Turtle Beach Corporation — Q3 2015 Form 10-Q
Reporting period: Three and nine months ended September 30, 2015. Financial amounts below are in millions unless stated otherwise. Turtle Beach sells gaming headsets and related products; HyperSound develops directional-audio products, including a planned hearing-healthcare product.
Financial performance and liquidity
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Revenue | $35.9 | $33.3 | $78.2 | $93.9 |
| Gross profit / margin | $9.6 / 26.7% | $7.7 / 23.3% | $16.1 / 20.6% | $24.9 / 26.5% |
| Operating loss | $(5.8) | $(7.3) | $(30.9) | $(21.0) |
| Net loss | $(15.9) | $(5.6) | $(36.4) | $(17.8) |
| Adjusted EBITDA, non-GAAP | $(3.3) | $(4.5) | $(21.3) | $(8.4) |
- Q3 revenue increased 7.7%, led by next-generation Xbox One headsets and stronger domestic sales. Gross margin improved on product and channel mix, partly offset by royalties and promotional credits.
- Nine-month revenue fell 16.7%, and gross margin declined, reflecting lower prior-generation sales, the prior-year launch-related sell-in benefit, promotional activity, manufacturing transition costs, and $1.3 million in reserves for discontinued legacy-license products.
- Q3 net loss widened despite improved operating loss, primarily alongside $8.2 million of income tax expense. The company recorded a full valuation allowance on its U.S. and U.K. deferred tax assets; the filing also identifies discrete tax items, including an IRS-related reserve release.
- Cash was $3.1 million at September 30, versus $7.9 million at year-end 2014. Operating cash outflow was $10.9 million for the nine months; capital expenditures were $4.2 million. Current assets were $93.8 million and current liabilities $84.2 million.
- Total debt was $55.4 million, including $20.6 million under the revolving facility, $21.4 million in term loans and $13.3 million in related-party subordinated notes. The balance sheet classified the $21.4 million term-loan balance as current. Excess borrowing availability was reported at approximately $13.3 million, subject to borrowing-base terms.
Material changes, outlook and risks
- Headset revenue was $35.7 million in Q3 and $77.8 million year to date. HyperSound revenue remained small at $0.2 million in Q3 and $0.4 million year to date; HyperSound generated a $3.8 million Q3 operating loss and a $10.4 million nine-month operating loss.
- Management cited increased HyperSound spending to develop and launch HyperSound Clear, including sales-force and R&D investment. It reported strong initial pre-orders and planned initial fulfillment through distribution partners, but gave no specific financial guidance.
- Liquidity and covenant concern: The company said it would not meet the Term Loan Due 2019 minimum EBITDA covenant for September 30. Amendments dated November 2, 2015 suspended and replaced certain financial covenants through November 30; management said compliance after that date was not expected and it was negotiating further amendments. It warned that failure to reach an agreement could adversely affect liquidity and operations. Management’s stated plans included debt amendments, additional capital-market funding and HyperSound revenue. The filing states there can be no assurance of a resolution.
- Management believed available cash, credit and operating cash flows would cover anticipated needs for at least 12 months, but that assessment depended on assumptions and was subject to the covenant uncertainty. The filing was prepared on a going-concern basis and did not include adjustments for a potentially adverse outcome.
- In July, Turtle Beach obtained a $15 million term loan bearing interest at 90-day LIBOR plus 10.25%; related-party subordinated notes were amended to mature in 2019 at LIBOR plus 10.5%, with payment-in-kind interest. The company issued warrants for 1.7 million shares at $2.54 per share as part of those note concessions.
- A voluntary recall of certain XO FOUR Stealth headsets followed reports of mold on ear pads. The company had stopped shipments and sales pending investigation and was working with its manufacturer on replacement units and reimbursement of certain costs.
- Contingencies include a shareholder class action related to the 2014 merger and a preferred-stock holder’s claim seeking redemption damages of $15.1 million. No loss accrual was recorded; the company said outcomes and any possible loss range could not be estimated reliably.
Important facts for investors to verify
- Whether lenders agreed to further covenant amendments after November 30, 2015, and the resulting borrowing availability and debt classification.
- Actual holiday-season headset sales, returns, margins and cash conversion, given the business’s seasonality and the reported inventory increase to $49.7 million.
- HyperSound Clear launch timing, order fulfillment, regulatory compliance and revenue contribution relative to ongoing investment and impairment risk.
- Financial and operational costs of the XO FOUR Stealth recall, and the status or potential exposure of the shareholder and preferred-stock litigation.
- Related-party note terms, required prepayments, warrant dilution and any additional financing or equity issuance.