Earnings Call: Q1 2021

May 21, 2021

Hi, everyone, and good morning, and welcome to today's presentation. My name is Hannes Wallen, and I'm the CEO and Founder of Fractal Design. And with me today, I have our CFO, Oskaroen Ingmarsson, and we will together today present a Q1 report and answer any questions that you may have. We've had a tremendous interest for the company during the IPO. We have now nearly 10,000 shareholders. Therefore, before we go into details about the quarter report, We will start off with a brief overview and introduction of the company and the market dynamics for those in the audience that are new to Fractal. We will also cover the latest market updates on the record high interest for PC gaming. We can move to next slide, please. Fractal operates in the fast growing PC gaming industry, and we have, with our innovative and high quality gaming products, managed to position ourselves in a premium segment. Next slide, please. Fractal has a top 3 global market position in our niche, which is gaming PC cases, power supplies and water cooling. Fractal is a premium branch, and we focus to differentiate ourselves through design, functionality and an outstanding quality. Our products are sold in more than 50 countries worldwide, and more than 90% of the sales to the end user is done through e commerce. We have an annual revenue of SEK654 1,000,000 in the last 12 months, and we have grown by nearly 40% per year since 2017. We have a high and sustainable profitability with an EBIT margin of about 19%, and we have been profitable every year since inception. Our sales is primarily consisting of compute cases with 80% of our sales, but we also sell power supply units and cooling products. And both of these categories are natural add ons to cases. In the last 12 months, we had 44% of our sales in Europe, 43% in the U. S. And 13% in Asia. Our headquarter is in Sweden, but we have also offices in the U. S, Taiwan and China. And in total, we're about 90 full time employees. Next slide, please. The PC gaming industry is favored and driven by several underlying long term trends. The number of gamers is steadily growing, and currently there's about 1,500,000,000 active PC gamers and about €2,700,000,000 across all platforms, with a big crossover in between the platforms. There is more and more gamers that play competitive and performance driven games, which results in that you put more money into your PC and accessories. Esports is a very important factor for PC gaming. It inspires the regular gamer to become better and put more time and money into the gaming, and esports is growing by about 18% annually. Streaming has become a dominant entertainment platform among gamers And it's unique in that way that it has a social connection between the viewer and the streamer, which creates a stickiness factor. And in esports, PC is the platform of choice. 98% of the 100 best esports professionals are using PC, mainly because it has superior control abilities. The games are becoming more and more advanced and demanding of the hardware every year. This puts a demand on the hardware industry to continuously release better and more powerful hardware. Gamers love hardware. The interest for hardware among gamers is very big, and there is an astonishing amount of information online on YouTube, websites, etcetera, and the community is very knowledgeable and demanding. Next slide, please. Despite a record setting year in 2020, the interest for PC gaming is continuing to be on very high levels. Twitch is the dominating streaming platform and measuring viewership hours on Twitch is a common benchmark in the PC gaming industry. And during the pandemic, the viewership of Twitch nearly doubled. What is interesting to see now is that the viewership is continuing to be very strong. For example, in April this year, the growth was by 25% over April last year, which was already in a peak pandemic month. It is believed by many that the increased gaming interest would survive post COVID and cement the position where gamers spend more time and Manion Gaming. Next slide, please. Before we go into details of the quarter report, I would like to go through a few highlights from the past quarter. Our net sales continue to be very strong with a 29% organic growth rate year over year. Adjusted EBITDA remains on a similar level as last year. And finally, we had a very successful listing on NASDAQ First North on February 11. Next slide, please. So the graph to the right shows the development in net sales. Net sales in the quarter increased by 13% To SEK169 million, driven by strong sales of power supplies, primarily in EU, but also in APAC. Sales of cases were still at a high level in line with previous year, but growth has been affected by the lack of advanced Semiconductors used in graphic cards. The limited availability of graphic cards means that some gamers are waiting to upgrade their equipment, Which also affect sales of our products. We also measure our sales in US dollars As we sell exclusively in dollars regardless of the end market and the organic growth in dollars in Q1 was 29% compared to 13% in SIEK. For those Of you who participated at the investor meetings during the IPO process knows that we talked about sales out, Which is an important measure for us. Sales out measure the sales made from the reseller or distributor to the end customer, which in turn reflects The underlying commercial development. In Q1, the organic growth of sales out was 12% Compared to Q1 last year. The reason for the discrepancy between the organic growth in sales out of 12% and net Sales of 29% has mainly to do with 2 things. First, the sales channel had Too low inventory level when entering 2021 and needed to refill for healthier stock levels. 2nd, we have sold new products to our customers and there is a delay before this is visible in the market and in the sales out numbers. Despite the fine organic growth in Q1, our view of the full year is unchanged. Q2 last year was a very strong quarter inflated by the pandemic and will be hard to meet in Q2 this year. The lack of components hampers the sales of cases. But if there were graphic cards available on the market, we believe we would have seen growth For the full year 2021. Moving on to Page 8 and segment development. We can see that we have the strongest sales in EU with 59%, followed by Americas with 26% And APAC and Other with 15%. Sales of cases was slightly lower, but more or less in line with Q1 2020, However, lower in Americas and higher in the other regions. Sales of other products, Especially power supplies was strong and grew around 130% in both EU and in APAC and others. In Americas, sales of other products was in line with last year. CASES stands for 76% Of the total net sales in Q1 and other products for 24%. Moving on to Page 9. Adjusted EBITDA was SEK 32,000,000 and at the same level as Q1 last year. The margin was 19%, which is 3% lower versus last year. Investment in Q1 amounted to SEK 21,000,000 and was related to the costs for the listing on NASDAQ. No other adjustment Has been made? 2 third of the decrease in adjusted EBITDA margin versus last year Has to do with unfavorable currency effects due to products in U. S. Dollar not being purchased and sold at the same time. However, this effect will not be material going forward due to stabilized currency. The rest of the decrease is mainly due to product mix effect with higher sales of lower margin products. We have also had higher costs for freight due to increased shipping prices as a result of container capacity. Shipping prices remain at a high level, but are expected to normalize during the year. We have also seen increased raw material prices driven by a high demand for products in general during the pandemic, As well as imposed tariffs for imports of products from China to the U. S. However, due to a high opening stock, We have not seen any significant effect in the Q1 of the increased costs. At present, all our production is in China, but we are working together with our manufacturing partners to be able to move some final assembly Our products for the U. S. Markets to other countries starting during the Q4. By doing that, we can avoid tariffs. We have good opportunities to largely compensate for the external factors that will affect our costs, Both by increasing prices and by moving assembly from China to 3rd country for the U. S. Markets. Moving on to Page 10 and cash flow. Operating cash flow is mainly Goodbye, lower EBITDA due to non recurring costs of SEK 21,000,000 as mentioned earlier. The change in networking capital is related to increased accounts receivable due to higher sales in Q1, Reduced accounts payable due to large payments related to stock building in Q4 2020, but also to lower stock. Investments are only related to development of new products and of the SEK 8,800,000, 60% is tooling and 40% is capitalized development hours. Moving on to page 11 and the income statement. As previously presented, We had a strong sales and organic growth of 29% in Q1. I said before, we only sell in US dollar Regardless, the end markets and that goes for COGS too. It's also 100% in dollars, Which gives us a natural hedge. However, net sales in SEK depend on the U. S. Dollar exchange rates, which have fluctuated. Q1 2021 had an average US dollar SEK rate of 8.4 compared to 9.6 last year. Goods for resale and product margin are, as previously said, affected by unfavorable currency, Higher sales of lower margin products and higher costs for shipping. Cleared for one offs, Other external costs are in line with last year. Other external costs and personal costs are denominated in SEK to 46%, US dollar 42 percent and other currencies 12%. Interest expenses related The overdrafts facility and FX translation effect are the main explanations to the financial net. All this together gives us a net profit for the period of SEK 4,200,000. Moving on to page 12 and our financial targets. We have 3 financial targets. The first one is a growth target of over 10% organic growth in U. S. Dollar because all our sales are in dollars. The performance in Q1 2021 was 29% organic growth and last 12 months were 54%. Our view of the full year 2021 is unchanged. We have many product releases scheduled in 2021, but our assessment is that we will not have full effect on those product releases this year. Even if the growth in Q1 was 29%, our assessment of the full year 2021 Is that it will be hard to meet the growth target of 10% when the base from 2020 is so high. And as mentioned earlier, there is a lack of graphic cards in the market. The second target is a margin target of 20% adjusted EBITDA margin. The performance in Q1 was 19 And last 12 months, 21%. As you know, we are a company that intends to grow and to support That growth we need to invest in our organization. Given our profitability level today, We believe in this target long term. The 3rd target is dividends and our goal is to pay out 30% to 50% of our net income, taking into account other factors such as financial position, cash flow, but not least Growth Opportunities. With that, we can move to the next slide and I hand over to Hannes again. In the past quarter, we have launched a successful successor to our best selling PC case, the Meshify C, and it was received very well by the markets. We talked before about the increased raw materials and tariffs. To mitigate these costs, we're working hard on plans to raise prices to the markets and also to relocate final assembly our production outside of China to avoid the tariffs to the U. S. Markets. We have also hired a new VP of Supply Chain to further improve our sourcing, logistics and production. And for the more long term strategic initiatives, we are working with several very exciting ways to further Accelerator Growth. We, of course, want to continue doing what we do today, which is to deliver best in class products to be one of the leading brands in our current categories. And we can continue to grow in these categories and we will launch a lot of new products this year. But we also want to expand our product portfolio into new categories and we have identified several adjacent product categories that are interesting for us to expand into, which fits well into our brand and with strong margin profiles. And we're working hard on that initiative as well. We want to diversify and improve our marketing efforts, primarily with visibility in streaming. We also want to do geographical expansion in Asia, which is primarily succeeding in China, but also Southeast Asia It's an interesting market in coming years. Next slide, please. A brief summary of the quarter report and the current business events. We show a continued strong organic growth of 29%. We have an adjusted EBITDA that is in line with previous year. We see shortages and components, increased raw material costs and reimplemented U. S. Tariffs. These things are a challenge for the industry. However, at the same time, We see a record high interest in gaming that is seemingly continuing post COVID. And we're working very hard on focusing on our growth initiatives to take the company to the next level. Next slide, please. And with this, we have reached the end of our presentation. We will hand over to the operator for questions. Thank you. And the first question comes from the line of Simon Granat from ABG. Please go ahead. Your line is open. Thank you, operator. Good morning, Hannes and Karin. Congrats on a strong quarter. Initially, could you give us any color on how your resellers inventory levels have developed in Q1 and whether you have any thoughts on stock building into Q2? And as a follow-up question to that, how would you say that your customers are positioning themselves in terms of inventory levels ahead of the reopening of society? Yes, the resellers inventory is something that It was relatively low going into this quarter. So end of Q4, the inventory levels were on quite low level, And they have now been normalized to a more normal level. So outgoing Q1, it is on a quite normal, maybe even a bit below normal level, but quite normalized. And our resellers And our channel partners are not talking so much about what's happening post COVID as they see that The gaming interest seems to be on a very, very high level, even in many societies that has opened up more or less completely. It is very hard to judge, of course, and it's anyone's guess, but the belief is that this Elevated gaming interest is here to stay. Thank you so much. I think you have previously communicated that the availability of these use have been hurt by the supply chain shortages. Would you say that this was also the case in Q1? And if not, did you see a catch up effect in Q1 given your positive wording In the report around the PSU sales? Yeah. We've had relatively good availability of power supplies in Q1, so that has not hurt our sales. We had some availability issues in Q4, so That improved the sales in Q1 a little bit, but the availability is good on parts placed right now for us. It is long lead times for these kind of products when we order them from the manufacturer, but we have stocked up well to manage those lead times. Thank you. And as a final question before I go into the queue again, how would you say that the market Prices are developing in the current environment. Are you able to raise prices due to a component shortages? Or and what are competitors doing? Yes, we see an increased price in the market in terms of MSRPs to end users. We see that across the board on almost all products in PC gaming hardware, actually. It is still too early to say How big the increases will be since it has a certain delay from when the manufacturer or the brand It's raising the price until it's visible to the end user. But yes, we have seen quite some price increases already. Thank you so much. Thank you. Thank you. The next question Comes from the line of Oskar Eriksson from Carnegie. Please go ahead. Your line is open. Thank you, and good morning, Hannes and Karin. A few questions from me. Just interested to hear your input on clearly a very important factor also going forward, the supply of GPUs currently and what you see in terms of development during the year, do you expect it to improve at some point? Has there been any improvements yet? Thank you. Yes. No, that's a good question and something that's very important for Our product categories that there's a good availability of especially graphics cards, which is a driving upgrade reason, which also then drives sales for cases. And As I think everyone knows, it's been very difficult to get graphics cards in the last 6 to 9 months. And this has definitely hurt the hardware industry. But I think the record high interest in gaming has still kept it on quite high levels. It's very hard to say availability can become much better again. We've heard just recently some positive signals from graphic cards manufacturers that availability would start getting a bit better in June July. Exactly what that means remains to be seen. We don't really know. It is positive that crypto is having some issues because mining has also been a factor in the graphics card shortage. And now especially when the biggest mining currency, which is Ethereum, is moving to proof of stake, which means that it's no longer possible or useful to mine. And that will happen in the second half of this year. So, all in all, I think it's likely that graphic card supply should be better in the second half year than First half of the year, but exactly how much is very hard to say. Understood. Very interesting comments on crypto there as well. And I mean, gaming engagement Clearly, at all time high levels, along with your net sales in dollars in Q1 here. What do you See ahead when the supply of graphics cards presumably improves in the second half, Do you expect some catch up effect for those that haven't been able to buy now in Q1 and potentially Q2? Or it's will it depend on the gaming engagement in the second half of the year as well, I suppose? Yeah, I think definitely will depend on the gaming engagement. If that continues To stay on a higher level, it will be very positive for the market if graphics cards are coming back with a higher availability. I think that there was so much sales in 2020 That is probably not that much pent up demand, even though graphics cards have been out of stock in the last half year. But rather, I think that has been maybe a normalizing period where demand are catching up. But if graphic cards becomes available in the second half of the year and gaming it stays on a good level, I think that will be very positive for the industry. Great. And then with regards to the full year guidance, I mean, given the quite Resilient or even strong Q1 figures here and net sales and continued expectancy of high gaming engagements. How should we think about guidance here for the full year of No growth or low growth below your target. Should we see it as cautious? I mean, assuming Gaming engagement remains at elevated levels, which you're currently seeing, and graphics card expected graphic card supply expected to Come back. Is guidance a bit cautious, would you say? Yes. We still stick with our estimates that Karin mentioned surrounding the financial targets that we believe in no small growth or no growth at all in 2021 compared to 2020. And We believe that even though we had a strong Q1, there is many uncertainties and also the strong Q1 was partly because of stock filling effect. We had a 12% growth in sales out, which is not bad, but Our view for the full year is unchanged. Understood. And then just a final question from me before handing over here. On the progress on expansion to adjacent product areas, how is that progressing? And also how is the work with sort of building the organization and supporting that Svensson as well and how that relates to cost development this year and the next. Thank you. Yeah, yeah. So we are working very hard on the product expansion initiative. That is something that's very high on our agenda. And we are building the organization in order to be able to handle that, both from a product engineering perspective, but also from from a marketing perspective. That will be more hired people and more cost, but that is Order is something that we have planned since long and has been included in our estimates concerning the financial targets. So that is nothing new. In terms of development and how it's going, it is definitely progressing. As informed previously, we don't see any new categories in this year. But it is progressing well, and We are very excited about going into these new categories, which will be a big step for the company. Perfect. And then actually, I will try to sneak in just one last question here, perhaps to Karin, but I'll let you leave it, Let anyone answer, of course. But regarding the cash flows in Q1 and the working capital, I mean, I suppose there's certainly some one off costs due to recent IPO, But also a quite negative working capital effect from the strong net sales here in the quarter. Should we expect the working capital movement to reverse already in Q2? Or just some if you Could elaborate on the development there on working capital in Q1? Thank you. Yeah. I mean, As I said there, the reason for the operating cash flow we have in Q1 is due to, as you also mentioned, Investments costs we had related to the listing. And we also had, as you said, higher sales. We had a negative effect regarding decreased accounts payable that will not come in Q2 Because as we have been talking about, we built stock during fall 2020. So we had an outgoing Stock that was really high, that decreased during Q1 and we did some large payments. So that will not occur again. So that will be positive for net working capital obviously. We don't expect the inventory To grow, so yes, I would say that Q2 will look better. The investment will be, I would say, on the same level. It fluctuates between quarters, but it's not that material. So yes, we can expect some improvements Going forward. Great. Thank you very much, both of you. You're welcome. Thank you. Thank you. And we have no further questions at this time. Speakers, please go ahead for webcast questions. Thank you. We don't have any webcast questions. So with that, I would like to thank everyone for attending the presentation today And thank you for your time. Thank you.