Embracer Group AB

Good morning and welcome to Embracer's Q3 report presentation. My name is Erik Larsson. I'm an equity research analyst at SEB. I will be the moderator today, obviously. We will start today with a handful of presentations from Embracer management, including an update on the restructuring program before we go back to Q&A. So with that, I'll hand the word over to you, Lars.

Thank you, Erik, and hello and welcome everyone to this Embracer Group's Q3 presentation from Stockholm. Let's dive straight into the business highlights for Q3. First of all, I'm happy to say we delivered another stable quarter with net sales of 12.1 billion and adjusted EBIT of 2.2 billion in Q3. The financial performance was driven by a strong quarter from Asmodee, Middle Earth Enterprises, and our mobile businesses. Organic growth amounted to minus 4%, a result of positive organic growth within tabletop, offset by a light release schedule within PC console, and an increased focus on profitability within mobile. The performer growth was minus 2%. The free cash flow in Q3 was the second highest ever for Embracer at 1.2 billion SEK. Importantly, for this year, we see even more distribution of free cash flow in the second half compared to second half last year. For fiscal year 2023-2024, we reiterate our adjusted EBIT forecast of SEK 7 to 9 billion. and now see it likely that we will reach the low end of the forecast range. This is driven by a somewhat softer outlook for PC Console compared to our assessment in Q2, due to the performance of recent new game releases, as well as a few additional pipeline shifts from Q4 and shift within the quarter. While we have seen a solid delivery across three out of four segments throughout the year, there is room for further improvement of our financial performance, primarily within PC Console. In Q3, cash EBITDA or EBITDA less capex in the last 12 months was 3 billion on a group level, excluding the four of our operative groups within PC console that has a negative contribution, EBITDA less CapEx would be 5.3 billion SEC. Johan will discuss EBITDA less CapEx in more detail later today. We are tracking well towards the CapEx and OpEx target set out in the program as we approach the final stretch of the restructuring program, which includes both possible divestments and consolidation. On CapEx, we saw an important shift in the quarter with a decrease in run rate from 7.9 billion when the program started to around 6.4 billion in December, tracking towards our CapEx targets of 5 billion when coming into next fiscal year, 24-25. As part of the restructuring program, we still have a few larger structure divestment processes ongoing that could strengthen our balance sheet and further reduce CapEx. Processes are in mature stages. It's important to add that certain companies might initiate restructuring before any divestment is announced. However, our overruling principle is always to maximize shareholder value in any given situation. We are unlikely to reach the target under the restructuring program of below 8 billion SEK in net debt by March 31st. However, certain divestments could significantly reduce net debt post-March 31st. To be clear, our group leverage target of net debt to adjusted EBIT of one times on a 12-month forward-looking basis remains unchanged. We are creating a strong foundation for the future. We are excited about the future and have a notable pipeline of sizable new games in the coming two years. I'd like to give some more color on this. In recent years, we have made strategic investments into accelerated organic growth. This has created an imbalance between CapEx and completed games development. meaning new releases, which is now being addressed through our restructuring program. In the past 12 months, we have invested around 6.5 billion into PC console game development, while we completed games, meaning release games, with a value of less than half of that, around 3.2 billion. As we now continue towards reducing CapEx to 5 billion on a group level, it's important to note that for PC Console, on a forward-looking basis, we still be investing more than we currently are releasing. This means we are laying the foundation for future organic growth. Importantly, an updated group-wide capital allocation process is in production, including a clear game investment green lighting model. Our future games portfolio will be more focused around established IPs and studios, which we are confident will generate better predictability as well as increased ROI and profitability going forward. With the actions that we are now taking, We are creating a strong foundation for the future with an improved financial profile and a more streamlined structure while leveraging the potential for our diverse portfolio. We have amazing assets and IPs, and we aim to demonstrate the earnings power of those assets over time. Phil Rogers, one of our key people managing the restructuring, will go further into details about our progress later in this presentation. From my point of view we are making good progress on CAPEX and OPEX targets and we are working hard to finalize important aspects in the final stretch of the restructuring program. Now let's move over to the details of different segments. Net sales in the quarter for PC console games amounted to 3.4 billion, a decrease of minus 5% compared to the same period last year, or minus 9% organically and pro forma in constant currency. The negative organic growth development is mainly explained by lower other revenues year-over-year relating to work-for-hire and other games development revenues. Adjusted EBIT in the segment amounted to 469 million, providing a 14% margin. The adjusted EBIT margin remains impacted by games development amortization, combined with the soft performance for a range of primarily mid-sized titles across operative groups last and this fiscal year. The performance of our strongest franchises in PC Console has been stable. In general, we see a more selective consumer and reduced levels of platform content investments. Revenue from new releases in the segment amounted to 470 million in the quarter. an increase of 2% year over year. The main revenue driver among new releases in the quarter were Hot Wheels Unleashed 2, Risk of Rain Returns, Arizona Sunshine 2, and Last Train Home. Hot Wheels 2 and Last Train Home were well received by critics and players, but performed a bit below the financial expectations. likely partly due to a crowded release window. Risk of rain returns by far outperformed management expectations. We also saw a notable underperformance for Wild Card Football released early in the quarter. In the quarter, other releases were Teardown on console, Jagda Lions 3 on console, Borderlands that finally came on Nintendo Switch, SpongeBob SquarePants, the cosmic shake on the console and mobile. Revenue for back catalog titles amounted to $2 billion in the quarter, a decrease of 2% year over year. The quarter included the successful release of new content for several games, including the DLC The Awakened King for Remnant 2 and House for Dead Island 2. but was impacted by a soft performance for Payday 3 in previous quarter. If you look at the top 10 back catalog titles, you see it's topping by Remnant 2, Dead Island 2, Chivalry 2, Deep Rock Galactic, Payday 3, Ghost in the Nature 3, Star Trek, Online, Wreckfest, Risk of Rain 2, and finally SnowRunner. Other revenues amounted to $843 million in the quarter, a decrease of 16% year over year, but a stable development compared to Q1 and Q2. In corresponding quarter last year, a publishing deal for Tomb Raider was signed with Amazon, driving a notable revenue contribution. Looking at the ROI chart, It was a mixed bag in Q3. Again, we had a few new small and mid-sized game release that did not perform. Risk of rain returns notably outperform expectation and a very strong ROI. Hot Wheels 2 perhaps did not perform as well as previous game in the franchise and saw a tough release window, but ultimately had a positive ROI contribution in the third quarter. Several other titles, including Wild Card Football, Lost Train Home, Arizona Sunshine, and Let's Sing 2024, underperformed and also had an ROI below one. The weighted average ROI now stands at around 2.2 as of end of the quarter compared to 2.3 in second quarter. It's lower than we would like due to the underperforming releases in the past 18 months. Our concrete restructuring actions to date are expected to have a positive effect on our ROI going forward. For the games from studios that we have closed down, combined with third-party publishing games where we have no ownership in the development studio, the ROI on performer basis is one time. Meanwhile, for all other games on this chart, the ROI is 3.2. While, worth noting, while we still do third-party publishing in the future, we will be considerably more selective through our updated capital allocation process going forward. Our future games for Fordo will be more focused around established, owned IPs and studios that we are confident will generate better predictability as well as increased ROI and profitability going forward. Looking in the investment and pipeline in PC console game segment, investments in game development remained high. we continue to have the imbalance between CapEx and completed games development, which is impacting our free cash flow generation within PC Console. In the past 12 months, our investment into new PC Console games were two times higher than the value of the games we completed. As stated earlier, we now continue towards reducing CapEx to below 5 billion on a group level, but we still have a growth CapEx This means we will be investing more than the value of complete game development, laying the foundation for future organic growth within PC console, but with a better free cash flow. As of Q3, the capitalized game development costs for ongoing game development projects in the balance sheet amounted to $9.7 billion. In the quarter, we had around 340 million in write-downs related to the restructuring program, which Johan will discuss more later. Looking to the pipeline for the coming, well, seven weeks, there is a high activity with a range of new game, including Alone in the Dark, Outcast, South Park Snow Days, expeditions and a few others including yesterday we released the Deep Rock Galactic Survivor and together with Spellerosh also released this week the first public it's the first publishing titles from our family members at Ghost Ship Games in Denmark they have done an excellent job together with the developers and especially Survivor are off to a really strong start. Tomb Raider Remastered released yesterday from Aspire are also off to a very strong start, both in terms of critic and the sales performance. We are, as stated, looking forward to Alone in the Dark, another game developed in beautiful Skövde in Sweden. We also have Lightyear Frontier also developed in Skövde coming in March from the studio frame break within Amplifier Games. Amplifier Games is entering a period of more intense release schedule after several years of investments. Following the release of Lightyear Frontier in Q4, several studios have games that are nearing release over the coming 12 months, which we look forward to. Feel the pressure, Per-Arne. Turning to Homeworld 3, it's a long-awaited sequel in the award-winning sci-fi real-time strategy franchise, developed by external studio Blackbird Interactive and published by Gearbox Publishing. This title has recently been moved from Q4 to May this year. Moving over to mobile game segment, the net sales in the quarter for mobile games amounted to 1.6 billion, an increase of 4% compared to the same period last year. or by minus 10% organically and minus 2% pro forma. EasyBrain had a mid-single-digit organic growth in Q3, while DecaGames, including Crazy Labs, saw a clearly negative organic growth, primarily impacted by a business model shift and an increased focus on profitability and cash flows. The number of Monthly active users and daily active users both declined year over year, driven by DECA games and Crazy Labs, partly driven by a shift to a genre with smaller player bases but better retention and monetization. Performa growth was more stable thanks to a strong performance for Alien Invasion, for which the publishing rights were acquired by Crazy Labs in August 2023. Adjusted EBIT in the segment amounted to 611 million in the quarter, giving a 37% adjusted EBIT margin. Our user acquisition cost amounted to 646 million or 39% of net sales. The improved profitability year over year is driven mainly by an improved product mix with a stronger than expected performance for EasyBrain and for Crazy Labs hybrid casual game Alien Invasion, as well as optimized user acquisition investments. EasyBrain saw a solid performance in the seasonally strongest quarter. driven by better monetization and a strong live operations execution across its key games. Crazy Labs' shift to the hybrid casual genre has been accelerated through the game Alien Invasion, which has performed notably stronger than expected. The game was notably accretive to profitability already in this quarter, Meanwhile, hyper-casual is expected to slow slightly and partially offset the performance of Alien Invasion. The strongest catalog titles in the quarter were Sudoku.com, Alien Invasion, Blockadookoo, Art Puzzle, and Jigsaw Puzzle. Now, let's move over to Paris. Tabletop game segment. Net sales for tabletop game segment amounted to 4.4 billion, an increase of 7% compared to the same period last year, or by 1% organic or 1% pro forma on constant currency. Growth was driven by the trading card games category, with a slightly negative growth for board games. Growth in Europe outperformed growth in the U.S., For the calendar year, the tabletop mass markets saw a slight positive growth, confirming the industry resilience to a difficult macroeconomic environment. Adjusted EBIT amounted to 832 million, providing a 19% margin, mainly due to product mix more geared towards trading card games and a very strong earnings growth year over year in the previous quarter. Asmodee delivered a strong free cash flow in the quarter with a notable inventory reduction in the seasonally strongest quarter of the year. Asmodee has a strong pipeline of novelties and new releases with a number of exciting new titles that reached the market during Q3, 23, 24, including new original titles such as Forest Shuffle from Lockout, Waterfall Park from Repos Prod, and Perspectives from Space Cowboys, along with the new legacy version on our evergreen Ticket to Ride franchise, Ticket to Ride Legends of the West. Next quarter, releases include Ticket to Ride Paris from Days of Wonder, MLEM Space Agency from Rebel Studio, and World Traveler from Office Dog. Preparations for the exciting launch of the trading card game Star Wars Unlimited on March 8, 2024 are progressing well, with strong pre-orders and a positive buzz in general. Releasing later this year, we were very excited to announce the collaboration, our first collaboration with Lego on board games, with the global launch of Monkey Palace. Asmodee also announced during the quarter its worldwide exclusive distribution rights and premium supply lines on the upcoming trading card game, Altred, which is experiencing consumer success on Kickstarter with a funding goal achieved within two minutes. Heading over to entertainment and services segments. Net sales in a quarter amounted to 2.6 billion, an increase of 12% compared to the same period last year. or minus 2% organically and 5% performer in constant currency. The organic growth was primarily driven by play on partner publishing and film, which saw a notable release of an external first-person shooter game, a solid back catalog revenue, as well as a solid performance for its film business. The higher performer growth is driven by Middle Earth Enterprises within Operative Group Free Mode, as the acquisition was closed in October last year. Adjusted EBIT amounts to $305 million, providing a 12% margin. The higher margin year-over-year is primarily explained by stronger than expected licensing revenues for the Lord of the Rings IP. This was primarily driven by continued solid performance for the Magic the Gathering trading card game, The Lord of the Rings Tales of Middle-Earth. Consistent performance of the Warner Bros. movie catalog with the Lord of the Rings trilogy and the Hobbits trilogy, as well as the PC console game Return to Moria. Beyond the quarter, Middle Earth Enterprises is looking forward to the theatrical release of The Lord of the Rings, The War of Rohirrim, which has been set for release December 13th, 2024. Dark Horse Entertainment had an encouraging performance in Q3, partly supported by less headwind from external factors and with an increased focus on profitability and cash flow generation. Limited Run Games successfully launched pre-orders during Q4 for many games, including the physical edition of Persona 4 Golden in partnership with our friends at SEGA. Limited Run also continues to build the catalog of classic games that are being brought back to modern platforms via the property tech carbon engine. The latest carbon title, Jurassic Park Classic Games Collection, released on November 22nd, showed solid performance on digital storefronts, adding new revenue streams to limited run games. Now looking to the market, the games market in calendar 2023 is estimated to have generated $184 billion and grown 1% year over year, despite the challenging macro environment for consumers and businesses alike. 2023 was the second highest grossing year in history and saw a return to growth following a post-pandemic dip 2022. The market value is a substantial 28% above pre-pandemic levels. The longer term growth prospects remains strong. The total games market is predicted to grow again by 3% 2024. driven by growth across PC, console, and mobile. The market is then expected to grow by 5% CAGR between 2019 and 2026 to a value of 205 billion 2026. With that, I will leave over to Johan for financial comments. Thank you, Lars.

Let us take a look at an overview of the financial development. So although last year Q3 was strong, we see growth in net sales and EBIT this year. With the trading 12 months, net sales and EBIT reaching 43 billion in net sales and approximately 6.6 billion or 15% in EBIT. The sequential reduction in gross margin in the quarter is in line with the expectations with the product mix geared towards EBIT. tabletop entertainment and services. We note that marketing expenses in relation to sales are at 8%. The marketing expenses outside of mobile are lower than previous quarters, mainly related to fewer larger releases in the quarter. Marketing expenses or user acquisition costs within mobile are also lower than previous periods mainly due to the increased focus on the profitability in the segment. Operating expenses are slightly lower than what we saw in the last quarter. They amount to 2.7 billion or 22% in relation to net sales. Adjusted EBIT increased over last year, amounting to 2.2 billion for the quarter, setting a new all-time high for adjusted EBIT in a single quarter. As mentioned in June, when the restructuring program was announced, we treat expenses related to the fulfillment of the program. as items affecting comparability, excluding them from adjusted EBIT. Items affecting comparability amounted to 0.6 billion in the quarter, where 0.3 billion is related to write-offs of game development. It is important to note that write-offs of game development are considered as items affecting comparability only when they are related to projects affected by the ongoing restructuring program where the studio or team has been discontinued. Let us have a look at the cash flow for the quarter. We do see positive effects from our restructuring program in the quarter, and we expect them to accelerate in Q4. Sequentially, CapEx was reduced with 0.3 billion or 13% in the quarter. The savings are not linear. So if you look at December alone, the run-rated CapEx amount to approximately 6.4 billion, which is a reduction of 1.5 billion compared to the run rate as per Q4 22-23. We generated a solid free cash flow in the quarter of 1.2 billion, which is a significant improvement compared to Q2, and slightly above our expectations. In a year-over-year comparison, it is important to note that last year included 0.5 billion in a publishing deal relating to Tomb Raider, and that changes in working capital included unwinding of excess inventory from end of December last year. Further, we note the healthy reduction of inventory in the quarter, driven mainly by the solid performance during the seasonal peak for tabletop and entertainment and services. Net investment in acquired companies amounted to 2.2, billion in the quarter and relates to historical acquisitions where the majority are related to Middle Earth enterprises and tripwire. The cash flow effect of items affecting comparability relates to payment, cash out payments under the ongoing restructuring program and amounted to 260 million in the quarter. Cash flow from financing activities were impacted negatively by less utilization of credit facilities in sale. At the end of December, net debt amounted to 16.1 billion, and available funds amounted to 5.1 billion. As Lars mentioned, we are unlikely to reach the restructuring program target below 8 billion in net debt by end of March. Certain divestments could significantly reduce net debt post 31st of March. In December, agreements were signed for the parent company regarding our two main credit and loan facilities. extending the maturity to February and May 2025. The agreements include scheduled quarterly minimum prepayments that amount to 2.6 billion on an accumulated basis up until January 2025, starting in April. Free cash flow and cash at hand provide us with sufficient funds to amortize the debt accordance to the existing bank agreements in 2024. Embrace Group have covenants in the loan agreements. The terms for these are 2.5 times net debt, EBITDA to net debt calculated according to the agreement. As per the end of December, we have significant headrooms to these covenants. Looking ahead, we expect free cash flow to improve, driven by an expected strong underlying performance in fiscal 24-25, coupled with benefits from our restructuring program. On this slide, we look at EBTA, CapEx, Cash EBTA, or EBITDA by segment. It is worth noting that the majority of CapEx is directed towards the PC console segment for game development. The other three segments are CapEx Lite, and working capital is a more important component of cash flow generation. PC console is the only segment that shows a negative EBITDA. And naturally, the CapEx savings in our restructuring program are geared towards PC console. If we zoom in on PC console, it is worth noting that three operative groups have a positive EBITDA of $1.1 billion. whilst the other four have a negative EBITDA of 2.3 billion. On this slide, we look at EBITDA for Embracer in total, and also compare it with Embracer excluding the segment PC console. In 2.3, the TTM EBITDA was 3 billion on the group level, If you would exclude PC console, it would be 4.3 billion. Applying the run rate, the December capex of 6.4 billion to the trailing 12 months EBITDA improves EBITDA by 1.4 billion to 4.4 billion for the total group. As Lars mentioned earlier, we reiterate the forecast for this financial year with the 7 to 9 billion range. And now see it likely that we will reach the low end of the range. This is driven by a softer outlook for PC console for the remaining part of 23-24 compared to our assessment in Q2. due to performance of recent game releases, as well as a few additional pipeline shifts within the quarter and also outside of the quarter. Yes.