Turtle Beach Corporation — Q1 2018 Form 10-Q
Business context and period. The unaudited quarter ended March 31, 2018. Turtle Beach primarily sells gaming headsets; its smaller HyperSound segment develops directional-audio technology. Results are seasonal, with management stating that historically 45%–55% of annual headset business occurs in the fourth quarter.
Financial performance and position
| Metric | Q1 2018 | Q1 2017 / comparison |
|---|---|---|
| Net revenue | $40.9 million | $14.4 million; up $26.5 million, nearly 3x |
| Gross profit / margin | $15.0 million / 36.8% | $2.2 million / 15.4% |
| Operating income (loss) | $3.8 million | $(8.1) million |
| Net income (loss) | $2.0 million; $0.16 per diluted share | $(9.9) million; $(0.81) per diluted share |
| Adjusted EBITDA (non-GAAP) | $5.3 million | $(6.2) million |
| Cash from operations | $38.0 million | $33.4 million |
Revenue and margin gains reflected higher sales volumes and fixed-cost leverage, along with a less promotional environment. Management attributed stronger consumer demand in part to Fortnite and PlayerUnknown’s Battlegrounds. Headset revenue was $40.9 million; HyperSound revenue was $18,000. Cash margin, a non-GAAP measure, was 37.1%, versus 15.7%.
At March 31, cash was $4.3 million, down from $5.2 million at year-end. Current assets were $45.4 million and current liabilities $21.1 million. Operating cash flow was supported by collections and inventory reductions: accounts receivable fell to $21.8 million from $50.5 million, and inventory to $15.8 million from $27.5 million. Investing used $0.4 million; financing used $38.5 million, principally net revolver repayments and term-loan repayments.
Reported outstanding debt was $32.7 million, comprising the revolving facility, term loans and related-party subordinated notes. Separately, Series B redeemable preferred stock had a $19.3 million redemption value. Stockholders’ deficit was $20.4 million. The company reported approximately $19.6 million of excess borrowing availability and compliance with its financial covenants at quarter-end.
Material changes and notable events
- Compared with Q1 2017, revenue, gross margin and operating results improved substantially, turning a net loss into net income. There were no restructuring charges in Q1 2018, compared with $0.3 million in the prior-year quarter.
- On March 5, the company refinanced and extended its revolving and term-loan arrangements. The new revolving facility provides up to $60 million, subject to a borrowing base, and matures in 2023. A replacement term loan permits up to $12.5 million and also matures in 2023.
- After quarter-end, the company drew an additional $3.3 million under the term loan on May 2 and repaid $3.3 million of a related-party subordinated note on May 4.
- On April 23, the company agreed to exchange its Series B preferred stock for 1,307,143 common shares and pre-funded warrants for 550,000 shares, and settled related claims. It paid $1.0 million and may owe another $1.25 million if a specified change-of-control transaction occurs within three years. The preferred shares were retired April 26; the transaction is to be accounted for in Q2.
- The company adopted ASC 606 using the modified retrospective method, reducing opening retained earnings by $0.6 million. It expected no material ongoing impact on results.
- A one-for-four reverse stock split took effect April 6, 2018. The filing states that share amounts and related computations were retroactively adjusted.
Outlook, risks and contingencies
Management did not provide specific numerical revenue or earnings guidance in the supplied filing text. It said cash, operating cash flow and borrowing availability should cover anticipated working-capital and capital-expenditure needs for at least the next 12 months, assuming no material adverse developments. The business remains exposed to seasonal demand, game and console cycles, retailer demand, product returns, competition, and dependence on third-party platforms, manufacturers and suppliers. The company also highlighted reliance on asset-based borrowing and the risk of covenant noncompliance; substantially all assets secure its debt.
The company was defending a shareholder lawsuit and a German commercial dispute in which Bigben sought €5.0 million plus interest and additional damages. No accrual was recorded because losses were considered possible but not probable, and the possible loss range could not be reasonably estimated. The company stated an unfavorable outcome could materially affect its business, results, financial condition or cash flows. It was also subject to an IRS examination of its 2015 federal return and reported $2.3 million of uncertain tax positions, including interest and penalties.
Interest expense increased year over year, which management attributed mainly to higher borrowing costs and compounding of subordinated notes and preferred stock. The company reported effective disclosure controls and internal control over financial reporting as of March 31, 2018.
Investor verification priorities
- Verify whether the strong headset demand and margin improvement persisted beyond Q1, accounting for the business’s pronounced holiday seasonality and reliance on hit game releases.
- Review borrowing-base availability, covenant headroom, interest costs and the effects of the May term-loan draw and related-party note repayment.
- Assess dilution and settlement accounting from the preferred-stock exchange, common-share issuance and pre-funded warrants; confirm the post-reverse-split share counts.
- Track the shareholder and Bigben litigation, including any change in estimated loss exposure or accruals.
- Monitor accounts receivable, inventory, returns and customer concentration, which can affect both operating cash flow and asset-based borrowing capacity.