that, the year with a strong financial position that allows us to invest in our strategic initiatives and drive further growth in the market.

Looking forward, we see that the uncertainty in the Red Sea that escalated in the end of the quarter has affected the freight costs negatively. This will have some impact on sales and freight rates during especially the first quarter of the year. For the full year, we see good opportunities for continued growth with a weaker first half facing high comparable numbers and a stronger second half, primarily driven by our growth initiatives that we believe will continue to strengthen our position in the market.

And finally, it's worth repeating that it is our assessment that there is still a pent-up demand among gamers to upgrade their equipment with a stronger upgrade cycle in the upcoming 2 years. And with that, we are finished with the presentation and open up for any questions.

[Operator]

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

[Simon Granath, analyst]

Congrats on your new position, Jonas. Initially, could you talk about the recently intensified agreement that you have with Amazon and also we should see this driving materially higher volumes kicking in here in 2024.

[Jonas Holst, executive]

First, thank you for your well wish -- and kind wishes. Yes, the initiative to work more towards Amazon is an important sales initiative for Fractal and something that has leveraged for us during 2023, especially in the European region but something that we believe will continue to boost our business from the U.S. primarily in 2024.

[Simon Granath, analyst]

And I presume it's not easy to quantify and assess, but do you -- but you do mention that there is still a pent-up demand for gamers to upgrade their PCs. And what's behind the statement? And how should we see the replacement cycle playing out ahead? What's the latest and greatest?

[Jonas Holst, executive]

Well, first of all, looking at the replacement cycle for PC and especially for gaming equipment, it's about 3 years or approximately that period, which then takes us back to the previous peak season or sales season during Corona times for 2020 and 2021. And we are now seeing that replacement cycle coming back, so to say, or we are in the next step for that. And there is also, during this entire period, has been known issue, as we know, with components that has been important for the industry that has been lack of during this period, which is now fully available, which also drives further growth in the coming years.

[Simon Granath, analyst]

Very encouraging. And going into 2023, you did launch multiple new products. How is the current pipeline going into 2024 and more specifically talking about the pipeline for PC cases.

[Jonas Holst, executive]

You're right. 2023 was a very strong year, or actually, I should say, 2022 and 2023 has been very strong years for us, and it's also something that we will leverage fully for the full year of 2024, and we will have a full year effect in the coming year. But of course, our pipeline continues to be strong for all the categories that we are active in, and that definitely also includes PC cases. So there should be expectation of our [ tracker ] launches also during the coming year.

[Simon Granath, analyst]

Perfect. And could you give us an update on the timing for expanding into new categories? Should one see this starting to yield the results in H2? Or is it more so that we should expect more volumes coming in 2025?

[Jonas Holst, executive]

The message regarding the new categories are the same as before. We are targeting an H1 launch for the new categories, but that, of course, means that the key main effect of that initiative will happen during the second half of the year. And again, the full year effect of that will then be in the year after in 2025 but new categories to be launched during H1 is -- as we previously communicated.

[Simon Granath, analyst]

And just finally, could you elaborate somewhat on the current inventory levels for your resellers?

[Jonas Holst, executive]

Yes. So as we saw very strong growth, especially during the first half of 2023, we have also had a need to reset what kind of inventory channel inventory levels we needed to be at. And that was a continuous work during the last year. And by the end of the year, we have worked on, as we said, normalize that inventory to be on where we want to be. And by the end of the year, we closed -- let's say, on target, meaning we're rather -- neither under or overstocked out in channel in general, looking at the global markets.

[Simon Granath, analyst]

Okay. And are there any large differences here looking into regions? You do mention on a global basis, but I'm just curious to know if there are discrepancies between regions here on inventory levels?

[Jonas Holst, executive]

No, it's the same, if we look at it in general for the whole world.

[Operator]

The next question comes from Thomas Tang from MediumInvest.

[Thomas Tang, analyst]

I have a number of questions, just go through them one by one. First of all, just to make sure I understand your 2024 expectations correctly. When you say you expect a positive growth for the full year and that inventory levels are balanced, which contributed positively to growth in 2023. That means that you would expect your sales out to be even stronger than the positive growth for your overall revenue. Is that correctly understood?

[Jonas Holst, executive]

Yes. We're looking at the full year, as I said, we're going out to 2023 with a balanced inventory level out in market and that means that our [ ad ] sales and sales out should correspond well and we are foreseeing then also a safer growth in 2024.

[Thomas Tang, analyst]

And then for the first half of 2024, you mentioned the Red Sea situation affecting your negativity and also the majority of the inventory expansion as there was -- or all of it was in the first half. Do you expect sales out to be positive in the first half of 2024.

[Jonas Holst, executive]

Without going into too much details there, I think, on also the regional or the split per quarter. First of all, on the Red Sea situation and how that is impacting us; one, it's primarily on a sales in point of view, reducing slightly the need or the willingness to load up inventory, especially in the European region, which is, at this point, not a problem per se and doesn't impact sales out. And then in second round, it would be versus our freight costs taken for our shipments to our regional inventory in the U.S. where we could foresee slightly higher freight costs that is affecting our P&L directly. But the growth that we are foreseeing, especially looking at Q1, we are facing very high comparable numbers during 2023, especially in the beginning of the year. But our overall outlook for the year is a positive development, both in sales in sales out, but we see that to be stronger in the second half.

[Thomas Tang, analyst]

And could you expand or provide a bit more color on your increased marketing initiatives? What are you doing or doing anything new or doing more of what already works for you?

[Jonas Holst, executive]

Yes, absolutely. Very important part is to continue on the successful path and track that where we are already on. We have very strong engagement with our community, and that's something that we will leverage on and build further. But of course, during this year, we are -- has been talking about launching also into new product categories and presenting what Fractal -- our take on the full gaming station is going to be an important aspect for us going forward and then continue with all the growth initiatives that we have also on marketing and communication side.

[Thomas Tang, analyst]

All right. And then you already mentioned that the payments for products purchased earlier in 2023 is the majority of the moving parts in the net working capital, are there any other significant moving parts to your somewhat volatile net working capital?

[Jonas Holst, executive]

No, I wouldn't say so. That's a good understanding as you presented it.

[Thomas Tang, analyst]

And a final question from my side, could you provide a bit more color on the negative growth in the U.S. in the fourth quarter?

[Jonas Holst, executive]

Yes, that relates back to the situation back in 2022 and also this inventory situation we had in the U.S. market by then where we were driving quite aggressive sales out activities during the last quarter, as Karin previously mentioned. So the comparable number there is main reason, which was previously driven by high promotional activity during Q4 of '22 compared to a more balanced approach in '23.

[Operator]

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

[Jonas Holst, executive]

Okay. So we have a couple of questions here. First, [ Karl Mikel ] from [indiscernible]. So tell us about new product launches. We -- yes, as now mentioned here on the previous question, we have a good pipeline for 2024 within the categories where we are active. So that is upcoming during the coming quarters. And then talking about dividend for 2023, we are focusing on securing the growth initiatives and the initiatives that we're driving ahead. So that's the key reason right now. Of course, this is a Board decision rather than a decision for the management team. So we need to forward further question on that to them. And then to Karin, why finance cost was high in Q4.

[Karin Ingemarson, executive]

Yes. And what you're saying there [ Karl Mikel ], is that we don't have any loans. So why do we have SEK 2.7 million in cost, and it actually has to do with the revaluation of the amount that we have on the bank account. So it's an effect of the SEK dollar effect more or less. So that's the answer.

[Jonas Holst, executive]

And then we have a question early on from [ Ludwig ], what makes you confident in strong sales development during 2024 and mostly H2? As mentioned, we have strong pipeline for our product launches and the growth initiatives that we're driving for the full year together with the market development in general.

Further questions. Yes, the strong product pipeline. So a question regarding new chassis, yes, it's also part of the product road map. Then in Q3, you said that you thought the sales out would match your sales going forward, but it deviated by 25%, did something happen during the quarter?

Not more than what we have just gone through here, I would say, on that question. Then from [ Max ]. regarding the expanded distribution with Amazon in the U.S., what's the rationale here? And how much do you think this will add in comparison to existing distribution.

Yes, as I mentioned earlier. regarding Amazon, we have -- it is one of our important sales initiatives to grow with that platform. It's not only a sales platform of choice, which is also a communication platform for many customers. So it is important to be there and to grow not only in Europe or U.S., but around the world, of course, in all markets where Amazon is present.

Then can you explain the logic behind how your exchange rate movements impact your gross margin. Karin, maybe you want to take that?

[Karin Ingemarson, executive]

Yes. So can you explain the logic behind how FX movement impacts your gross margin? Well, when we do the purchases, we do all our purchases in U.S. dollars and we sell only in dollars. So to start there, we have a natural hedge. So what's happening is that we buy to an FX rate and we sell to another. And there in between, we get an FX effect. So that is the effect more or less, so why this occur? I hope that explains your question.

[Jonas Holst, executive]

Thank you, Karin. We have another question from [ Eric ] at SBM. The difference in net sales versus sales out about SEK 3 million in 2023 and whether it's fair to assume that these this gap will be closed during H1. I think as the message before that we are expecting sales in and sales out to be matching during the following quarters or periods that we have ahead. And regarding the new products, whether we would go through existing channels, we will come back to that, I would say when we're looking at what channels and products we are launching.

And yes. The final question. I am not sure if I answered the question from [ Mikel ], but so I'll do it again. Sequential sales out did not grow as much as historically from Q3 to Q4. Could you explain that? So our growth, first of all, 2022 Q4 was the first quarter of that very high growth that we had. So the comparable numbers changed very much in -- from 2022 Q4. So we are sort of comparing them to a different level. And that's the main reason why the growth in Q4 is not the same as the growth in Q3 essentially. And I believe I've given color on the weaker H1 here, and especially that is due to the comparable numbers that we are facing and that we will see strong effects during the full year on -- from our sales and marketing and product initiatives.

Regarding EBITDA margin, and that's down sequentially. And what EBITDA margin should we expect going forward? We -- maybe Karin, it's a question for you.

[Karin Ingemarson, executive]

Yes. So the EBITDA margin. I mean our financial target is 20% EBITDA margin and sales growth of 10%. And the EBITDA margin did not reach the 20%, but that is, of course, our target to do so. So I don't know if I can say more than that at the moment. So I think I'll leave it there. But 20% is our financial target at the moment. So that is what we're aiming for.

[Jonas Holst, executive]

Thank you, Karin. I believe that was all the written questions as well.

[Operator]

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

[Jonas Holst, executive]

Yes. With that, we thank you for joining today's call and listening into the Q4 and report for Fractal Gaming Group and our 2023 record year and we wish you a great rest of the day. Thank you so much.