Turtle Beach Corporation — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016. Amounts are in U.S. dollars; financial statement amounts are in millions unless otherwise noted. The filing is unaudited.
Business context
Turtle Beach sells gaming headsets and HyperSound directional-audio products. Headsets generated nearly all revenue. HyperSound sales were slower than expected as hearing-care offices required more training and support than anticipated. The company began restructuring HyperSound and exploring strategic alternatives, including a shift toward licensing.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $38.4 | $35.9 | $91.8 | $78.2 |
| Gross profit | $3.9 | $9.6 | $12.4 | $16.1 |
| Operating loss | $(42.7) | $(5.8) | $(93.0) | $(30.9) |
| Net loss | $(44.8) | $(15.9) | $(99.4) | $(36.4) |
| Net loss per share | $(0.91) | $(0.38) | $(2.05) | $(0.86) |
| Adjusted EBITDA, non-GAAP | $0.5 | $(3.3) | $(12.1) | $(21.3) |
- Revenue increased 7% in Q3 and 17% year to date, driven by new-generation headset demand, particularly in North America and Europe. Headset gross margin rose to 33.3% in Q3 from 27.8%, and to 27.0% for nine months from 21.7%.
- Consolidated gross margin fell to approximately 10% in Q3 from 27% a year earlier, and to approximately 14% for nine months from 21%. HyperSound’s gross loss included a $7.1 million inventory reserve tied to its strategic alternatives and transition plans.
- Reported losses include $32.1 million of Q3 intangible-asset impairment and $63.2 million of impairment charges for the nine-month period. The latter includes $31.2 million of HyperSound goodwill impairment recorded in Q2 and $32.1 million of intangible impairment recorded in Q3.
- Cash from operating activities was $3.1 million for nine months, versus cash used of $10.9 million in 2015. The filing attributes the improvement to higher sales and margins, cost savings, reduced HyperSound cash burn and improved collections. Investing activities used $2.3 million; financing activities used $4.6 million.
Financial position and liquidity
- At September 30, cash was $3.3 million, down from $7.1 million at year-end 2015. Current assets were $83.5 million and current liabilities were $79.7 million.
- Total debt was $57.0 million, comprising $26.3 million drawn on the revolving facility, $14.8 million in term loans and $18.8 million of subordinated notes before related discounts and fees. Series B redeemable preferred stock, reported separately, had a $17.1 million redemption value.
- Stockholders’ equity was a deficit of $33.6 million, compared with positive equity of $56.7 million at year-end 2015. The company issued 6.7 million shares in an offering and private placement, receiving approximately $6.0 million net; proceeds were used to reduce the revolver.
- The company reported approximately $9.4 million of excess borrowing availability and compliance with amended financial covenants at September 30. Management stated that cash, credit availability and anticipated operating cash flows were expected to meet working-capital and capital-expenditure needs for at least 12 months, subject to assumptions including no material adverse business developments.
Changes, outlook and notable matters
- Headset performance improved, but HyperSound’s slow sales and resource-intensive sales channel led to a strategic review, cost reductions and a planned licensing-oriented model. The filing gives no quantified revenue or earnings guidance.
- On October 31, 2016, after quarter-end, the company amended its credit arrangements, including revised financial and cash-flow requirements. The amendments provide for a potential $2 million subordinated loan from an affiliate of a major shareholder if borrowing availability falls below specified levels; any funding would carry high interest and warrant consideration.
- The company’s gaming-headset business is seasonal, with historically more than half of annual headset revenue generated from September through December. Management cited continued demand for new-generation products but warned that sales depend on console platforms, consumer demand and holiday-season execution.
- Two shareholder-related legal matters remain disclosed. The company recorded no accrual, stating losses were not considered probable; any possible loss range was not reasonably estimable. A voluntary recall of certain XO FOUR Stealth headsets remains ongoing; possible additional costs and CPSC penalties could not be estimated.
- Disclosure controls were not effective at September 30 because a previously identified material weakness related to review of goodwill-impairment assumptions had not been fully remediated. Management said remediation was in progress.
Important facts for investors to verify
- Whether the October 31 lender amendments and potential affiliate financing provide adequate liquidity, and whether the company can meet revised cash-flow and covenant requirements.
- Whether holiday-season headset sales, gross margins and cash generation support management’s 12-month liquidity assessment.
- Progress and economics of the HyperSound restructuring or strategic alternatives, including the viability of licensing and the risk of further impairment or cash needs.
- Remaining exposure from the XO FOUR Stealth recall and the disclosed shareholder litigation.
- Remediation and testing of the material weakness in financial reporting controls, particularly impairment analysis and assumptions.