Turtle Beach Corporation — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Financial statements are unaudited. Turtle Beach sells gaming headsets and accessories; HyperSound is a separate, very small business segment.
Financial performance
| Metric | Q2 2018 | Q2 2017 | First six months 2018 | First six months 2017 |
|---|---|---|---|---|
| Revenue | $60.8 million | $19.1 million | $101.7 million | $33.5 million |
| Gross profit / margin | $20.3 million / 33.3% | $6.3 million / 33.0% | $35.3 million / 34.7% | $8.5 million / 25.5% |
| Operating income (loss) | $8.3 million | $(5.0) million | $12.1 million | $(13.1) million |
| Net income (loss) | $6.3 million | $(7.1) million | $8.3 million | $(17.0) million |
| Diluted EPS | $0.40 | $(0.57) | $0.56 | $(1.38) |
| Adjusted EBITDA | $9.8 million | $(2.8) million | $15.1 million | $(9.0) million |
Six-month operating cash flow was $46.3 million, versus $26.6 million a year earlier. Investing used $0.4 million and financing used $42.0 million; cash increased by $3.9 million to $9.1 million.
At June 30, cash was $9.1 million, current assets were $76.9 million and current liabilities were $44.4 million. Total debt was $30.9 million: $11.8 million of term loans, net of financing costs, and $19.1 million of related-party subordinated notes, net of discount. There were no revolver borrowings; stated excess borrowing availability was approximately $30.5 million. Stockholders’ equity was $5.0 million, compared with a $22.2 million deficit at year-end 2017.
Changes versus the prior period
- Revenue more than tripled in both the quarter and first half. Management attributed demand to the popularity of Fortnite and PlayerUnknown’s Battlegrounds, with higher sales across channels and strong demand for specified headset lines.
- First-half gross margin rose 9.2 percentage points, attributed to higher-volume fixed-cost leverage and a less promotional environment. Q2 margin improved only 0.3 percentage points; management said $2.8 million of incremental air freight partly offset benefits from volume and lower obsolescence reserves.
- Operating expenses rose to $23.3 million for the first half from $21.6 million, including increased selling and marketing spending; as a share of revenue, expenses fell substantially with revenue growth.
- On March 5, the company refinanced its revolving facility and term loan, extending maturities to 2023 and reducing the term-loan rate relative to the prior facility. It repaid $38.5 million net on the revolver during the first half.
- Series B preferred stock was retired in April in exchange for 1.307 million common shares and pre-funded warrants for 550,000 shares, with a $1.0 million cash settlement payment. The transaction removed the preferred stock balance but increased potential common-stock dilution.
Outlook, risks and unusual items
- No specific revenue or earnings guidance is provided. Management said cash, revolver availability and operating cash flow should meet anticipated working-capital and capital-expenditure needs for at least 12 months, subject to assumptions including no material adverse developments.
- Gaming headset sales are seasonal; historically, 45%–55% of business occurs in the fourth quarter. Results depend on game launches, console platforms and consumer demand, so interim results may not indicate full-year performance.
- Debt facilities carry monthly financial covenants, restrictions on activities and liens on substantially all assets. The company reported covenant compliance at June 30; noncompliance could permit acceleration of debt. The asset-based revolver’s availability depends on eligible receivables and inventory.
- Related-party subordinated notes bear payment-in-kind interest. After quarter-end, on August 3, 2018, the company paid down an additional $5.0 million using operating funds.
- Two disclosed legal matters remain unresolved: a shareholder action with trial set for November 2019, and a German distributor claim seeking €5.0 million plus interest and other damages. No loss accrual was recorded; the company said a possible loss range could not be reasonably estimated.
- Other stated risks include dependence on a small number of customers (the three largest represented approximately 43% of 2017 gross sales), third-party gaming platforms and suppliers, manufacturing in China, product returns and inventory, and competition. The first-half tax rate was affected by a full valuation allowance on domestic earnings, foreign tax benefits and state tax expense.
- The company adopted revenue standard ASC 606 in 2018 using the modified retrospective method, reducing opening retained earnings by $0.6 million; management expected no material ongoing impact. A one-for-four reverse stock split took effect April 6, 2018; share data was retrospectively adjusted.
Important facts for investors to verify
- Whether game-driven headset demand and the improved gross margin persist, particularly through the seasonal holiday period.
- Whether operating cash flow converts sustainably to cash after inventory, freight and customer-return requirements.
- Debt balances, payment-in-kind interest, borrowing-base availability and continuing compliance with monthly loan covenants.
- The dilution and settlement terms related to the preferred-stock exchange, pre-funded warrants and other outstanding equity awards.
- Developments in the shareholder and Bigben litigation, including any change in estimated exposure.