Turtle Beach (HEAR) Q3 2023 Earnings Call Transcript

Turtle Beach (HEAR 0.64%)
Q3 2023 Earnings Call
Nov 07, 2023, 5:00 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Welcome to the Turtle Beach third quarter 2023 conference call. My name is Michelle, and I'll be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session.

[Operator instructions] Delivering today's prepared remarks are chairman of the board, Terry Jimenez; interim chief executive officer and senior vice president of global sales, Cris Keirn; and chief financial officer, John Hanson. Following their prepared remarks, the management team will open the call up for any questions. As a reminder, the conference is being recorded. I will now turn the call over to Alex Thompson from investor relations.

Alex, you may begin.

Alex Thompson -- Investor Relations

Thank you, Michelle. On today's call, we will be referring to the press release filed this afternoon that details the company's third quarter 2023 results, which can be downloaded from the Investor Relations page at corp.turtlebeach.com, where you'll also find the latest earnings presentation that supplements the information discussed on today's call. Finally, a recording of the call will be available on the Events and Presentations section of the company's website later today. Please be aware that some of the comments made during this call may include forward-looking statements within the meaning of the federal securities 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 management's current expectations. While the company believes that its expectations are based upon reasonable assumptions, numerous factors may affect actual results and may cause results to differ materially. So, the company encourages you to review the safe harbor statements and risk factors contained in today's press release and in its filings with the Securities and Exchange Commission, including, without limitation, its 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 our forward-looking statements.

The company does not undertake to publicly update or revise any forward-looking statements after this conference call. The company also notes that on this call, we 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 the company's reported GAAP results and the reconciliation tables provided in today's earnings release and presentation.

And now, I'll turn the call over to Terry Jimenez, the company's chairman of the board.

Terry Jimenez -- Chairman of the Board

Thank you, Alex. I'm excited to be here today, and I'm very pleased with our board and the management team's recent progress, energy, and focus. As the management team will discuss shortly, we believe that today's results clearly point to a company now heading in the right direction. Our cost structure has improved dramatically in very short order.

We have taken share in our core markets, we've grown share and outpaced category growth in other key markets, and our people and our products are winning. You will hear from Cris and John regarding the company's results and our improved forecast shortly, but first, a few comments regarding the previously announced permanent CEO search and the value enhancement committee's ongoing review. Firstly, as previously disclosed, the board is conducting an extensive and well-organized search process for the permanent CEO position. Cris Keirn, our longtime Global Head of Sales has served as our interim CEO since July 1.

And as you can see from our results, the board's confidence in Cris' ability to lead in this transition time has been well placed. Andy remains a candidate for the permanent CEO position. The board has met with several strong candidates, and we expect to conclude the CEO search ahead of our next earnings call, and we will notify the investment community at the appropriate time regarding the results of our comprehensive search. Next, I'd like to comment on the value-enhancing committee of the board, which continues to review any and always to drive value for our shareholders and stakeholders in conjunction with the full board and the management team.

Significant progress has been made to date. The committee has been working closely with the company's new financial advisors since they were hired a number of months ago, and we continue to be encouraged with our progress. While we cannot provide any formal update at this time, the committee continues to be fully engaged and we'll notify the market once that process has concluded. While I'm proud of the progress to date, our work is not done, and we will continue to drive a clear path to near- and long-term value creation.

We look forward to sharing more developments at the appropriate time, and we appreciate your investment and support of Turtle Beach. I believe that the prospects and potential for Turtle Beach continues to get stronger every day. With that, I will hand it over to Cris Keirn, our interim chief executive officer. Cris?

Cris Keirn -- Senior Vice President, Global Sales

Thanks, Terry, and good afternoon, everyone. Thank you for joining us to discuss our third quarter 2023 results. We showcased strong operational and financial execution in the quarter with our third-quarter sales and adjusted EBITDA results up significantly compared to a year ago. Our revenue results were in line with our expectations and track well toward our 10% to 12% revenue growth guidance for 2023, supported by over 13% growth in revenue year to date.

During the quarter, revenue grew 15% year over year, driven by share gains across categories and geographies, which exceeded overall market performance. We delivered positive adjusted EBITDA of $1 million, an improvement from the $6.9 million negative adjusted EBITDA in the year-ago quarter. This significant improvement was driven by higher revenue, lower freight costs, a more normal promotional environment, and margin benefits from value-creating initiatives outlined on our previous earnings call. Overall, gaming accessories markets continue to perform in a similar trend to second-quarter dynamics with slight variations depending on the category.

Year to date, U.S. consumer spending across gaming hardware, software, and accessories was 2% higher than a year ago and up 10% in September. The U.S. console headset market is up 2% year to date, including year-over-year growth in the last month of the quarter, which continues to support the expected momentum in the gaming industry as we head into the holiday season.

During the month of September, our outperformance was especially apparent as the market was only up 0.8% year over year, while Turtle Beach was up 7.4% for the month. We expect to continue leading the headset category with new and exciting console gaming headsets that gamers love as demonstrated by the nearly $1 billion in U.S. retail sales that the three of our top sellers, Stealth 600, Stealth 700, and Recon 70, have collectively delivered since their respective launches. In key non-console headset categories, we continue to take share and demonstrate growth.

Per [Inaudible], the U.S. flight simulation category is down 11% year to date, but our year-over-year growth and value share both exceed 20% in the category. Like last quarter, U.S. PC gaming accessories markets continue to be challenged and are still down roughly 12% year to date.

However, we are well positioned to benefit when PC categories return to growth with launches like Vulcan 2 Mini and Vulcan 2 mechanical keyboards in the third quarter. IGN recently named our full-size Vulcan 2 as their choice for Best Mechanical Gaming keyboard. While PC World gave our Vulcan 2 Mini Air, the publications coveted Editor's Choice designation. We also announced the availability of the mobile Atom Controller for iPhones in Q3, which comes on the heels of the previously announced Atom Controller for Android.

As we continue to launch exciting new products across these categories in the coming months, we believe there are further opportunities to extend our growth runway in PC gaming, simulation, and controllers. Before I turn it over to John to walk through our financials in more detail, I'd like to cover the progress we've made against the profit improvement initiatives we outlined during our second quarter conference call, and how this positively impacts our 2023 adjusted EBITDA guidance. These initiatives include SKU rationalization, portfolio optimization, platform product development for a range of cost improvements, and more. Due to the strong progress that we've made on these profitability initiatives during the quarter, we are raising our full year 2023 adjusted EBITDA guidance to the range of $8 million to $10 million.

Additionally, we now expect to exit 2023 and with a run rate EBITDA of approximately $28 million to $33 million, up from the previously communicated range of $25 million to $30 million. We are thrilled to report this continued progress. While formal earnings guidance for 2024 will be provided next year as it is consistent with our past practice, and after we receive complete visibility on an important Q4, we felt it appropriate to highlight the work completed to date that has gone into developing opportunities ahead in 2024. I'll now pass it over to John to cover the financials.

John?

John Hanson -- Chief Financial Officer

Thanks, Cris, and good afternoon, everyone. For the third quarter, we reported revenue of $59.2 million, a 15% year-over-year increase compared to $51.3 million a year ago. The increase was primarily driven by strong performance in console headset and simulation products year over year. Additionally, channel inventories increased during the third quarter due to holiday load-ins, which we believe is a positive sign from retailers for the fourth quarter.

Gross margin in the third quarter improved to 29.9%, the highest level in the past six quarters compared to 14.1% in the year-ago period. This increase was primarily driven by lower freight costs and promotional spend. Just to remind everyone, last year, we recorded a $5.3 million incremental inventory provision related to the pandemic-driven supply chain challenges. Excluding the provision, adjusted gross margin was 24.5% a year ago, a 540-basis-point margin improvement year over year.

Operating expenses in the third quarter were $20.2 million compared to $21 million in the year-ago quarter. The third quarter recurring operating expenses have declined 7% and year over year, which was primarily driven by continued proactive expense management. Our third quarter adjusted EBITDA improved to a positive $1 million compared to a negative $6.9 million in the year-ago period. The year-over-year improvement is primarily driven by higher revenue, improved margins, and lower expenses resulting from proactive expense control.

We are on track to deliver positive adjusted EBITDA for 2023. On an LTM basis, adjusted EBITDA has improved approximately $18 million this year and is slightly below breakeven. Turning to the balance sheet. At September 30, 2023, we had $12.3 million of cash and $13.3 million outstanding on our revolving credit line.

Inventories at September 30, 2023, were $76 million compared to $118.4 million at September 30, 2022. Cash flow from operations was $7.9 million, which was a $77.5 million improvement year over year on a year-to-date basis. As the global supply chain continues to normalize, we expect inventories to decline further. Now, I'll turn the call back over to Cris for additional comments.

Cris?

Cris Keirn -- Senior Vice President, Global Sales

Thanks, John. We are pleased with our third quarter results and believe the positive trends in gaming will support increased accessories demand through the end of this year and into 2024. While some aggressive competitive discounting still exists, the scope of these promotions continues to decline across accessories. Demand for gaming accessories is normalizing higher than pre-pandemic levels as expected, and the replacement cycle for pandemic accessory purchases is expected to drive ongoing demand into 2024.

Console hardware supply is strong, and there are promotions already running as we head into holiday that will drive new hardware sales and new games are performing well with an exciting lineup to close out the year. With these points in mind, all the industry drivers for accessories sales growth are in place and Turtle Beach is well-positioned to capitalize on these positive conditions. We remain committed to maintaining our leadership in gaming headsets and driving growth in adjacent categories and remain confident that our value-creating initiatives including SKU rationalization, portfolio optimization, and platform product development will continue to result in profitability improvements. We're energized by the trends around our business, and I would like to thank the entire Turtle Beach team for performing at such a high level in this dynamic environment.

We remain highly focused on driving enhanced value for our gamers, retailer partners, and shareholders. And with that, let's turn to our Q&A.

Questions & Answers:

Operator

Thank you. We will now begin the question-and-answer session. [Operator instructions] Our first question comes from Mark Argento with Lake Street Capital Markets. Mark, your line is open.

Mark Argento -- Lake Street Capital Markets -- Analyst

Yeah. Hey, guys. Mark Argento here at Lake Street. Just a couple of quick ones.

Gross margins looked -- ticked up nicely. And I apologize if you broke it out already, but I know freight obviously benefiting from a better freight environment. Can you guys kind of peel the onion a little bit on what you're seeing in the gross margin line?

John Hanson -- Chief Financial Officer

Yeah. So, thanks, Mark. Yes, certainly, the improvement is certainly driven by lower freight costs. We've seen the freight costs returning to near pre-pandemic levels but still slightly elevated as well as a lower promotional spend.

In terms of the quarter, for the quarter, we realized the lower freight year over year was several million dollars value and benefit to the margin line. And we expect our freight cost to continue to improve over the next several quarters, which is also a key part of the exit 2023 adjusted EBITDA run rate that we increased here this quarter on the call.

Cris Keirn -- Senior Vice President, Global Sales

Yeah. In addition to that, Mark, thanks for the question. The improvements that we've seen with some of the actions we took last quarter and have been taking on the SKU rationalization and some of the portfolio changes, we're seeing a better mix. And so, that's also helping us.

Mark Argento -- Lake Street Capital Markets -- Analyst

That's super helpful. And then in terms of obviously, really strong revenue this quarter, kept the full-year guide in line. Obviously, EBITDA guide up a little bit, which is nice to see. But are we -- is the readthrough here that you maybe pulled in some orders into Q3? What kind of retail buying patterns are you seeing right now?

Cris Keirn -- Senior Vice President, Global Sales

Yeah. Great question. When you look at where retailers are coming up for holiday, we did see some orders coming in sooner in September to load and for holiday. We take that as a really good sign how retailers are feeling going into the holiday with all the great things that are going on between the games that are out there, the console supply, the promotional environment, just a really good time for the accessories business.

So, I think retailers are also anticipating a good holiday, and that's why we saw those earlier orders. There's still a lot of the quarter to go, as you know. It's 40% of our year. So, we feel like at this point, we wanted to hold revenue there despite the fact that we got some of those orders in a bit sooner than expected.

But we're pleased to see how that's progressing and expect to realize that $265 million to $270 million for the year.

Mark Argento -- Lake Street Capital Markets -- Analyst

Great. Thanks, guys. I'll hop back into queue.

Thanks, Mark.

Cris Keirn -- Senior Vice President, Global Sales

Thank you, Mark.

Operator

[Operator instructions] Our next question comes from Jack Vander Aarde with Maxim Group. Your line is open.

Jack Vander Aarde -- Maxim Group -- Analyst

OK. Great. Hey, Cris, John. Strong results, great to see strong outlook as well.

So, Cris, can you maybe just speak to the SKU rationalization a bit more? Maybe as it relates to all of your product categories. Is there any sort of target number or a range of SKUs that you believe is optimal? Or just any added color there would be helpful. Thanks.

Cris Keirn -- Senior Vice President, Global Sales

Sure. Jack, thanks for the question. Yes, I think when you look at the categories that we operate in, we've expanded pretty quickly over the last several years. We've invested into the new spaces.

We've learned from our experiences there, which products are really tracking with customers. and we've seen some that aren't. And so, we've taken action on those over the last couple of quarters to really rightsize, I would say, our portfolios in those areas to the point where we're seeing the sales consolidate into the higher-performing SKUs we've selected to move forward with. So, there's no number per se per category that we're targeting.

We're really just looking to see from a margin mix and from a sales mix, what's really resounding with those gamers out there and consolidating our portfolio to those products. There's other categories where we still continue to grow. You look at the simulation categories and controllers, we're adding SKUs there because we've seen good success, and we've seen good performance in those categories. So, it's something that we're looking at very closely.

We've got a really sharp focus on that moving forward to ensure that we've got the right mix.

Jack Vander Aarde -- Maxim Group -- Analyst

OK. Great. That's helpful. And then maybe just in terms of -- if we can review, I think in the past, you guys have provided more of a granular or specific update on non-console versus console revenue mix, I know you haven't been doing that routinely or consistently.

But just wondering if you could speak in general as you look into 2024, given the SKU rationalization in some of your comments about the PC market in general. Can you talk about maybe just how you expect your revenue mix or to evolve as you head into 2024 between console and non-console?

Cris Keirn -- Senior Vice President, Global Sales

Sure. Absolutely. Great question. The mix that we're seeing now is somewhere in that 20% range is looking like non-console.

I know we've said before it was 20% to 25%. We've seen some real strength in the console business this year. If you look at the markets and how they're performing, the U.S. console business is up 2%.

We're up more than that. We've picked up some share there. But the rest of the categories are down. So, flight simulation is a good example.

It's down pretty significantly. I think 11% were up 20% in that category. And controllers as well, the third-party controller market is roughly flat to slightly down despite the growth in controllers this year. So, we're really seeing some strong results in the headset space.

And we're taking actions to mitigate some of those markets that are maybe not performing quite as well. And so, that's why you see the mix shifting a bit more toward the console space for this year. Looking into next year, we've got some really exciting launches in these other categories that I believe are going to drive our share even further. And I think you'll see that mix continue to expand from that 20-ish level from this year.

Jack Vander Aarde -- Maxim Group -- Analyst

OK. Great. And then just one more question if I might. So, looking at 2024, and just given -- I know you can provide formal guidance, I think, next quarter.

But you did -- you are exiting the year at a higher adjusted EBITDA run rate level. So, maybe just -- if you could just talk about how does gross margin versus improved opex control kind of factor into that higher adjusted EBITDA exit run rate?

Cris Keirn -- Senior Vice President, Global Sales

Yeah. It's a bit of both. When you look at the mix, we're focused on all areas here that we can go in and drive profit improvements. And there are certainly opportunities in each.

The platform product development that we've shared over the last couple of calls, that's going to drive a lot of really great improvements in our gross margin. We've got, again, some very exciting new products coming out next year on some new platforms that bring a lot of efficiencies, and they bring a lot of great features for gamers as well. So, we're excited about that. On the opex side, we've taken a very close look on how that's shaping up for the company, where we're headed over the next two to three years, and what the structure of the business needs to be.

And so, we've taken actions there as well, and we'll continue to look at that. So, it's coming from both fronts really, and we're excited on where we're headed there.

Jack Vander Aarde -- Maxim Group -- Analyst

OK. Great. Nice work, John and Cris. Appreciate the time.

Thanks.

Cris Keirn -- Senior Vice President, Global Sales

Yeah. Thanks, Jack.

Operator

Thank you. We have no further questions at this time. Now, I'll turn the call back over to Cristopher Keirn for closing remarks. Cris?

Cris Keirn -- Senior Vice President, Global Sales

Thank you, Michelle, and thank you, everyone, for your participation and interest in Turtle Beach. Have a great day.

Operator

[Operator signoff]

Duration: 0 minutes

Call participants:

Alex Thompson -- Investor Relations

Terry Jimenez -- Chairman of the Board

Cris Keirn -- Senior Vice President, Global Sales

John Hanson -- Chief Financial Officer

Mark Argento -- Lake Street Capital Markets -- Analyst

Jack Vander Aarde -- Maxim Group -- Analyst

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