Embracer Group AB (publ) (EMBRACB) Earnings Call Transcript

Ladies and gentlemen, welcome to the Embracer Group Q1 Report Conference Call for Fiscal Year 2026/27. I am Sherry, the Chorus Call operator. [Operator Instructions] The conference is being recorded. [Operator Instructions] The conference must not be recorded for publication or broadcast. At this time, it is my pleasure to hand over to Mr. Phil Rogers, CEO. Please go ahead, sir.

Thank you very much, operator, and good morning, everyone, and thank you for joining our webcast today covering our Q1 results. This is a quarter that shows the foundations we have been laying are starting to pay off. So let's get straight into it. Muge and I welcome you today from our Stockholm office, and as usual, we'll run through the main updates for our operating segments and the financial performance and then open it up for Q&A. one important reminder: from this quarter, we report in our new operating segments, and we've introduced cash EBIT as our key earnings measure. Together, these changes sharpen our focus on operating performance, capital discipline and stronger conversion of earnings into cash flow. This is the operating model we are building the future on, and it sets us up for the spin-off of Fellowship Entertainment in calendar 2027. So let's get going. Overall, our quarterly results reflect another delivery above plan on both the revenue and cash EBIT side. Net sales were SEK 3.9 billion, a 33% organic growth year-over-year, driven by the Embracer segment with broad growth across its business areas, PC/Console, Mobile and not least Entertainment & Services, which had a standout quarter. Following a strong Q4, we delivered positive cash EBIT and positive free cash flow on a group level in a quiet quarter from a major game release perspective. Now that's the power of the catalog we are building that our core franchises keep delivering quarter after quarter. For the full year, we confidently reiterate our cash EBIT forecast of at least SEK 1 billion. The year is anchored by METRO 2039, expected to be released in February next year and the momentum is building fast. After its reveal, METRO 2039 raced to 1 million wishlists, reaching this milestone faster than any title in our history, and wish lists continue to grow ahead of expectation. Our team is lining up a major marketing beat for METRO at this year's Gamescom, just in a couple of weeks now, with new content at the Opening Night Live show on Tuesday, the 25th of August. There's also a huge show floor presence where players can get hands-on with the game for the first time. During the quarter, we made further progress in building the future Fellowship Entertainment organization toward the planned spinoff in 2027, with IP increasingly at the center of our operating model, investment decisions and long-term value creation. Rather than simply replicating existing structures, we're creating a leaner model where experienced people take broader responsibility across clearly defined areas. This includes ongoing strengthening of greenlight and portfolio decisions while bringing community insight closer to game development and live operations. The organization continues to evolve, but the direction is clear: IP is at the center of our operating model, investment decisions and long-term value creation. And starting this quarter, we've made several changes to our reporting to improve the relevance and clarity of the information presented for the group ahead of the Fellowship spinoff. From my side, the message is clear: the groundwork is done, the progress is visible, and we are moving into the next phase from a position of strength. Now let's just step back and look at the longer-term picture because it tells a powerful story. The trough is behind us. After FY 2025/26, the trajectory has turned. On a trailing 12-month basis, as of Q1, organic growth is running at 5% versus fiscal 2025/26, and our cash EBIT margin is climbing. Two things, I think, make this genuinely impressive. First, we've achieved this improvement with no major game releases for Fellowship in the period and limited sizable revenue drivers for Licensing. And that's while being measured after the February 2025 launch of Kingdom Come: Deliverance II and the momentum that followed through FY 2025/26. This is what a diversified business looks like when it's working, with multiple segments and business areas all pulling their weight. Second, please note that our historic numbers in FY 2023/24 and FY 2024/25 include a significant positive contribution from Easybrain. So the absolute numbers are not fully like-for-like. The underlying momentum is stronger. So here's the key point. Today's trailing 12-month levels are the floor, not the ceiling. The hard work is behind us, the release engine is ramping up, and there is substantial growth ahead across both operating segments, and we intend to capture it. As a quick recap from May, from this quarter, we report our business across 2 segments: Fellowship Entertainment and Embracer, and in total, these business areas we show here. Now let's dive into the segments now and first up, let us look at Fellowship Entertainment. Fellowship Entertainment is built around 1 strategic focus: IP or worlds that fans return to again and again. In Q1, Fellowship delivered net sales of SEK 810 million, so a headline 22% organic decline. Now let me put that in context. We had limited new content across both Publishing & Development and our Licensing businesses. And we were up against tough comps with Kingdom Come: Deliverance II releasing in February 2025. From a cash EBIT perspective, the margin was minus 4% in the quarter. I'll be straight with you: not a strong quarter on the headline. But here's what it proves. We came in above our internal expectations, powered by solid catalog performance, especially Kingdom Come: Deliverance, METRO, Remnant and Dead Island. The worlds we steward keep earning and that's really the foundation this business is built on, and it's exactly why the release slate ahead matters so much. On the next slide, let's look at some earnings dynamic that drive Fellowship. This chart shows the engine of the Publishing & Development business. New releases drive the revenue peaks, feed the catalog and ultimately power cash EBIT margins and cash EBIT. You can see it clearly: the release of Kingdom Come: Deliverance II in February 2025 drove a significant revenue peak, followed by solid catalog performance in FY '26, boosted by 3 DLC releases. Over the past 5 quarters, new releases have been limited. So the model has been running on catalog alone. That's about to change. First up, we have 2 titles lined up for Q3, both Dawn of War IV and Stage Tour and both are showing promising early traction. From a publishing perspective, the big one this year, METRO 2039, is scheduled for February and is expected to be a key driver, bolstered by Amazon's publishing of Tomb Raider: Legacy of Atlantis. Our collaboration with Amazon continues strongly on all things Tomb Raider. We are excited to share more updates on Tomb Raider: Legacy of Atlantis again at Gamescom in just a couple of weeks. And it builds from there. From FY '27, we expect the release of the next game in the Kingdom Come franchise from Warhorse Studios and Darksiders 4 from Gunfire Games, as we said in May, at least 2 major games with full economics. That's the rhythm this business was designed for. We spent the past 2 years putting the studios, the pipeline, the discipline and the empowerment in place to sustain it, and it will power the growth and profitability of Fellowship Entertainment.

Thanks, Phil, and good morning, everyone. Looking in a bit more detail at Fellowship's financial performance. While Phil has just spoken about the top line performance where Fellowship delivered net sales of SEK 810 million, down 22% on an organic basis, the gross margin percentage for the quarter remained stable year-on-year at 85%. The impact of the top line evolution was partly offset by lower operating expenses, which came in at SEK 373 million before marketing costs, reflecting the realization of prior year savings initiatives. CapEx remains relatively stable at SEK 288 million for the quarter. Adjusted EBIT margins were relatively stable due to lower D&A as a result of no new releases in the quarter. Cash EBIT amounted to minus SEK 32 million with the year-on-year evolution, mainly due to the strong top line comparator mentioned earlier and limited new content in both Publishing & Development and Licensing during the quarter. We would like to emphasize that cash EBIT margins will be impacted by the level of capital we decide to deploy in growth CapEx relative to the revenue generated in a particular year. In the short term, these margins may be lower as we build the revenue engines Phil referred to earlier. But as that ramps up and release cadences increase, we can expect a steady improvement in the cash EBIT margins over time.

Now to the pipeline, and there's a lot to be excited about. The current financial year is anchored by METRO 2039 and Tomb Raider: Legacy of Atlantis, both expected to be released in February. To touch on Warhammer 40,000: Dawn of War IV, this is now expected in Q3 December rather than Q2, and fan excitement is building strongly. The game looks really promising and early indicators show the excitement amongst fans is building, with over 1 million wishlists on Steam already. The fan engagement for Stage Tour from RedOctane Games is also very real. This game is being built with community at the heart, and it was great to see their reaction at the recent San Diego Comic-Con. And as mentioned, in the year after, a further strengthening pipeline with Darksiders, Kingdom Come and Tomb Raider: Catalyst, the next chapter in our Tomb Raider series, published again by our friends at Amazon. In May, we talked about our new Licensing business area and our conviction has only grown since. This is a durable, high-margin revenue stream that sits alongside development and publishing, and the foundations are already producing. There is a lot of exciting stuff going on, some near-term and some further out. Starting tomorrow with the launch of Magic: The Gathering, The Hobbit, the trading card game from our great partners at Wizards of the Coast. So far, it's tracking very well. It's a fan favorite and follow-up to the 2023 successful release of The Lord of the Rings: Tales of Middle-earth. In Q2, we expect our Licensing business to compensate for the lighter new content quarter in Publishing & Development. Further out, the slate is genuinely exciting: multiple feature films with our partners at Warner Bros., a strong collaboration with Asmodee across tabletop games, plus merchandise, location-based experiences and, of course, video games. In closing, The Lord of the Rings is one of our core IPs, but as we highlighted in our May update, we've got a great roster of other amazing IPs to fuel our Licensing business. Now let's turn to the Embracer operating segment, which delivered a strong earnings improvement. The PC/Console business area led the way with a successful launch of Gothic 1 Remake and continued momentum for REANIMAL. Gothic saw a strong reception from players, reaching 500,000 copies sold within the first week. The game is, as of today, already close to recouping its full development and marketing spend. And the strength ran right across the segment. Mobile grew net sales and profitability year-over-year, driven by Sled Surfers. Entertainment & Services delivered very strong top line growth with higher profits driven by distributed titles from PLAION Partners, including Crimson Desert. Embracer is much more than a games business, and that's a strength. With the diversity of activities and stable revenue-generating businesses in the E&S and Mobile business areas in particular, we expect Embracer to deliver a steadier, more predictable revenue profile on a like-for-like basis going forward. These businesses share a lot of DNA, but they are different in terms of revenue and profit dynamics. In Q1, each business area grew, everyone. E&S grew the strongest, driven by PLAION Partners' physical business spanning software, hardware and retro -- true specialists. Cash EBIT showed a strong improvement, though the gross margin was notably lower year-on-year due to the sales mix. Going forward, sales or revenue mix between the business areas will be the primary variable driving gross margin and cash EBIT margin year-over-year. That's a mix effect, not a health question. The underlying businesses are performing.

Turning to the more detailed Embracer financials. The Embracer segment was the main driver of group top line performance with SEK 3.1 billion of net sales, representing 63% organic growth year-on-year. As Phil has mentioned, the PC/Console Games, Mobile and Entertainment & Services business areas all contributed to this growth. The very strong growth in the Entertainment & Services business area resulted in an adverse mix effect, which reduced the gross margin by 10 points to 49% for the quarter. Operating expenses, excluding marketing, declined to SEK 543 million. This was driven by targeted savings actions, including divestments over the last year. User acquisition costs for the quarter amounted to SEK 300 million, supporting revenue growth in Mobile. The increase in segment marketing costs resulted from higher release activity in PC/Console. CapEx of SEK 389 million was down SEK 76 million year-on-year, also benefiting from savings actions taken over the course of last year. Adjusted EBIT margins improved by 10 points due to the gross margin contribution of new releases in PC/Console and the effects of the OpEx savings. Cash EBIT for the quarter of SEK 136 million represents a significant improvement of over SEK 300 million year-on-year, with around SEK 40 million of that arising from the impact of decisions to divest or close certain entities over the course of last year.

Now to the Embracer pipeline, and it's packed full of fun. In the second quarter alone, we have several exciting releases: Hot Wheels: Infinite Rush from Milestone, Way of the Hunter 2 for console from Nine Rocks Games and THQ Nordic and the early access release of The Guild - Europa 1410 from Ashborne and THQ Nordic. Although not on this slide, I also want to spotlight REANIMAL, again, developed by the talented team at Tarsier and published by THQ Nordic. With solid continuing momentum, REANIMAL's main expansion, The Expanded World, will release in 3 chapters, and Chapter 1, The Prisoner, just launched on 7th of August. On top of that, there's a stream of new iterations of previous releases and asset care plays for some great IPs, as you can see here. This is an area where Embracer truly excels. Embracer today has the strongest, most focused PC/Console project pipeline it has had in years, with an improving ROI and profitability outlook. The strategy is decided, the portfolio is set. Now it comes down to execution and converting this pipeline into significantly higher profitability and cash generation, which is exactly what this team is built to do. And with that, I'll hand over to Muge to take us through the group financial performance.

As you've already seen this morning, we have delivered a strong start to the year with net sales for the quarter of SEK 3.9 billion, up 24% year-on-year and above our expectations. The top line performance was primarily driven by strong performance across all business areas in the Embracer segment, including the successful release of Gothic 1 Remake and partly offset by negative growth in the Fellowship segment due to a strong comparator we mentioned. Sales growth was also partly impacted by divestments, primarily from Arc Games, as well as moderate FX translation effects, which had a combined impact of around minus SEK 210 million for the quarter. Now if we exclude the divestment and FX impacts, our organic and pro forma net sales growth stands at 33%. The gross margin percentage for the quarter was 56%, down 12 points year-on-year. The primary driver is the revenue mix, with a higher proportion of revenues in the Entertainment & Services business area in Embracer and the lower revenue contribution from Publishing & Development in Fellowship. Operating expenses, excluding marketing costs, decreased from SEK 1.1 billion to SEK 972 million, supported by targeted savings actions, including divestments. User acquisition costs increased around SEK 80 million to SEK 300 million, supporting the sales growth seen in Mobile within the Embracer segment, while other marketing costs increased by around SEK 60 million due to higher release activity, also in Embracer. In total, operating cost as a percentage of net sales reduced by 10 points year-on-year. We're happy to maintain discipline and focus on our operating expenses. CapEx for the quarter amounted to SEK 677 million, down slightly from SEK 736 million in the prior year, driven by Embracer and largely stable since Q4. This results in cash EBIT for the quarter of SEK 47 million, up SEK 146 million year-on-year, a strong start to the year in the context of our expectations. Similar to the net sales drivers, the improvement is mainly driven by higher new release activity and the effects of savings actions in Embracer, partly offset by the effect of the strong KCD2 comparator in Fellowship. Moving on to cash flow. We delivered positive free cash flow for the quarter, a significant improvement compared to minus SEK 383 million in Q1 last year. On a trailing 12 months basis, free cash flow amounted to SEK 192 million, up almost SEK 400 million compared to last year. We're happy to see another quarter where TTM free cash flow continues to trend positively. The improvement was driven by improved profitability and lower CapEx, which I've described on previous slides. Lower tax payments and improved net working capital movements also contribute. Below free cash flow, cash flow from financing activities mainly relates to drawing of local facilities, but also includes an outflow of SEK 94 million related to the share buyback. The net cash flow from acquired or divested companies is primarily driven by earn-out payments. The earn-outs paid in Q1 cover the vast majority of earn-out obligations for the fiscal year. Total remaining obligations related to historical acquisitions amount to SEK 214 million. At quarter end, we have a net cash position of SEK 3.5 billion and total available funds of SEK 6.4 billion, taking into account undrawn facilities. Finally, looking ahead, we are reiterating our full year guidance of at least SEK 1 billion cash EBIT with improving confidence following our Q1 performance. For Q2, we expect cash EBIT improvement year-on-year following a similar pattern to Q1. Free cash flow is expected to be weighted still towards H2 with some seasonal buildup of working capital expected in Q2, with significant improvement in full year free cash flow generation in line with the improvement expected in cash EBIT. Overall, we're happy with the quarter, and we're working hard with our teams to continue delivering on the ongoing business while also preparing for the separation and spin-off of Fellowship. With that, I'll close out the presentation part of this morning's call, and we'll move on to Q&A. Operator, over to you.

[Operator Instructions] The first question is from Jesper Stugemo, Handelsbanken.

A few questions from my side. So first question is on the cash EBIT and CapEx here as more of the year-on-year cash EBIT improvements appear to come from lower CapEx and leases. How much of this lower investments should we view as structural versus quarterly phasing?

Thank you very much for the question. We had already mentioned during last quarter that we expected the CapEx levels to continue trending lower than last year. But I shall say, as the structuring group has already made big progress, the levels represent a higher portion of our underlying activity. So we don't expect big swings or big changes in the levels we are having on our CapEx levels now.

All right. That's clear. And secondly, on Fellowship and the Licensing business, if you could give some more color around this one, how large do you think it could be? What annual growth rates could we see in the next 3 years? And is this more a lumpy business for you?

That's a great question. I think it's too early right now to predict sort of percentages and get overly precise. I think what we see is, as we mentioned, it's a very durable and we believe high-margin revenue stream. We're getting going with it. And we've got a number of initiatives right now between the sort of further out and the nearer term. And we'll see growth certainly in the quarter we're in now when we get through the launch tomorrow of Magic the Gathering: The Hobbit. But we see it as really something that can grow well for us. If we look at other licensing streams from different organizations and see how they've approached and sort of scale they get, we certainly see that's well within our reach. But I don't think right now it's the time to get drawn on particular growth rates. Will it be lumpy? I think there can be some element of lumpiness. Of course, it all depends on the relative scale you're looking at. We certainly see growth. We see the importance of building up a broader portfolio on the Licensing. We have a broader portfolio now. But of course, a lot of the focus is always on The Lord of the Rings and The Hobbit primarily, but we have more Licensing opportunities, and we're executing on that on a number of our IPs. So I think we'll, over time, come and present back more on this business, but certainly see big growth opportunities for us.

Okay. And it would be interesting to hear your view on Sony's decision here to stop support physical copies. What implications you see from this given that you had quite good sales growth in Entertainment & Services from distribution in this quarter?

Yes. I think we know it's something we -- I guess we've always known in some ways is potentially this can happen. So to get that news out and delivered is something now that we're planning hard for. I think firstly to say with our physical distribution businesses, there is always already today a natural diversity. We have distribution of retro products. We're also distributing physical consoles as well. So I think it's too early to get too precise again on what that could mean for us, especially if other solutions, it's going to be interesting to see from a broader perspective how the code in box works with GTA and what a great example that could be to see how that sort of trends going forward. But we're always adapting, and we'll judge the impact over time.

The next question is from Rasmus Engberg, Kepler Cheuvreux.

Just on the guidance for the second quarter. So you don't have any real releases of any significant size. But so the driver for the better profit is a combination of is it the Licensing and lower costs and CapEx? Or what is the sort of -- how does that play out in your guidance?

First, we had already indicated that the first part of the year would be more quieter because, as you know, primarily Metro has already lined up in the second part. But as you have seen today, Embracer segment, for example, has contributed on all business areas to both sales and earnings growth. And we expect the following quarters to benefit from all our business areas. It will be a combination of both new releases, which are lined up in the coming quarters with different depth as well as the underlying performance, so the catalog performance and obviously, the right level of CapEx monitoring. So we don't expect any surprise or it isn't relied on any unexpected or uncommon initiative, if you will.

So basically, if I was trying to take the 2 businesses separately, there is Licensing to help in Fellowship and then in both businesses, I guess, or you have the current momentum in Embracer Group then, so from Mobile and the releases you had in the previous quarter? Is that how it works or...

The momentum in Embracer is correct. On our Fellowship activity, we expect to benefit from Licensing, but our PC/Console activity is also expected to contribute to our [ year-to-date ] growth with the releases we've shared earlier.

But I mean, just in the coming quarter, there isn't anything from Fellowship, right?

No major release.

The next question is from Simon Jonsson, ABG.

I just have a question on the new game from Warhorse scheduled for next year. If I understand correctly, this is a Kingdom Come game. Can you maybe elaborate a bit on how long it has been in development and the scope of the game given the short time line since the last game?

Yes, I'll take that question. Thanks, Simon. It's a big game. When we talked about this in May, I think we wanted to sort of make that announcement in May, really is quite symbolic because it helps put color on the Fellowship pipeline. But it really is for the game team to talk more about the title with the right time with players. But we think it's something that if you stand back, we've got a great player count now through the Kingdom Come: Deliverance II. We see through their play styles, what they're looking for. So you can imagine we're building something really that's going to, we believe, hopefully excite the audience in that Kingdom Come sort of setting. So -- but it's a full-size game. I mean this is what Warhorse is supreme at building these rich, really vast open-world sims, and it's something we're very excited about. As for development time, it's been in development for quite some time. It's a full project. And it's going to have a very -- this is part of our planning to have that better cadence coming off Kingdom Come: Deliverance II. There's a lot of smart work between the respective teams. And that's really when we talk about the rhythm and the structural changes, but primarily, it's by having world-class studios like Warhorse who can really deliver in that way. So it's -- I'm excited. So I hope you will be soon.

And when you say it's like a full-sized game, does that mean like a regular sequel? Or could there be some kind of spin-off?