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Turtle Beach Corp (HEAR) Q2 2019 Earnings Call Transcript

By Motley Fool Transcribers - Aug 12, 2019 at 5:56PM

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HEAR earnings call for the period ending June 30, 2019.

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Turtle Beach Corp  (HEAR 10.69%)
Q2 2019 Earnings Call
Aug. 12, 2019, 5:00 p.m. ET


  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Good day, ladies and gentlemen and welcome to the Turtle Beach Second Quarter 2019 Conference Call. [Operator Instructions] As a reminder, this call is being recorded.

Before we get started, we'll be referring to the press release filed today that details the company's second quarter 2019 results, can be downloaded from their Investor Relations page at On that website you will also find an earnings presentation that supplements the information to be discussed on today's call. Finally, a recording of the call will be available on Investor Relations section of the company's website later this evening.

Please be aware that some of the comments made during this call may include forward-looking statements within the meaning of the federal security laws. Statements about the company's beliefs and expectations containing words such as may, will, could, believe, expect, anticipate and similar expressions constitute forward-looking statements. These statements involve risks and uncertainties regarding the company's operations and future results that could cause Turtle Beach Corporation's results to differ materially from the management's current expectations.

The company encourages you to review the safe harbor statements and risk factors contained in today's press release and in their filings with the Securities and Exchange Commission. Including without limitation, their most recent quarterly report on Form 10-Q, Annual Report on Form 10-K and other periodic reports, which identify specific risk factors that also may cause actual results or events to differ materially from those described in forward-looking statements.

The company does not undertake to publicly update or revise any forward-looking statements after the date of this conference call. The company also notes that on this call, they will be discussing non-GAAP financial information. The company is providing that information as a supplement to information prepared in accordance with accounting principles generally accepted in the United States or GAAP. You can find a reconciliation of these metrics to their reported GAAP results in and the reconciliation tables provided in today's earnings release and presentation.

And now, I'll turn the call over to Juergen, the company's Chief Executive Officer. Mr. Juergen Stark.

Juergen Stark -- Chief Executive Officer

Good afternoon, everyone, and thank you for joining us. We're pleased with the results we achieved in the second quarter. Revenues were right in the middle of our guidance range and earnings slightly higher, resulting in best Q2 financials outside of last year. For example, while our second quarter sales were down 32% compared to second quarter of last year, they were more than twice the level of the second quarter of 2017.

As we look at the console market and our position in it during the first half of 2019, as well as our emerging presence in the PC gaming accessories market, things are tracking pretty closely to what we expected when we laid out our initial outlook for 2019.

2019 is shaping up to be the second biggest year for console gaming headsets ever, second only to last year. We continue to lead this market with a powerful high-quality and innovative portfolio of headsets for all levels of gamers and our continued growth in the PC gaming accessories market has gone well with our PC gaming headsets market share increasing significantly and with the successful closing of the ROCCAT acquisition. As you may recall, 2018 saw a large influx of new console gaming headset users. Both new and existing gamers who adopted headsets to play Battle Royale games like Fortnite, PUBG and more.

These first time buyers drove record headset sales last year. We also gained market share despite our already strong share due to what we believe is our ability to keep our products in stock through the dramatic sales increase and our 50-plus percent market share in the entry level headset price tiers. As a result we grew revenues 93% year-over-year in 2018. Coming into 2019, we expected the influx of new gamers to normalize, but last year's large base of new headset users would continue gaming and upgrade and replace their headsets at roughly historical rates of around 24 months. And as the percentage of market sales in the entry level tiers reduced somewhat and our in-stock advantages that drove share gains last year weren't a factor this year, our share would reduce somewhat, but remain higher than the 42% levels of the year's prior to 2018.

Note, my share and sell-through comments throughout today's call are using US NPD data we're referring to US share, which represents our largest market. So far this is what has happened and the market is tracking roughly where we had projected. June year-to-date sell-through is down about 21% for the market from 2018, but up over 50% from 2017. And as expected, our market share this year is down somewhat, but higher than 2017 and continues to significantly outpace our competitors. As a result, revenues were in line with our expectations and this is despite more aggressive pricing and marketing from competitors maybe as a result of them over forecasting the market.

We remain quite pleased to have completed the ROCCAT acquisition at the end of May and we remain highly confident that the combination of ROCCAT strong portfolio of PC gaming, keyboards and mice, plus their PC headsets and our own Atlas line of PC gaming products has us well positioned to grow in this $2.6 billion market. And I'm thrilled with the talent and PC gaming expertise we've added the Turtle Beach with that team joining us.

I'll have more to say about the current environment as well as updated commentary on our outlook after John walks through our second quarter financial results. John?

John Hanson -- Chief Financial Officer

Hey, thanks, Juergen, and good afternoon, everyone. Moving right into our second quarter result, net revenue in the second quarter of 2019 was $41.3 million or $42 million on a constant currency basis, reflecting the increased installed base of gaming headset users who are now part of the core market. Q2 2018 net revenue was $60.8 million, while consumer demand remained above historical rates or levels, this delta was the result of the expected decline in demand from the record levels in the prior year driven by Battle Royale games, as Juergen has just covered.

Gross margin in the second quarter was 31.9% compared to 33.3% in the second quarter of 2018. This expected decrease was primarily due to the product mix, a decline in volume based fixed cost leverage as a result of the decrease in revenue, increased refurbishing and warehouse cost, partially offset by a decline in freight cost. Operating expenses in the second quarter of 2019 increased as expected and planned to $15.5 million from $12 million in the same quarter of 2018. This was primarily due to $1.6 million of ROCCAT transaction and integration cost, acquired ROCCAT operating expenses, sponsorships and digital marketing spend and an increase in non-cash stock-based compensation.

Net loss in the second quarter of 2019 was $2.4 million compared to a net loss of $2.3 million in the year ago quarter, which included an unrealized loss of $8.6 million on a financial instrument obligation. Exclusive of this unrealized loss, the larger loss was driven by lower gross profit as a result of the expected decline in revenues and the planned increased in operating expenses, partially offset by the a decline in interest expense. Net loss per share in the second quarter of 2019 was a negative $0.16 on 14.6 million weighted average shares outstanding, compared to a net loss per diluted share of negative $0.17 a share on 13.4 million weighted average shares outstanding in the year ago quarter.

Adjusted net loss, which excludes transaction and integration costs incurred related to the acquisition of ROCCAT was $0.9 million or $0.06 per diluted share compared to net income of $6.2 million or $0.40 per diluted share in the 2018 period. Adjusted EBITDA was $1.6 million compared to $9.8 million in the year ago quarter.

Please note, our first half 2019 adjusted EBITDA and earnings per share exceeded guidance ranges primarily due to the deferral of certain marketing initiatives that are now planned in the back half of the year.

Now turning to the balance sheet. At June 30, 2019, the company had $3.4 million of cash and cash equivalents with $10.8 million of outstanding debt under our revolving credit line. This compares to $9.1 million of cash and cash equivalent and $32.4 million of outstanding debt at June 30, 2018. This year-over-year improvement primarily resulted from the company's improved operational performance, partially offset by the cash paid for the acquisition of the ROCCAT business in 2019. Inventories at June 30, 2019 were $50.4 million compared to $28 million at June 30 last year and includes approximately $8.3 million for ROCCAT.

We continue to assume an effective tax rate of approximately 10% due to the expected utilization of the net operating losses. If we fully utilize the remaining NOLs due to higher than expected pre-tax profits, we will experience an increase in our 2019 effective tax rate accordingly. Assuming the pre-tax income implied in our 2019 guidance, we continue to expect to utilize most of the NOLs in 2019.

Finally, on April 10th, we announced a $15 million share repurchase program. During the less than two months that this authorization was active in our second quarter, we repurchased approximately 156,000 shares at an average cost of $9.62 per share. The timing of our buyback activity will of course, be subject to regulatory parameters, market conditions and our cash flow and we will continue to prioritize investing in growth and business development, but we expect to be opportunistic if the right conditions present themselves.

Now, I'll turn the call back over to Juergen for some additional comments. Juergen?

Juergen Stark -- Chief Executive Officer

Thanks, John. Let's look a bit closer of what we expect for the second half. At the major gaming expo E3, in June, we didn't see or hear much that dramatically changed our view of how the market will develop this year. The titles that were announced were in line with our expectations and the news that was released on next-gen console launches confirmed what we had anticipated prior to E3. Still it was good to have Microsoft and Sony now both formally confirmed that they are launching new Xbox and PlayStation consoles next year.

We believe this is the first time in the history of console video game business that the next generation launches were formally announced this far ahead of launch dates. It will be interesting to see how this affects Q4 with a potential positive of Microsoft and Sony more heavily discounting console prices to maintain sales and the potential negative of some customers delaying accessory purchase until new consoles are launched. That said, we're very excited about the new consoles and their potential positive impact on the next few years. Both platforms will again significantly upgrade power, speed and capabilities to enable even more immersive and entertaining gaming. Sony specifically said that, the PlayStation 5 will have a big focus on 3D audio, which suggests that games developed for that console will also have a focus on audio in order to optimize the gaming experience. This should make it even more important to have a high quality gaming headset, not just for chat, but to really take advantage of the audio capabilities of the console.

Microsoft, as expected, talked a bit more about their progress with Project xCloud, which as it rolls out, should not only expand the user base for all games, but should also lead to higher usage among existing gamers. And as the market leader in gaming headsets, we always stand to benefit from initiatives like Microsoft xCloud and Google's Stadia and anything that grows the base of gamers and increases the hours of gameplay.

One other very good piece of news is that both Xbox and PlayStation are expected to be backwards compatible. In addition to potentially reducing any reluctance for consumers to buy accessories during holiday, we also expect to not have the disruptive need to change out many products that we experienced during the last console transition. Net-net, we're quite excited about the new consoles and their impact on gaming and our business in the future. I should also mention that Nintendo Switch continues to do very well. While it's a small driver of headset sales relative to Xbox and PlayStation, it is indeed becoming a third platform for gaming headset use and we have a great portfolio of headsets for those gamers.

Turning to ROCCAT. As I said, we continue to be very excited about the portfolio and team we've added to the company. I know several analysts were very impressed with the quality of their products during visits to our booth at E3. Retail discussions continue to go well. We are already -- also already starting to take advantage of ROCCAT's presence in Asian markets to accelerate Turtle Beach headsets there. Even without any significant benefit from ROCCAT in the first half of 2019, we've been able to grow our share of PC gaming headset significantly. Yes, from a small base, but it's a very good start. ROCCAT's PC gaming headsets will just add to that momentum and we look forward to having an integrated line of accessories in the market for 2020. We fully continue to be able -- to expect to be able to build $100 million PC accessory business in the coming years.

Now turning to our outlook for 2019, which remains unchanged. We are maintaining our guidance for the full year 2019, which calls for net sales of $240 million to $248 million, gross margins of 33% to 34%, GAAP EPS of $0.70 to $0.90, adjusted EPS of $0.90 to $1.10 based on 15.7 million shares and adjusted EBITDA of $27 million to $31 million. We expect roughly $154 million to $162 million in second half revenues to be phased at roughly 26% to 28% in Q3 and 72% to 74% in Q4, with some normal possibility that revenues can shift between those quarters without impacting the total.

Since the ROCCAT deal closed later than we had planned, we anticipate ROCCAT to contribute approximately $16 million to $20 million to our full year revenues versus $20 million to $24 million prior. That difference is small relative to our overall business and to the overall dynamics in the console market, so it does not impact our guidance. Note that gross margins this year are expected to be slightly below our mid-30s target, impacted by purchase accounting of ROCCAT inventory, which dissipates as that inventory is sold. And our gross margin forecast is based on the ability to mitigate most of the tariff impacts for 2019, if they stay in place for and after September 1.

New console launches next year and our prospects in PC gaming accessories with ROCCAT have us very excited about 2020. So while we are focused, as you'd expect on finishing out 2019, we are also opportunistically looking at all of our activities with a view on how they impact 2020 and where we can accelerate initiatives even if they require some incremental OpEx in 2019. As a result, we expect operating expenses to increase by $12 million to $14 million in total, a bit higher than our previous $11 million to $13 million estimate.

As per John's comments, our net income and EPS outlook continued to assume an effective tax rate of 10%. As I mentioned, it's going to be interesting to see how the rest of the year plays out ahead of what should be a very exciting 2020. Our forecast for the overall console gaming headset market is driven by a few key assumptions, and of course, these could vary significantly from our current view. Number one, the influx of new gaming headset users and the headset upgrade, replace dynamics of the installed base of headset users reflect normal historical rates. That is like 2016 or 2017, no added Battle Royale effect.

Number two, console prices will be discounted, contributing to Q4 accessory sales despite expected new console launches in 2020. So that holiday driven sales as a percentage of the full year sales are similar 2012, which was the prior last console year. AAA game launches will be weaker, consistent with our prior assumptions, but Call of Duty: Modern Warfare will be very strong, as some analysts have recently noted. Number four, pending 10% tariffs, which impact gaming headset starting September 1, again, if they remain in effect, will not have a meaningful impact on Q4 sell-through, due to a variety of mitigating factors.

Those are the key dynamics for the overall console gaming headset market and then our sales within that market are driven by our forecast of revenue share that will be modestly lower than 2018, but higher than 2017 based on our assumption of a normal level of competitive promotions and marketing.

Let me end by reiterating a few points I made on our last earnings call. We're in a great market. Gaming, including eSports, streaming and influencers continues to be an exciting market that we believe is the best global consumer segment to be participating in today. We have a strong brand and leadership position in console gaming headsets, which are additionally benefiting from the continued increase in multiplayer and social gaming. And new Xbox and PlayStation consoles could drive incremental growth after they launch next year.

We've positioned ourselves well to drive future growth with a target of 10% to 20% per year in 2020 and beyond. On top of the trends above, our move into PC accessories including the acquisition of ROCCAT adds an incremental $2.6 billion of market we can address with our portfolio now.

Finally, I believe, we've demonstrated our capabilities to execute well across all functional areas. And I'm grateful to have a fantastic team of colleagues in our company for this.

Operator, we're now ready to take questions.

Questions and Answers:


Thank you, sir. [Operator Instructions] Our first question comes from Mark Argento of Lake Street Capital. You may proceed.

Mark Argento -- Lake Street Capital Markets -- Analyst

Hey, guys, congrats on the decent quarter. Just want to get your thoughts on the launching of some -- more of these cloud based gaming platforms Google, some of the other guys. How you think about your product relative to that market if it's a decent fit? And then also just wanted to get your thoughts on growth rates, I think you've talked historically of 2020 growth rates and beyond on the 10% to 20% revenue, 15% to 30% on EBITDA. Any kind of updates there would be helpful? Thanks.

Juergen Stark -- Chief Executive Officer

Sure, Mark. So cloud gaming devices, Google Stadia, as you mentioned, and now Xbox with xCloud, we think are a net positive going forward for gaming headsets, because those devices essentially lower the barriers to entry for new gamers. So in the Google Stadia kind of the marketing materials, they gave an example where someone can be watching a YouTube video of a game going on. Click on the video and be up and running on that game within a matter of minutes versus today having to go out order or buy the game. Downloaded it, install it all of that. You need -- if you're going to play multiplayer games on those cloud devices, no matter who they come from, you're going to need to talk to people, you're going to want to hear the audio well. And so those devices will have a headset jack or support headsets. And therefore, the more gamers that play on those devices and the lower the barrier of entry to new gamers, the more positive it is for a critical accessory like our headsets.

And then you asked about growth. Yeah, I mentioned we're quite excited about the ROCCAT addition with our progress on PC. And now also with new consoles confirmed, very excited about 2020 and going forward. And are reiterating our target -- are very important target to achieve a 10% to 20%, revenue growth rate and a 15% to 20% -- 15% to 30% EBITDA growth rate. And frankly, we feel as of now more comfortable with those targets then the last time I mentioned them on the prior call.

Mark Argento -- Lake Street Capital Markets -- Analyst

Fantastic. Thanks, guys.

Juergen Stark -- Chief Executive Officer

Thank, Mark.

John Hanson -- Chief Financial Officer

Thank you.


Our next question comes from Andrew Uerkwitz of Oppenheimer & Co. Your line is open.

Andrew Uerkwitz -- Oppenheimer & Co -- Analyst

Hey, thank you. Just -- you guys do a pretty good job of survey here now what gamers want to and I think there's a bit of fear that a lot of the new purchases that came in related to Fortnite another Battle Royale. Those gamers won't upgrade, they won't buy again, they believe. I know, it's -- we're only a year out or maybe a little longer than that. What is some data suggesting at this point that would suggest that maybe those gamers are going to stick around and upgrade? Thank you.

Juergen Stark -- Chief Executive Officer

Great. Great question, Andrew, thank you. Yeah, we mentioned and we've discussed our survey results in more detail in prior calls. We did another round, of course, like we always do. We used those to inform our forecasting and I think this is -- those -- that's one of the drivers to why we've been reasonably good at forecasting the overall market. And so the latest round of survey results indicate that things are tracking pretty much as we expected. That is new game -- influx of new gamers have slowed down a while ago, frankly. In fact, even in Q4 last year, there wasn't that big of an impact from Battle Royale games. And very importantly, as I articulated on the last earnings call and I'll just reiterate here, those gamers are staying in as gamers. They're not leaving. They're actually -- even if they stop playing Fortnite, for example, they're playing other games. They're playing at the rough -- at roughly the same level of hours per week as the average console gamer. So they're kind of right in the mainstream and they are upgrading or replacing their headsets or intend to at a rate that reflects the roughly 24-month historical average. And keep in mind when we talk about 24 months, it's a wide curve around that and not a normal distribution curve. So a lot of people will replace well ahead of 24 months. All that's tracking pretty much as we expected and in line with our market projections.

Andrew Uerkwitz -- Oppenheimer & Co -- Analyst

Excellent. Thank you. And then just one follow up. It seems like a lot of moving pieces with this next console side and as well as your PC potential growth rates there. How should we start think about the impact -- look, this historical [Indecipherable] around attached second consoles should -- do those numbers -- will those numbers hold in the next console cycle do you think?

Juergen Stark -- Chief Executive Officer

We think on average, yes. Usually what you see in console transition cycle is -- and this is reflected by the way in DFC's forecasts. They are the guys who forecast console sales. Is that the active installed base dips a bit in the year prior to the new launches, that would be this year. That it's up a bit, the first year of the new launches and keep in mind that the launches are late in the year and so you have three-plus quarters without any effect of that. And then you get a significantly increased growth rate in active installed base in what would be now 2021 and 2022. That's how we anticipate things will roll-out. That's active installed base of consoles.

On top of that, you have a bit of a tailwind on accessories, because social gaming and multiplayer tends to go up every year a bit. Obviously, took a huge step function increase last year. And so on top of that trend, we would expect that to continue. We would expect that to add some tailwind to headset accessories on top of the installed base projections. And maybe lastly, we did update a few pages in the quarterly presentation that's released now, that walks through some of the data and the typical impact of a new console launch.

Andrew Uerkwitz -- Oppenheimer & Co -- Analyst

Got it. Thank you guys. Appreciate the color. Thank you.

Juergen Stark -- Chief Executive Officer

Thank you.


Thank you. Our next question comes from Nehal Chokshi of Maxim Group. Your line is open.

Christine Jian -- Maxim Group LLC -- Analyst

Hi. This is Christine in for Nehal. Thanks for taking my questions guys. I just have a few. First, if you could provide some clarification on how inventory was managed, is that on a current Q or 4Q basis. And where did that inventory come in relative to your expectations for this quarter? And any comments on channel inventory would be great? Thanks.

Juergen Stark -- Chief Executive Officer

Sure. So inventory we manage very actively, including having a very good understanding of channel inventory on a weekly and monthly basis. Inventory came in at I believe, around $50 million. A big piece of that is ROCCAT, by the way -- ROCCAT inventory -- about $8 million. And inventory is in line with our expectations, so is channel inventory. And so we -- it's kind of right in line with what we had planned and where we wanted to be at this point in time. Be very careful not to draw comparisons to -- like 2018 were inventory levels were still quite low if you look at our inventory level and so rely on the comment that the inventories are in line with our plans and our expectations versus trying to do math on prior years, because it won't be productive to do that analysis.

Christine Jian -- Maxim Group LLC -- Analyst

Got it. That's helpful. And any additional color on sell-in and sell-through data?

Juergen Stark -- Chief Executive Officer

Only what we said in that prepared remarks. It's tracking roughly in line with our expectations. Sell-through using as always US NPD sell-through data, down 21% year-to-date, up more than 50% over 2017. So exactly as we cited and have expected. The market is much bigger than it was in the past. But obviously, last year included the incremental benefit of a lot of first time buyers, who are now replacing and upgrading and part of the market, again, roughly right as we had predicted.

Christine Jian -- Maxim Group LLC -- Analyst

Got it. Thanks. That's it. Thanks guys.

Juergen Stark -- Chief Executive Officer

Thank you.

John Hanson -- Chief Financial Officer

Thank you.


Thank you. [Operator Instructions] We have a question from Sean Henderson of D.A. Davidson. Your line is open.

Sean Henderson -- D.A. Davidson -- Analyst

Hi, guys. Thank you for taking my question. So now that US government plans to place a 10% tariff on goods made in China that have not previously been subject to tariffs. How does that affect you guys? And what levers can you guys pull to offset any potential impacts? And then secondly, I know you guys had touched on this earlier, but how should investors think about the timing of your share repurchase efforts? Thank you.

Juergen Stark -- Chief Executive Officer

Sure. Thanks, Sean. So tariffs, they were -- now 10% tariff that has been announced to go in effect September 1, does affect gaming headsets and we've stated in the prepared remarks that we expect to be able to largely mitigate any impact on 2019, so that's very important. And mitigation, without going through the gory very details, is based on channel inventory -- our inventory levels going into September 1, how long that industry will -- how long that inventory will essentially last to sell into the market. That by the way covers a good part of holiday already and then how much more purchasing do we have to do to satisfy holiday sell-through needs. So that's the first mitigating factor. Essentially, we only have to cover a few months of 2019 and not have it have a big impact.

Second, we are working with our manufacturing partners to see if we can get some offsetting cost savings to help essentially tie us through the holiday. Third, if needed, we will increase wholesale prices to remain margin neutral with the goal -- of course, that's wholesale prices. Retailers will then decide what they want to do with retail prices. But the goal is to have this not disrupt this year's financials.

And I'll just note that this round of tariffs is very different. The reason why I keep saying, if they remain in effect, is that this round of tariffs, unlike the prior rounds that were largely components and things that didn't affect consumer purchases, this round of tariffs is directly impacting major consumer purchase items in the United States. And tariffs by definition increase the cost of goods and manufacturers and retailers are unlikely to swallow those costs. So they will be passed along through. And consumers -- over time they see consumer prices go up. So it is a much more sensitive area to tariff than the prior rounds. So who knows if they're going to stay in place?

Last comment is, if they do stay in place, we have started working last year already non-China production and expect to be up and running with part of our production outside of China as early is Q2 next year. And obviously, if we feel like tariffs are going to stay in place, we will -- that will continue to impact our supply chain strategy over time. That's on tariffs. And then you asked, Sean, about your repurchase. So as we stated essentially the window is open and we can make purchases, we have done so in Q2. Our priority remains like Q2, where we used some of our cash to acquire ROCCAT to fund the business, invest in the business, invest in growth, growth invest in business development and then opportunistically, we will look at continuing those share repurchases.

Sean Henderson -- D.A. Davidson -- Analyst

Great. Thank you guys very much once again.


Thank you. Currently this concludes our question-and-answer session. I would like to turn the call back over to Mr. Stark for closing remarks.

Juergen Stark -- Chief Executive Officer

Thank you very much, and thank you everyone for joining. I'd like to just end as always on a big thank you to all the Turtle Beach colleagues who work hard every day to deliver great accessories to gamers. We look forward to speaking with our investors and analysts when we report our third quarter results in November. Have a good day.


[Operator Closing Remarks]

Duration: 34 minutes

Call participants:

Juergen Stark -- Chief Executive Officer

John Hanson -- Chief Financial Officer

Mark Argento -- Lake Street Capital Markets -- Analyst

Andrew Uerkwitz -- Oppenheimer & Co -- Analyst

Christine Jian -- Maxim Group LLC -- Analyst

Sean Henderson -- D.A. Davidson -- Analyst

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