Turtle Beach Corporation — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018. The filing was signed November 6, 2018. The company sells Turtle Beach gaming headsets and accessories and also reports its HyperSound business.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $74.4 million | $36.0 million | $176.1 million | $69.4 million |
| Gross profit / margin | $30.5 million / 41.0% | $12.5 million / 34.9% | $65.8 million / 37.4% | $21.1 million / 30.3% |
| Operating income (loss) | $16.5 million | $1.9 million | $28.6 million | $(11.2) million |
| Net income (loss) | $14.7 million | $(0.5) million | $23.0 million | $(17.5) million |
| Diluted EPS | $0.91 | $(0.04) | $1.56 | $(1.42) |
| Adjusted EBITDA | $17.6 million | $3.3 million | $32.7 million | $(5.7) million |
Management attributed the strong growth to demand associated with Fortnite and PlayerUnknown’s Battlegrounds, increased sales across channels, improved product and customer mix, and fixed-cost leverage. Nine-month gross margin improvement was partly offset by $3.1 million of incremental air freight. Selling and marketing expense rose in dollars but declined as a share of revenue for the nine-month period, from 22.4% to 12.1%.
Cash, liquidity and debt
- Nine-month operating cash flow was $43.4 million, versus $9.3 million in 2017; capital expenditures were $2.0 million. Cash ended the period at $6.2 million.
- At September 30, current assets were $113.7 million and current liabilities were $67.9 million. Inventory was $73.3 million, up from $27.5 million at year-end 2017.
- Reported outstanding debt was $30.1 million, down from $70.3 million at December 31, 2017. This included $3.5 million drawn on the revolving facility, $12.5 million in term loans and $15.4 million principal on related-party subordinated notes.
- The revolving facility provides up to $60 million, subject to its borrowing base; reported excess availability was approximately $55.8 million. The company said it was compliant with applicable financial covenants and believed cash, facility availability and operating cash flows would meet anticipated working-capital and capital-expenditure needs for at least 12 months.
Material changes and significant items
- Revenue more than doubled in both the quarter and nine-month comparison, with the Headset segment accounting for nearly all revenue. HyperSound revenue was only $21,000 in Q3 and $39,000 year to date.
- Debt declined following refinancing and repayments. The company entered new revolving and term loan arrangements in March 2018. It repaid $5 million of subordinated notes in August and a further $5 million on October 12, 2018, after quarter-end; management reported the related-party note balance then reduced to $10.4 million.
- Series B redeemable preferred stock was retired in April through an exchange for 1.307 million common shares and warrants for 550,000 shares. The company also paid $1.0 million to settle related claims and could owe an additional $1.25 million if a qualifying change of control occurs within three years.
- Adoption of the new revenue recognition standard reduced beginning retained earnings by $0.6 million; the company expected no material ongoing impact on results.
Outlook, risks and contingencies
The filing provides no specific revenue or earnings guidance. Management highlighted gaming headset seasonality, with typically 45%–55% of annual business in the fourth quarter, and dependence on the popularity and timing of game releases, console platforms and customer demand. It also cited potential inventory, product-return, supply-chain, customer-concentration, competition, foreign-exchange and trade/tariff risks; most production occurs in China. The substantial inventory build and the seasonal sales pattern make demand forecasting especially relevant.
The company disclosed a continuing stockholder lawsuit with trial scheduled for November 2019 and a German distributor dispute claiming €5.0 million plus interest and additional damages. No loss accrual was recorded because management considered losses possible but not probable; a possible loss range could not be reasonably estimated. The company also said a potential ownership change after September 30 might limit use of certain tax attributes, including net operating losses. Management reported effective disclosure controls and internal control over financial reporting as of September 30.
Important facts for investors to verify
- Whether the exceptional headset demand and margin improvement continued beyond Q3, particularly through the seasonally important holiday quarter.
- Whether inventory levels, sales returns and freight costs remain manageable as demand and supply normalize.
- Current borrowing-base availability, covenant headroom and progress on repayment of the high-cost related-party notes.
- Developments in the stockholder and German distributor litigation, and the potential change-of-control settlement payment.
- The impact, if any, of a post-quarter ownership change on tax attributes and the company’s future tax expense.