Earnings Call: Q2 2021

Aug 20, 2021

Yes. Hi, everyone, and welcome to today's presentation for quarterly results. We can move on 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 our premium segment. Our main product categories are today PC cases, power supplies and cooling solutions. Next slide, please. Our net sales in Q2 declined organically, meaning measured in U. S. Dollar, by 38% compared to Q2 2020. It's important that our quarter result is seen in the context of our record breaking Q2 in 2020. In the Q2 of last year, lockdowns and shelter in place regulations rapidly increased interest for PC gaming And acted as a catalyst for the revenues of Fractal Design. Our revenue increased by 100% compared to Q2 2019, And therefore, the comparable numbers for Q2 2020 were very challenging. We have seen a strong continuation of interest for PC Gaming Hardware in the first half of this year. But in quarter 2, we experienced an increasing negative effect caused by the accelerating shortages of graphics cards. The graphics card shortage, which began by the end of last year, has caused consumers to wait with their purchases and upgrade to PC gaming hardware. This, in turn, has affected our revenues negatively. Furthermore, the logistical situation in sea freight has worsened during the quarter, it has both taken longer time and become more expensive to ship containers. In June, a COVID-nineteen outbreak in Shenzhen and Guangdong in Southern China The major ports in the area to close down, which delayed shipments from China in June and negatively impacted our revenues in the quarter. It is worth mentioning that due to the relatively big volume of our cases compared to the value, PC gaming case industry is hit proportionally more Than other industries by the current situation. We would like to highlight, however, that our measured market shares in Q2 have increased in most key markets compared to Q1, which is a testament to our strong brand and competitive product lineup. The markets where we increased our market share in is, among others, The U. S, Germany and U. K. Adjusted EBITDA declined versus Q2 2020, which is primarily because of the lower sales volumes Due to the mentioned reasons, but also because of lower gross margin and increased costs, which is due to our continued investments in R and D and growing our product line. The interest in high performance gaming and e sport continues to be very high. Hours viewed on Twitch during Q2 was continuing to increase by 26% year over year. Next slide, please. And despite a record setting year in 2020, the interest for PC gaming is continuing to be on a very high level. Twitch is the dominant streaming platform, and measuring viewership hours on Twitch is a common benchmark in the PC gaming industry. During the pandemic, the viewership of Twitch nearly doubled with a rapid increase starting from Q2. However, the viewership is continuing to be very strong. In the last quarter, the viewership increased by 26% year over year, which is a strong indication The PC gamers continue to spend time with their passion even after lockdowns have ceased, and the increased results continued during July. Next slide, please. Afrakatul remains committed to continue to release award winning products. We have, in the last year, increased our investments in R and D to expand our product range, both within existing categories but also into new adjacent categories. In the Q2, we released 2 new Power Supply series, the Ion Plus Platinum 2 and the Ion Gold. Our power supply category grew by nearly 30% in the first half of twenty twenty. We also released a new fan series called the Aspect Available in black and white as well as with colorful RGB lighting. 2 days ago, we launched a torrent series of cases, which is a premium offering With a focus on high performance and airflow, for this case, we developed new unique fans optimized for airflow. Next slide, please. As I just mentioned, we launched a new case series called Torrent about 2 days ago, And this was our first launch of completely new family of cases in about 1.5 years. And the reception from media and reviewers have been extremely positive. Below, you can see a few of the quotes from them. This is one of the most successful launches in the history of Fractal Design. We are very excited to see the overwhelmingly positive feedback from the market. And it shall be noted that the product we launched this week is only the first in a series of torrent Next slide, please. And here you can see a list of the more than 25 awards We have so far received on the new Torrance case in just 2 days, which is amazing. Next slide, please. So moving on to the numbers. The graph at the top shows the development in net sales. Net sales in the quarter decreased by 45% to SEK 104,000,000 compared to Q2 2020. We also measure our sales in U. S. Dollar as we Sell exclusively in dollars regardless of the end market and the organic decrease in dollars in Q2 was 38%. Looking at the year to date numbers, the decline was instead 20% 8% organically. The Q2 deviation is mainly explained by high comparative numbers as the Q2 of 2020 had a growth of over 100% Driven by lockdowns around the world as a result of the pandemic. As Hannes mentioned, the shortage of graphics cards Break of COVID-nineteen in Southern China with new restrictions limiting port capacity and delayed transport. Delivery problems continued during July August, but our good inventory situation in the sales channels Means that sales to end customers are not affected. Our sales are driven by Retail sales, but may fluctuate slightly between quarters depending on whether our distributors and resellers Increase or decrease their inventory. The dynamic is that when the distribution chain sees an increase in demand in the markets, They increased their stock and vice versa. In the graph at the bottom, you can see our quarterly development in sales out To end customers that distributors and resellers report to us measured in dollars, Sales out is an important measure that shows the underlying commercial developments. In Q2, sales out decreased by In July August, the demand was much weaker than anticipated, Affected by the continued shortage of graphics cards, we expect that the shortage of graphics cards will impact our sales throughout the year. Inventory levels in the sales channels were on a healthy level going into Q3, but given the soft start of Q3, they are Slightly high in some regions. However, we see a continued strong underlying demand for our products, Which will lead to a strong sales development when there is availability of graphics cards in the markets. We have a continued strong market position. And as Hannes previously said, we have strengthened or maintained our market shares in all key markets It's during Q2 compared with Q1, which is a clear proof of the strength of our products range and our brand. Moving on to next page and segment development. We can see that we have the strongest sales in EU with 49% of total net sales, followed by Americas with 36% and APAC and others with 15%. Sales of cases decreased by 50% compared to Q2 2020. Americas decreased by 63%, EU and APAC and others by 35% to 37%. Sales of other products and mainly power supplies decreased 11%. However, EU and APAC and Other increased sales by 52% 37%, But in Americas, sales dropped by 66 percent of the total net sales in Q2 and other products for 24%. Moving on to the next page and product margin development. In Q2, product margin was 33% compared to 39% last year, adjusted for the received repayment For tariffs of approximately SEK 10,000,000. The deviation of 6 percentage points between Q2 and last This year is due to less favorable product mix, U. S. Tariffs, increased freight costs and currency effects. Product mix stands for 2% of the deviation and is explained by a larger share of sales of products with lower margin, Mainly power supplies. We expect the product mix to show some improvements during H2 Due to launches of new cases that have a higher margin than other products such as power supplies, Reintroduced U. S. Tariffs stands for 2% of the deviation versus last year. As we have explained Earlier, we have mitigation plans in place, which will reduce the impact of tariffs by working with our suppliers To move some assembly outside China. Due to new COVID-nineteen outbreaks in Southern China, the start of the project is delayed from Q4 this year to first half of next year. Temporary extraordinary high freight cost Decreased the product margin by 1%. The freight cost has increased during Q1 and Q2 and was record high in June And affect our P and L when we sell the goods, meaning some time lag before impacting the margin. The freight situation is short term and the freight rates is expected to normalize. Currency effect The product margin by 1% and is related to the revaluation of accounts receivables and payables. Let's have a look at the next page and earnings. Adjusted EBITDA was SEK 2,000,000 and the margin was 1.9%. Year to date adjusted EBITDA margin was 12.3% and rolling 12 months 14.4%. To compare apples to apples, we need to adjust for the Repayment of U. S. Tariffs in Q2 2020 of approximately SEK 10,000,000, which gives an adjusted EBITDA margin of 25% Instead of SEK 30 in Q2 last year. The big gap in Q2 versus last year has to do with Decreased sales volume, but also lower margin with higher sales of low margin products, increased freight and raw material costs And imposed tariffs. To mitigate increased costs, price increases have been implemented during Q2 beginning of Q3 and the possibility of additional price adjustment is also investigated. We have good opportunities to largely compensate for the long term external factors, both by increasing prices, But also by moving assembly from China to 3rd country for the U. S. Markets to minimize the tariff cost, But the latter will not occur until next year. However, as the freight cost is expected to be temporary, Prices won't be raised to accommodate for them and that is also something general consensus in the industry. Moving on to the next page. Operating cash flow is mainly affected by lower EBITDA. The change in net working capital is related to increased inventory by SEK 21,000,000, which mainly has to do with the Logistical situation and issues with shipment from China, but also refill of new products. Accounts payable has decreased by SEK 31,000,000 due to large payments related to stock building. Accounts receivables has decreased by SEK 54,000,000 due to lower sales. Investing activities amounted to SEK2.9 million And it's related to development of new products. Moving on to the next page and the income statement. As previously presented, we had a net sales decline of 38% organically. The main explanation is Tough comparable numbers with +100 percent growth last year. Continued effects from the shortage of graphics Cards, but also the COVID-nineteen outbreak in Southern China, which affected our sales in June. We only sell in U. S. Dollar regardless the end market and the same goes for COGS that is also 100% in dollars, Which gives a certain currency hedging. However, Fractal's reporting currency is SEK and the numbers are affected by fluctuating exchange rates In currencies other than SEK, Q2 had an average U. S. Dollar SEK rate of 8.4% compared to 9.6% last year. Goods for resale and product margin are, as previously said, affected by sales of lower margin products, imposed U. S. Tariffs, Higher costs for freight and raw material and currency loss. Other external costs are in line with last year. Personnel cost is SEK 1,000,000 higher due to hirings, which is according to plan. Other external And personnel costs are denominated in SEK to approximately 46%, U. S. Dollar $42 and other currencies 12%. Interest expenses related to the overdrafts facility and FX translation effect are the main explanation To the financial nets. With that, we move on to the next slide and I hand over to Hannes again. Thank you, Karen. We have a strong pipeline of new products, and we are planning to launch Several new products in the rest of this year and also into next year. We, as Kerry mentioned, are working on plans to relocate final assembly Our production on South China in order to avoid the used tariffs. At the moment, we see an impact from the extraordinary higher freight prices and containers, As we have discussed, and in order to mitigate the cost of tariffs and increases in raw materials and FX impacts, We have raised prices on most of our products during Q2 and early Q3. And for the more long term strategic initiatives, We are working with several very exciting ways to continue our growth journey. We want to continue doing what we do today, which is to deliver best in class products and be one of the leading brands in our current categories. We can continue to grow in these categories, and we will launch a lot of new products, both this and next year. Expand our product portfolio into new categories. We have identified several adjacent product categories They're interesting for us to expand into, which fits well into our brand and with strong margin profiles. We're currently in the process of developing such products. We want to diversify and improve our marketing efforts, primarily with visibility in streaming. We also want to do geographical expansion in Asia, which primarily is succeeding in China, But also Southeast Asia is an interesting market in coming years. Next slide, please. A brief summary of the quarterly report and outlook for the rest of the year. Our net sales was negatively impacted by the shortage of graphics cards On delayed shipments from China in June. Adjusted EBITDA was lower year over year due to the lower sales volumes and product margin. Sales and demand in July start of August was lower than expected, impacted by At the accelerated shortages of graphics cards, the shortage is expected to impact net sales and earnings negatively throughout second half of twenty twenty one. The extraordinarily high shipping costs are temporarily impacting product margins. The logistical situation is continuing to be difficult so far in Q3, and our supply chain team is working very hard to manage bookings and freight rates. It is unclear when the situation will normalize, but many believe that it will begin to normalize towards the end of this year. We have previously guided for a small growth or no growth at all in 2021, which is due to the challenging comparables from 2020. But because of the weaker demand seen in the market right now, we are changing our guidance on growth to negative 15% to 20%. As a result, a weaker but positive profitability is expected in the second half year. While the current headwinds with graphics card shortages and logistics issues are extreme and never before seen in our industry, They are expected to be short term, and we remain positive regarding our mid- to long term outlook and financial targets. We have increased our market shares in the key markets during the year and with a large number of new products we have in our product pipeline, both in existing and new categories, We believe strong growth resumes soon. The interest in gaming keeps being on a record high level, which indicates a strong underlying and pent up demand once graphics cards becomes more widely available again. Next slide, please. And with this, we have reached the end of our presentation and we'll open up for questions. And with that, I And over to the operator again. Thank you. We have a question from the line of Simon Granet from ABG. Please go ahead. Thank you, operator. Good morning, Hannes and Karin. I hope all is well with you. Firstly, how well balanced you say that your 2021 guidance is what do you pencil in into your expectation in terms of improvements of the GPU Situation in H2 compared with Q2 and the current state? Yes, we think that Our current guidance is balanced. There's, of course, a potential upside if the graphics card Availability is improving faster than we think in the rest of this year, but of course, also a possible downside if it It continues to be on this level that we are right now. We believe, however, that we have reached the worst part of the graphics card shortage and that things will start to improve in the remaining part of the year. Thank you. And looking into 2022, could you say anything on how you or other market Participants are expecting this situation to develop, meaning how is your current conversation with suppliers and other Parking spend is currently progressing. You mean in terms of graphics card shortage? Yes. Yes. So we believe, as I said, that we have reached the worst point right now and that it will start to improve In the remaining part of the year, we see that the big demand that came from mining In Q4 and Q1 and Q2 this year, it's starting to move away. And the mining activities That caused a demand of about 1,000,000 graphics cards per month that went into miners, not into gamers' hands. In 2022, it is expected that the general semiconductor shortage will continue. But according to NVIDIA's guidance, they believe that it will be better availability next year compared to 2021. Exactly how much better is very difficult to judge, of course. But Yes, we and others believe that it will be better in 2022. Thank you. That's very helpful. Furthermore, do you see any long term risk that the demand for PC as a platform will be hurt Due to recurrent shortages, meaning that the anticipated pent up demand that you mentioned will not be fully materialized? I believe that, that would have to be a significantly longer time period where graphics cards is not available for that to happen. Of course, if it will take a very, very long time, that could happen, but we don't see that as a realistic scenario in the current situation. Thanks. And finally, does the short term outlook Have any impact on your previously communicated expansion plans into adjacent product categories? No, we are currently full steam ahead in our investments in R and D and our expansion to new categories. It's an important part of our long term growth, and we will continue with that. Thank you so much. Thank you. And we have another question from the line of Oskar Ejeksson from Carnegie. Please go ahead. Thank you and good morning, guys. A couple of questions from me Regarding the guidance here for the full year, should this be seen as the Supply of graphics cards actually becoming worse now into Q3? Or is it Mainly you thinking or expecting it to improve here in the second half? We think that right now in Q3, we are at the worst point and that it will improve from here and throughout Q4. Understood. And I mean, assuming here a lot of moving factors, of course, But assuming, I mean, if it's improved supply of graphics cards in early 2022, let's say, first half of twenty twenty two. Do you think a strong recovery It's possible and that you may grow considerably above your long term target of above 10% growth And is growth versus 2020 numbers feasible, would you say? Thank you. Yes, yes, that's a good question. And we believe and also our industry partners believe We have seen this also in our consumer research when reading on forms, etcetera, that there is a big pent up demand of The consumers that have not been able to purchase in the last couple of months or half a year even. And we believe, therefore, that when graphics card starts to normalize that it will be a significant boost for the markets. And we think that the possibilities for us to grow significantly higher And then the current 10% plus in our financial targets is very realistic in 2022. Thank you. And the follow-up on that, would you say that, that type of recovery is dependent on The market, the underlying demand and the gaming market and engagement being as Strong as it is now? Or will it be sort of irregardless of that given the pent up demand? I think irregardless of that because you have seen a large surge amount of gamers that have entered the space of gaming and that according to the data are continuing to game even beyond the lockdowns have ceased. So, irregardless of that, there is a big pent up demand that needs to be satisfied, but we also believe and see no signs of the gaming 1st, and receding anytime soon. Great. That's right here. And then two questions On costs and margins, starting with the product margin here, 32.6% in Q2 with negative impact from Several factors, but then you speak of a lag effect from increased freight costs. Would you say there's downside here to your historical product margins from increased freight costs In the second half of this year and then also how about 2022? Thank you. Yeah. Yeah. So, the freight costs impacts our product margins, of course, that is inevitable. But we also believe that in the second half of the year, we will have a better mix of products in terms of more cases, which is Our high margin product. So, we expect those things to largely counterbalance each other, but it's likely to be A bit margin pressure compared to first half of twenty twenty one and the second half of twenty twenty one. Understood. And then just finally from my side to understand The indications that you gave on the margins here in the second half of the year, you talk about relatively fixed Operating cost base and some gross margin pressure. Looking at operating costs here in Q2, should we assume that they are, I mean, relatively fixed at these levels? Do you foresee them growing in the second half of the year due to your investment into other product areas? And is I mean, just inputting sort of fixed costs and slightly lower gross margin It implies perhaps an EBITDA margin of around 5% or so in the second half. Would be interesting to hear sort of some flavor on this. Thank you. Yes. We believe that the other the OpEx cost, the fixed Costs for the second half of the year will be largely in line with the first half of the year. Personnel costs will be Slightly higher because of the recruitments that we have made. And in terms of EBITA margin, It's likely going to be in the single digit range for the second half of the year. Great. Thank you. That's it for me for now. I might come back with 1 or 2 questions. Thank you. And it seems we don't have any further audio questions for now. So I'll hand it to the speakers. All right. Thank you. We have a question through e mail. The first question is, what can you tell us about factors in Time line for normalization of graphic card availability. We believe that we are in the worst situation right now And that it will improve in Q4 and that it will further improve in 2022. As mentioned before, there are certain factors that are in the favor of seeing an Improvements such as that mining demand for cryptocurrency is largely vanishing and that sucked up quite a big part of The graphics card production. The second question we have through email is that your sales in the U. S. Are in Glidown versus EU, what has driven this difference in H1 twenty twenty two between EU and U. S. Sales? So the reason to this is that last year, our increase in sales was largely driven by increase in the U. S. Markets. Of all our markets worldwide, all markets increased, but the U. S. Market and the market in Germany increased the most. So for that reason, it's a bigger difference this first half of the year compared to last year. All right. We don't see any more questions through email. So Just one follow-up from Oskar from Carnegie. Please go ahead. Thank you. Yes, just two quick questions here. Would be interesting to hear regarding freight costs, Which have increased, I mean, 600%, 700% year on year at least. Could Could you discuss your freight costs as a share of your average sales price and whether there are differences here between different Product areas and so what regions it affects as well? Thank you. Yes. Yes. When it comes to the freight costs, actually about 2 third of our sales, The freight cost is paid by our customers, which is the distributor, reseller that are buying the products from us. So what in turn happened then is that they will raise the price to the end users in the markets. But in terms of our sales to the U. S, we ship the products ourselves and therefore pay the freight ourselves. And it's in that market we see the margin hits from the higher freight costs. And In terms of differentiation between different product categories, our cases, they are fairly large compared to the Dollar value of them, so they are hit proportionally more than our other categories. The Power supplies and cooling products, they have fairly high value compared to the volume, so they are not hit at all that hard. Understood. And then just a final question from me. Just to understand here the second half guidance, I mean, looking at peers and Also suppliers, they largely reiterated the top line guidance here for the year, Including Acetec, for example, which I think is a supplier. Could you just explain the differences here for you a little bit And also talk a little bit about the difference in demand for components and perferrods. Thank you. Yes, that's a good question. Yes, we don't want to comment too much on our competitors' guidance for this year, But we are quite surprised that they are staying with the guidance for the full year because we are seeing that The Coursera, for example, that they have dropped even more than us in terms of market share in certain regions. So in the product categories that we share, they are losing as much as we have. They have a wider product range for Webber, and the peripherals market has probably A delay in terms of being affected by graphics card shortage that is not as affected because of different purchase behaviors. But we have also heard that the peripherals markets have flattened out and It's likely going to decrease in the second half of this year as well, although maybe not as much as components. Very helpful. Thank you. That's it for me. Thank you. And there are no further questions. Okay. Yeah, we don't have any more questions on email either. So with that then, I would like to thank everyone for your time and wish everyone a nice day and weekend. Thank you. Thank you. This concludes our conference call. Thank you all for attending. You may now disconnect your lines.