Turtle Beach Corporation (NASDAQ: HEAR) — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019. Unaudited results; dollar amounts below are in millions except per-share data.
Business context
Turtle Beach sells gaming headsets under the Turtle Beach brand and, following its May 31 acquisition, PC gaming peripherals under ROCCAT. Results are seasonal, with management indicating that historically 45%–55% of sales occur in the fourth quarter. The comparable prior-year period benefited from unusually strong demand associated with battle royale games.
Financial performance
| Metric | Q2 2019 | Q2 2018 | H1 2019 | H1 2018 |
|---|---|---|---|---|
| Revenue | $41.3 | $60.8 | $86.2 | $101.7 |
| Gross profit | $13.2 | $20.3 | $28.0 | $35.3 |
| Gross margin | 31.9% | 33.3% | 32.4% | 34.7% |
| Operating income (loss) | $(2.3) | $8.3 | $(0.5) | $12.1 |
| Net income (loss) | $(2.4) | $(2.3) | $0.7 | $(0.4) |
| Adjusted EBITDA (non-GAAP) | $1.6 | $9.8 | $5.9 | $15.1 |
Q2 revenue fell 32% year over year; first-half revenue fell 15%. Management attributed the declines mainly to comparison with prior-year record demand. Gross margins were pressured by product mix, promotional activity, refurbishment and warehouse costs, and lower volume leverage; lower freight costs and, for the first half, reduced royalties partly offset the pressure. Adjusted EBITDA also declined, reflecting lower sales and increased marketing and other expenses.
Q2 operating expenses were $15.5 million, up from $12.0 million, including $1.6 million of acquisition-related costs. First-half operating expenses were $28.5 million versus $23.3 million, including $2.3 million of acquisition costs. Selling and marketing spending rose with the Recon 70 launch and esports and digital initiatives; R&D and G&A also increased.
Q2 basic and diluted loss per share was $0.16, compared with a $0.17 loss. First-half basic EPS was $0.05; diluted EPS was $(0.06). The filing’s diluted calculation adjusts the first-half numerator for a $1.6 million unrealized warrant gain, so diluted EPS differs from basic EPS.
Cash flow, debt and liquidity
- First-half operating cash flow was $38.2 million, versus $46.3 million. The 2019 figure included a $41.0 million cash-flow benefit from lower accounts receivable, so it should not be read as recurring earnings-based cash generation.
- Investing cash outflow was $13.7 million, including $12.7 million for ROCCAT. Financing cash outflow was $28.1 million, including $26.6 million of net revolving-credit repayments and $1.5 million of share repurchases.
- Cash at June 30 was $3.4 million, down from $7.1 million at year-end. Inventory was $50.4 million, compared with $49.5 million.
- Revolver borrowings were $10.8 million, down from $37.4 million at year-end. The facility matures in March 2024; excess borrowing availability was approximately $20.0 million. The company reported compliance with its covenants. Borrowings were secured by substantially all company assets.
- Management said cash, facility availability and operating cash flows should fund working capital and capital expenditures for at least the next 12 months, assuming no material adverse developments.
Acquisition, outlook and key risks
Turtle Beach acquired ROCCAT for approximately $12.7 million in cash, with up to $3.4 million in revenue-based earn-outs. ROCCAT contributed $1.3 million of revenue and a $0.4 million operating loss during the reported period. The purchase-price allocation was preliminary. The company recorded $5.9 million of goodwill and $7.5 million of acquired identifiable intangibles.
No numerical full-year guidance is provided in the filing. Management cited continued consumer sell-through and a larger installed base of headset users, while noting a softer gaming-accessory market and a more promotional environment. It reported 41.9% North American console-market revenue share for the first half and said the Stealth 600 remained the top-selling console model.
Principal risks include reliance on third-party consoles, games and platform compatibility; seasonal demand and inventory forecasting; competition and price protection; dependence on customers and third-party manufacturers; potential tariffs on products made in China and Brexit-related uncertainty; and integration and realization of benefits from ROCCAT. The company also noted covenant and borrowing-base constraints. A shareholder class action was scheduled for trial in November 2019. Bigben’s €5.0 million commercial claim had been dismissed by a German court, but Bigben appealed; no loss accrual was recorded for these matters because losses were not considered probable, and a possible loss range could not be estimated.
Important facts for investors to verify
- Whether revenue, margins and adjusted EBITDA stabilize after the unusually strong 2018 comparison period.
- Whether operating cash flow remains adequate after the substantial first-half receivables collection benefit, and how inventory sells through.
- ROCCAT’s integration, subsequent contribution to revenue and profit, final purchase accounting, and any earn-out payments.
- Borrowing availability, covenant compliance and the effect of seasonal working-capital needs on liquidity.
- Developments in the shareholder litigation and Bigben appeal, plus any changes in the company’s risk outlook or guidance.