Fractal Gaming Group AB (publ) (FRACTL) Earnings Call Transcript & Summary

Welcome to the Fractal Gaming Group Q2 2024 Report Presentation. [Operator Instructions] Now I will hand the conference over to speakers CEO, Jonas Holst; and CFO, Karen Ingemarson. Please go ahead.

Hi, everyone, and welcome to today's presentation of the Q2 report for Fractal Gaming Group. We have now closed the first half of 2024, with a quarter that had challenging headwinds for the whole market, while at the same time, delivered confidence and optimism that Fractal is on the right track. Today, we'll take you through our Q2 numbers, the latest development within our industry and how we are embarking on a new journey. We're, of course, happy to answer any questions you have either in the end of the call or if you reach out to us individually. We will start with some of the general comments from Q2. As said, it has been a quarter where we have met short-term headwinds, while at the same time, gaining strong confidence and optimism for the future. As per our expectations, we were seeing that seasonality is starting to normalize after the last years of disrupted sales patterns. Q2 is usually the weakest quarter in our industry, but this year, sales has been further dampened by reduced consumer demand as well as increased freight costs and shipping times as the Red Sea situation has continued to impact sea freight between Asia and Europe. At the same time, we had very high comparable numbers in the quarter, following our extreme 157% growth in the same period last year, then driven by inventory buildup following reduced freight costs and our successful North launch. Q2 2023 were our strongest quarter ever. As a consequence, our total revenue decreased 41% in the quarter. This is slightly more than expected, but explained by the short-term headwinds the market has been experiencing. Looking at our sales to end consumers, we see a more modest decline of 12% in the quarter as lower consumer demand following high inflation and high interest rates as well as postponed releases of important gaming PC components have had a dampening effect on the market. But despite this decline, we are strengthening our position, and we are gaining share in key markets. EBITDA in Q2 was SEK 7 million and with an EBITDA margin of 4.8% compared to SEK 48 million and 19.5% in the same quarter last year. The result is due to the decrease in net sales in combination with increased costs in the quarter, primarily related to our extensive launch program. We continue to invest for the future, while at the same time working to streamline the operations. Our product margin continued to improve year-on-year, reaching 41.4% compared to 40.2% in Q2 last year. And we have a strong net cash position at SEK 21 million compared to a net debt of SEK 51 million in Q2 last year. Despite the current headwinds having a negative impact on financials for the quarter, we are, at the same time, filled with optimism after the launch of our long-awaited new categories in June. We then revealed our biggest launch program ever, marking the shift in Fractal's brand and market position. We presented two new categories, chairs and headsets as well as two new cases, all developed based on our Scandinavian design principles and quality focus. The reception from and after our launch event has been overwhelming and gives us strong confidence in the future. Fractal's long-awaited launch event at Computex 2024 in Taipei was the largest and most successful launch event Fractal has done to date. Showcasing our strategic direction to expand into new product categories and our dedication to enhance the gaming experience worldwide. We introduced an extensive launch program that will continue during the second half of the year with four new products: the Mood and Era 2 case series, the Refined chair and the Scape gaming headsets. Each designed based on our signature Scandinavian design principles and commitment to quality. With this, we are entering two critical new product categories that will open up new opportunities and broaden our market potential. We saw the event getting overwhelming positive feedback from key industry players, including resellers, tech and gaming media experts and professional streamers. All underscoring the success of our strategy to blend Scandinavian design with high demand gaming performance. And besides our traditional media, we also secured major media coverage from outlets like The Verge and Forbes. This significantly increased Fractal's brand visibility after the event with our products receiving top honors as Best of Computex, driving strong consumer interest and engagement. Now moving over to the market development in general, where we see some mixed signals. On one hand, it's supporting the perception we have of a short-term slowdown in our market, while at the same time, showing positive signs for the future. The overall PC market continues to show signs of recovery with a 3% growth in Q2. This is the second quarter of growth after eight previous quarters of decline and is primarily driven by the upcoming Windows 11 update as well as the introduction of AI-capable computers. This market includes prebuilt gaming PCs and gaming laptops, which is now with our new categories and addressable customer group for Fractal. The DIY gaming PC market is, however, seeing a slightly weaker development as our weighted upgrade cycles has been delayed due to later launches of important PC gaming components. For example, NVIDIA's RTX 50 series is now expected to early 2025, temporarily dampening the interest in gaming PC upgrades. We do, however, believe that it is likely to result in a strong demand once these components are available. It is also worth noting that the PC gaming platform revenue grew almost 10% last year, supported by strong games releases, while we are not seeing as many strong titles released and therefore, not as strong growth in 2024. The long-term growth outlook for the PC games industry does, however, remain positive and is supported by larger game releases in the beginning of next year and onwards. In conclusion, the prebuilt PC market, PC gaming as a platform and encouraging trends in the PC games industry, along with pent-up demand in the DIY sector collectively indicate promising signs of recovery and growth in the coming years. So now moving over to the financials, Karin, please move ahead.

Thank you, Jonas. So the graph at the top illustrates the quarterly development in net sales. In the second quarter, net sales amounted to SEK 144 million, reflecting a 41% year-over-year decrease. We also measure our sales in U.S. dollars since we sell exclusively in dollars regardless of the end markets. Net sales were $13 million, representing an organic decrease of 42%. We had strong comparative numbers last year with a remarkable 157% organic growth in Q2. The successful launch of our North product and increased channel stock significantly contributed to this growth. In Q2, the ongoing Red Sea conflict continued to affect our sales by causing longer delivery times and significantly increasing freight costs. This led to resellers becoming more restrictive with their purchases as they are responsible for covering the shipping expenses. Fractal's upgrade cycle is typically a 3- to 5-year period, but it's very dependent on consumer sentiment and their purchasing power, but also the timing of new graphics cards. We experienced weaker consumer sentiment in the second quarter, which was a market-wide issue affecting not only Fractal but also our competitors. Due to the market-related issues, we now anticipate the upgrade cycle to occur with full effect in 2025. Additionally, our business is seasonal, typically seeing higher sales during the second half of the year, with the second quarter generally being the lowest. In the graph at the bottom, you can see our quarterly development in sales out to end customers reported by distributors and resellers and measured in dollars. In Q2, sales out amounted to $15 million, reflecting a 12% year-over-year decline. It is important to note that while sales out declined by 12%, net sales saw a much sharper decrease of 42% compared to last year. This significant difference is mainly due to channel filling during Q2 the previous year. For the first six months, sales out were $2 million less than net sales but it's important to note that the sales out numbers only include key customers, which means it does not provide 100% coverage. Moving on to the next slide and segment development. Sales of cases accounted for 89% of total sales. This is approximately 3 percentage points lower year-over-year. In Q2 last year, we had very high sales of our newly launched case North, which drove up the percentage of case sales. In Q2 this year, we had the sales introduction of a new product category, which is categorized under other products. However, we do not yet see any material effect from the sales of new categories in Q2, but sales are expected to increase in the latter part of 2024 and give full effect in 2025. Total net sales of cases in Q2 amounted to SEK 128 million, which is a decrease of SEK 99 million year-over-year, and this is mainly related to EMEA. The decrease compared to previous year was primarily driven by a significant increased channel inventory at our customers. The strongest region in the quarter was EMEA with net sales of SEK 76 million, a decrease of circa 50%. However, sales of other products was in line with last year. EMEA share of total sales was 53%, which was 9 percentage points lower compared to last year. Americas net sales amounted to SEK 46 million, which was a decrease of approximately 21% year-over-year, of which the main part was related to cases. Americas share of total sales was 33%, which was 8 percentage points higher versus last year. Net sales in APAC were SEK 16 million, and their share of total sales was 14%, which was in line with last year. Moving on to the next slide and products margin development. In the second quarter, the product result amounted to SEK 60 million compared to SEK 99 million last year, and the product margin was 41.4% which was an increase of 1.2 percentage points year-over-year. The main driver for the strong and improved product margin had to do with product mix which affected the product margin positive by approximately 2 percentage points. Lower raw material prices and other COGS saving initiatives have given lower purchase prices on many of our high runners, and we will, of course, continue to work on COGS reduction going forward as a part of our strategy. Higher shipping costs negatively affected the product margin by approximately 1 percentage point. The main reason for increased freight cost had to do with increased freight prices related to the Red Sea conflict but also to Americas having a higher share of sales compared to last year. It is only the freight cost from China to our regional inventory in the U.S. that affects our numbers, other shipping costs are managed by our distributors and resellers. So let's have a look at the next slide. During the second quarter, EBITDA reached SEK 7 million with a margin of 5%, reflecting a decline compared to last year, primarily due to lower sales. Although many of our costs are variable, we saw an increase in expenses during the second quarter, primarily driven by our extensive product launch program. These costs mainly include marketing activities, participation in the Computex exhibition and certification for new product categories. As part of our long-term strategy and growth initiatives, we have been strengthening our teams, primarily within product development, which has led to a year-over-year increase in personnel costs. We remain committed to future investments, while at the same time, streamlining our operations to ensure greater efficiency and improve overall effectiveness. Operating cash flow in the second quarter was SEK 9 million with a cash conversion of 128%, which was an increase versus the first quarter, but the decrease year-over-year. The change in net working capital was positively affected by decreased inventory and accounts payable and negatively affected by decreased accounts payable. Cash flow from investing activities amounted to SEK 5 million and was related to the development of new products. We had net cash of SEK 22 million compared to net debt of SEK 13 million last year. The utilization of the bank overdraft facility has a total limit of SEK 120 million. And at the end of the second quarter, SEK 1 million had been utilized. With a lower utilization rate of the overdraft facility, Fractal demonstrate strong financial stability and flexibility. Cash conversion cycle amounted to 38 days, which was an improvement versus last year by 10 days, mainly related to improved days of inventory. On to the next slide and the income statement. And as previously presented, net sales in the second quarter amounted to SEK 144 million, a decrease of 41% year-over-year mainly related to high comparative numbers, the Red Sea conflict, postponed upgrade cycle and a more normal seasonality. Capitalized development increased by SEK 0.8 million related to the increased number of hours spent on development. Total revenue amounted to SEK 147 million. Goods for resales amounted to SEK 85 million and were in percentage of sales positively affected by favorable product mix with higher margins on cases. However, freight cost increased due to increased freight prices and higher share of sales to Americas. Other external expenses amounted to SEK 30 million, mainly affected by costs associated to our successful extensive product launch program. Personnel expenses amounted to SEK 26 million, an increase of SEK 5 million year-over-year, and the increase was mainly due to new hirings in 2024 and full year effect of hirings from last year. 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. However, lower interest cost due to a net cash position. With that, we have walked through the financials, and I hand over to Jonas again.

Thank you, Karin. So to summarize the quarterly reports. We faced very strong comparable numbers and short-term headwinds in the quarter, leading to a decrease in revenue of 41%. Consumer demand is dampened and the Red Sea uncertainties continue to impact both sales in and sales out due to increased freight cost and shipping times. Our product margin continued to improve year-over-year, up 1.2 percentage points compared to the same period last year. EBITDA margin decreased following lower sales in combination with significant investments in our extensive launch program. In the end of the quarter, we revealed Fractal's biggest and most successful launch ever introducing new -- two new cases as well as product families in two new product categories, chairs and headsets. The launch marks Fractal's development into gaming station brand with multiple categories, opening up new opportunities and broadening our market position. The response from the launch has been overwhelming. Our strong financial position continues to provide us the opportunity to support these growth initiatives. And we continue our planning for our Capital Market Day later this year to showcase the full portfolio to the market. We see that the weighted upgrade cycle has been pushed forward slightly as launch of important PC gaming components is now expected in early 2025. This is making 2024 an intermediate year with stronger development next year as we believe there is a significant pent-up demand among gamers to upgrade their equipment. As a result, we expect a continued software development in the third quarter, followed by a Q4 where our product launches in new and existing categories, together with continued marketing and sales initiatives will support us to show growth. And with that, we have walked you through the quarterly report, and we open up for questions. Thank you.

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

Initially, I'm happy to hear about the initial encouraging reception of the new products. But from a revenue perspective, how should we think about the tailwind from these? New chair was launched during the summer. So possibly started to generate some revenues in Q2, but the headset will not reach the market until later this year. So I guess the anticipated pickup in revenues from that lies further out in time.

Yes, the chairs sales start is happening right now in August. So we had some smaller impact in the end of Q2, but primarily during Q3, Q4. Same with headsets, North, as you said, that the launch is coming later in the year. We are targeting -- looking at Q4 and the impact will be coming from end of Q3 in Q4. So late year effects of both the new product categories, you could say and primarily full year effect in 2025.

And on the delayed GPU launches that we read about, how -- and looking at the GPU launches in more general terms, how well do they correlate or align to your revenues? Is there any buildup effect from resellers ahead of the anticipated launches to expect? Or should the timing match still launch [ with though ] relatively well?

Yes, there is definitely a correlation. And normally, we have seen historically quite the phases when these launches are coming on like approximately two years in a part. But now it is slightly delayed or postponed as it seems or of course, it's expectations and rumors. But in the month ahead of a launch, the demand in the market is slightly going down and it's coming up, of course, in closer to the actual launch event. And there is a correlation, of course, in our channel filling in connection with such products being launched that is coming fairly close in time.

And then a final question for me. How should we view the current inventory levels at your resellers. Could there be any large discrepancies to consider in Q3 between your net sales and sales out? Or should the net effect be relatively flattish in comparison to Q2?

No, this should be relatively flat, as we have talked about in earlier calls that we are expecting a more stable development of sales in and sales out and how that will correlate going forward and our channel inventory is at expected levels, and we are now, of course, in the ramp-up position and for the second stage of the year and with the high season coming.

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

So the first question is the numbers are seemingly quite variating between the quarters. Are there any concrete plans in place to make your numbers more even? I can start. Yes, we agree that there have been variating between the quarters. And that is one of the reasons to why we are entering new product categories. So that is definitely a long-term plan to make our numbers more even, to have more product categories in our portfolio long term. I don't know if you want to add something, Jonas, to that.

But of course, there is a normal the seasonality that we always need to take into consideration as well as the lead times that we're having to get goods from our production to our customers, which we know will potentially be in a different quarter from the actual sales period and so on, as we have discussed in the past. So there will always be variation between different quarters. But we are expecting us to come back to a more normal seasonality that will be more predictable compared to what it has been over the last few years where seasonality has been -- yes, where sales has not followed traditional seasonality. So that's what we also seeing partly now. But just as you said, Karin, the expansion and the broadening of Fractal's portfolio will help to smooth some of these peaks or movements down a little bit because, of course, we will then have different kind of products that is in different kind of upgrade cycles and affected by different activities in the marketplace. And that will have a positive long-term effect on balancing the sales in different quarters.

Next question, how come you did not issue a profit warning on these numbers?

We believe that even though it's, of course, a big change compared to Q2 2023, it was an extreme number that we had that year. And it's not that far off from what has been expected and with the normal seasonality that we are talking about. Karin, you can fill in more.

And also, we have been guiding on a low Q2. And so according to that, of course, we were -- as Jonas previously said during the presentation, so it was lower than expected, but not that much lower than we expected, and we have been guiding during the year on those numbers. So therefore, we did not issue a profit warning.

Indication of Q2 being the weakest quarter and with normal seasonality has been there from the beginning, and it's in line with that.

Simple question that I think is a very important one for many investors. What is Fractal's competitive advantages compared to competitors over time?

We believe that we have a unique position in what we are bringing to the market. The value proposition and the type of product that we are bringing stands out compared to competition and that's a strength that is really beneficial for us. Scandinavian design principles in combination with quality and high performance is unique in the marketplace and is making us stand out compared to competition. And together with then a broader product portfolio, we are really strengthening our position in the marketplace.

Next question. According to reviews on YouTube, Fractal Mood scores incredibly good in terms of GPU temperature, but poor when it comes to CPU temperature. Can you elaborate on the release of Mood and your thoughts on the negative comments?

I think without going maybe into too much details on technical questions, which we can also come back to. But Mood is also breaking new ground with type of case and style that is different than what we have had and market has seen before. And that's also sort of the perception and the reception that we are having. It is something that stands out compared to traditional gaming chassis and delivering actually fairly good results, and you also review our [ sites ] or the reviews that are out there, if you can find both good and more negative ones. And we are very positive actually looking at what the Mood has delivered. And in these first weeks of sales and also the reception that consumer is having to it.

Next one, as Refine and Scape or product categories, not under a tariff exemption in the U.S., how will this affect your gross margin in these new product categories? And what we have said -- yes, sorry, go ahead.

Sorry, that is correct and has been part of the business case all along and shouldn't have a material effect on our results.

No, exactly. I mean that is something that we have taken into account. And as we have said previously regarding margins on our new product categories, they are within if we say our current margin span. So yes, they are accounted for. Next question. Can you talk anything about the size of the market for your new product categories? For example, how many gaming chairs and headsets are sold each year through your distributors and resellers?

No, we don't go into exact numbers like that. But of course, looking at these new product categories, both headsets and chairs is significant markets. And by that opening up potential for Fractal that long term will be equal to or at least comparable to our traditional marketplace. So opening or the step towards more product categories and broadening the portfolio has a big market impact for us.

Next question. You state that you expect to return to growth in Q4 supported partly by channel initiatives. Can you be a bit more specific in what you mean by channel initiatives and how it will support your growth in Q4 and beyond?

Well, we continue our development of our channels and markets around the world. So here we are, of course, looking at both geographies and expansion in different markets but also with different partners. It's too early to say anything more in detail than that, but it's a continuous effort, of course, to strengthen our sales network and work on improving it.

Sales have decreased almost 12%. If not already specified in the slides or presentation, can you provide a figure of how sales out in the case category developed during Q2?

Cases. We don't have that number in detail, exactly in the presentation, but the case category, case decreased less than our business in total. So our other categories decreased more, so cases had a lower decrease than 12%.

Sales from other categories increased by almost SEK 3 million. How much of this growth is attributable to the two new product categories?

Here, you can fill in also Karin, but we don't break out the different categories within other categories yet, and it's not -- of course, it has an impact. But as I mentioned in the beginning here on the questions, it was just by end of Q2 that we had some effect from chairs coming in. So it will be more material during the second half of the year.

Moving forward, entering new product categories is very difficult. How do you plan to succeed?

Indeed, it is. But this is not something that is just coming overnight. Fractal's position to enter into new categories has been sort of prepared over the last few years. And with the product launches and the position that we have gained over the, say, to 2022 and 2023, we have sort of paved way for the launches into the new product categories. The brand that we are now with North, Terra and we would reach a lot of our new products, we have the position in the market to also come with other product categories on clear principles when it comes to the design and the quality and the high performance that we are offering to the market. So of course, the product portfolio per se, but also with an extensive launch program that we are talking about here, we are utilizing our whole machinery, of course, to bring the products into the market and to gain momentum in sales by different kind of marketing activities. So it's an activation plan that has been prepared for a long time, and we are now in the middle of.

Next question. You mentioned that you are gaining market share. Could you elaborate on how the market for cases developed during Q2 compared to your performance?

Correct. So we gained market share in key markets during the quarter, which essentially then means that the market had a weaker development than what we did from a sales out perspective.

How do you plan to balance costs, growth investments and profitability in the current market situation?

Do you want to start with that, Karin?

Yes, I can do that. As we've been talking about during the presentation, we have seen the damped market and the damped consumer sentiment but we are also guiding that we see a brighter Q4 and 2025. So we are definitely aware of lower sales and the fixed cost that we have. So that is something that we are definitely aware of. What we can say about Q2 is that we have had one-off costs in terms of launch-related costs and that will not occur during the second half of the year. So we are not recruiting that many people at the moment. So we are aware about the costs and handling that in the best way. You mentioned sales out only include key resellers. Does that mean sales out structurally under represent actual sales to end customers? Because some sales are not included in the numbers. If so, you give us a rough indication how much of the actual sales end customer is not included in the sales-out number? As I said, we don't have 100% coverage regarding sales out because we only have included our track partners. What we can say roughly is that 90% is included.

That's something that, of course, our sales out numbers is dependent on reporting from our partners, whilst, of course, revenue sales in is 100% from our side. So the actual sales out numbers also varies or depending on quarter-by-quarter, but around 90% coverage is what we are estimating here.

Next question. Will the new product categories continue to significantly drive higher costs? Or is it more of the launch activities already completed? As I said before, the launch activities are completed. So the one-off regarding Computex exhibition and all that is taken.

There's also one more question there.

Sorry, I read it backwards. Is sales out only including your part of sale? Or is it based on the price the end customer pays?

It is based on market or are part of the sales. So it's comparable in that sense.

What are the biggest obstacles during the end of 2024 to make new launches as success? Maybe you answered that before, Jonas, I don't know.

That is very much related to the other question there about launching a product is difficult. Yes, it is. And that's the big challenge that we have, which is the exciting challenge as well, which we are in now. And that's why we're also so very, very happy about the reception that we received back in June or beginning July when -- after the actual launch event, very positive comments from market, media, partners, sale channels about the products that we're coming with and that people are actually seeing it as something new in these new product categories. So getting that out there, getting product into all the channels, into all the markets just as with any kind of product launch is the same here and then creating or building the momentum for sales, of course.

Next question, is there any information about the market in Q2 2023 and Fractal's market share?

As I mentioned there, we do gain market share in Q2.

The last question, are you exploring any new revenue channels, such as your own sales channel, e-commerce?

It's not something that we are activating now. But of course, we are continuously exploring different kind of revenue channels and ways to improve or develop our sales network. And that's of course, also includes always monitoring when and if and how we would do our own e-commerce.

That was all questions.

Very good. Interesting question. Thank you so much, everyone, for posting those. If nothing else, I think then we are done with the presentation for Q2, and please feel free to reach out to us if you have any other follow-up questions afterwards.