Turtle Beach Corporation — Q2 2017 Form 10-Q
Reporting period: Three and six months ended June 30, 2017. Amounts below are in U.S. dollars; financial statement amounts are in millions unless stated otherwise.
Business context
Turtle Beach sells gaming headsets under its Turtle Beach brand and directional-audio technology under HyperSound. Headsets are the principal business; HyperSound revenue remained minimal as the company shifted that business toward licensing and substantially completed a restructuring. Headset sales are seasonal, with management stating that historically more than half of annual headset revenue is generated from September through December.
Financial performance
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Revenue | $19.1 | $29.4 | $33.5 | $53.4 |
| Gross profit | $6.3 | $5.1 | $8.5 | $8.5 |
| Operating loss | $(5.0) | $(40.5) | $(13.1) | $(50.3) |
| Net loss | $(7.1) | $(42.6) | $(17.0) | $(54.6) |
| Adjusted EBITDA (non-GAAP) | $(2.8) | $(6.3) | $(9.0) | $(12.6) |
| Operating cash flow | Not presented by quarter | $26.6 | $18.2 |
Revenue fell 34.5% in Q2 and 37.0% in the first half. Headset segment revenue accounted for nearly all sales. Headset gross margin improved to 33.3% in Q2 from 24.5%, and to 27.4% for the first half from 22.5%. Management cited product mix, lower logistics and obsolescence costs, and reduced returns; Q2 margin also benefited from a nonrecurring $0.5 million royalty adjustment. First-half fixed-cost leverage on lower volume partly offset the improvement.
The much smaller reported losses versus 2016 chiefly reflect the prior-year $31.2 million goodwill and intangible-asset impairment, rather than a return to profitability. Adjusted EBITDA remained negative. Q2 2017 Headset operating loss was $4.5 million, compared with $4.4 million a year earlier.
Balance sheet, cash flow and liquidity
- Cash was $1.2 million at June 30, down from $6.2 million at year-end 2016. First-half operating cash flow of $26.6 million was substantially offset by $31.2 million of financing outflows and $0.5 million of capital spending. The operating cash inflow included a $47.1 million reduction in accounts receivable.
- Total debt carrying value was $37.4 million, down from $66.9 million at year-end. This included $5.2 million drawn on the revolving facility, $12.9 million in term loans and $19.3 million in related-party subordinated notes. The company also reported $18.2 million of Series B redeemable preferred stock.
- Stockholders’ deficit was $36.7 million. The company reported approximately $3.9 million of excess borrowing availability, net of the Term Loan Due 2018 amount treated as an additional facility obligation, and stated it was compliant with amended financial covenants.
- Management said cash, revolver availability, financing proceeds and operating cash flows should be sufficient for anticipated working capital and capital expenditures for at least 12 months. This assessment depends on assumptions, including no material adverse developments.
Changes, outlook and key risks
Management attributed lower sales to weak gaming demand, a slow 2016 holiday season, retailer efforts to reduce inventory, and consumer purchasing delays around mid-cycle console releases and anticipated technology. It expected the Xbox One X launch in the 2017 holiday season to support gaming engagement, but provided no specific financial guidance. Management also said some first-half sales were believed to have shifted into the second half.
Key exposures include the company’s low cash balance, limited borrowing availability, debt and covenant requirements, seasonal sales concentration, dependence on major customers and third-party gaming platforms, and reliance on suppliers and manufacturing in China. Management warned that a covenant breach could permit lenders to restrict borrowing or accelerate repayment. HyperSound has generated little revenue, and future licensing success is uncertain.
Contingencies include a preferred-stock redemption lawsuit seeking damages and redemption (the reported preferred-stock redemption value was $18.2 million), a German distributor claim seeking €5.0 million plus interest and additional damages, and shareholder litigation related to the merger. No accrual was recorded for these matters because management considered losses possible but not probable and said a loss range could not be reasonably estimated. The XO FOUR Stealth headset recall may also result in further costs or CPSC penalties; the possible loss was not estimable.
Nasdaq notified the company in May 2017 that its share price had been below the $1.00 minimum bid for 30 consecutive business days. The stated compliance deadline was November 6, 2017. The company reported effective disclosure controls and internal control over financial reporting as of June 30, 2017.
Important facts for investors to verify
- Whether second-half and holiday-season sales recovered as management expected, and how retailer inventory levels affected orders.
- Whether cash generation, borrowing availability and covenant compliance remained adequate despite the low cash balance and continuing operating losses.
- The terms, interest burden and maturity obligations of the term loans and related-party subordinated notes, and any subsequent financing or warrant dilution.
- Developments and potential financial exposure in the preferred-stock, shareholder and BigBen disputes, as well as the headset recall.
- Whether the company regained Nasdaq’s minimum-bid-price compliance by the stated deadline and whether HyperSound licensing produced meaningful revenue.