Q3 2022 Turtle Beach Corp Earnings Call

Yeah.

The conference will begin shortly to raise your hand during Q&A you can dial star one one.

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Welcome to the Turtle Beach third quarter 2022 conference call.

As Daniel and I will be your operator for today's call.

At this time all participants are in a listen only mode.

We will conduct a question and answer session.

During the question and answer session. If you have a question. Please press star one one on your Touchtone phone.

Delivering today's prepared remarks are chairman and Chief Executive Officer, Juergen, Stark 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 Thomson Alex you may begin.

Thank you Daniel.

On today's call, we'll be referring to the press release filed this afternoon that details the company's third quarter 2022 results, which can be downloaded from the Investor Relations page at Corp debt Turtle Beach Dot 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 <unk>.

Mr 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 corporations 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.

<unk> annual report on Form 10-K, and other periodic reports.

Which identifies 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 it 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 Companys reported GAAP results in the reconciliation tables provided in today's earnings release and presentation and now I'll turn the call over to Youre going to start with the Companys, Chairman and Chief Executive Officer Jurgen.

Thanks, Alex Good afternoon, everyone and thank you for joining us in.

In the third quarter, we announced multiple new gaming and simulation products made progress on our key strategic priorities and executed to deliver financial and operational results that were in line with our expectations against very challenging market and operating conditions.

We continue to believe that the gaming market is a great market to be a leader in despite the difficult year driven by a slowdown in consumer demand retail channel inventory reductions heavy competitive discounting a strong dollar and continued global logistics and supply chain challenges, including high freight rates.

While these challenges persist we are seeing signs of sequential improvement in the gaming market per NPD, the third quarter console gaming headset market in the U S was down 17% year over year, comparing that to the second quarter of 2022, which was down 20%, 27% year over year.

The third quarter showed some recovery.

Additionally, the improved supply of new generation counsels provided multiple months of double digit growth in council hardware.

Against this backdrop for our third quarter 2022, we delivered net revenue of $51 3 million up 24% sequentially from Q2, and an adjusted EBITDA loss of $6 9 million versus a loss of $12 1 million in Q2 as.

As you May recall, we faced a difficult comp from a year ago as our third quarter 2021 was the second highest third quarter revenues in the company's history as.

As we discussed last quarter in light of the poor macroeconomic conditions, we proactively and quickly took steps to reduce our operating expenses, which were down 16% on a recurring basis in Q3.

In the third quarter of 2022, we continued our position as the number one counsel gaming headset provider again, leading the category by far our new wireless models have done very well as five of the six models in our latest <unk> series of products made the top 10 list of best selling wireless headsets.

We also announced the availability of the multi platform still 600, it still 700 Gen. Two Max series and the <unk> 600, Gen. Two USB gaming headset for Playstation.

Playstation models follow the successful launch of our Gen. Two Max and USB models for Xbox earlier, this year, where both gamers and reviewers raved about the products.

In fact, since our new stealth wireless series launched IGN, one of the world's leading gaming and entertainment publications reviewing the stealth 700 Gen. Two Max and gave at IGN Editors Choice Award IGN also named the 700 Gen. Two Max the best Xbox Series X and S gaming headset.

As well as the best wireless Xbox headset.

In a rocket PC gaming portfolio, we've continued to expand our lineup of award winning PC gaming mice keyboards, and headsets with new products that deliver the performance PC gamers desire and leverage RGB lighting to create the most beautiful desktop game for gamers available.

In August we announced the availability of the new cone XP are wireless customizable RGB gaming mouse.

The cones expertly crafted ergonomics deliver Supreme comfort with Great, Texas Tech specs and showcase our <unk> technology to create a unique <unk> RGB lighting effect on the mouse for.

For PC gaming keyboards, we expanded rockets iconic walk in line with two new models. The Vulcan too many in the Vulcan to Max both models introduced ground breaking first to market features including the world's first dual led smart keys, plus new tightened to optical switches.

Beyond their ridiculously fast responsiveness, the new tightened to switches showcase rockets, <unk> RGB lighting better than ever the Vulcan to Max also comes with an innovative translucent risk.

Risked rest, which combined with the dual led switches is stunning in fact, the Vulcan to Max has been named the most beautiful gaming keyboard by multiple leading gaming publications.

Welcome to many is the compact version with a footprint, 65% the size of a standard keyboard. Many keyboards are a rapidly growing segment. So we now have a great option for gamers wanting a keyboard and a smaller footprint.

We also unveiled our flagship rocket PC headset, the sin Max Air, which delivers a premium wireless <unk> audio experience perfect for gamers and streamers in need of high quality audio with unique RGB infused lighting the.

<unk> combined decades of turtle Beach's audio expertise and exclusive gaming audio features with rockets beautiful design.

Great specs meaningful innovations and stunning design are the pillars of our rocket portfolio and I am convinced that our expanded portfolio enables PC gamers to create gaming desktops that are a stunningly beautiful as they are functional.

We have been taking everything we know about running the world's best selling counsel headset business and putting that expertise into controllers. We continue to expand our controller family with additional products that offer a game winning controls and features at a variety of price points and for more systems.

We added a new Arctic camo color way to the recount controller line and also launched the recon react our controller, which offers gamers. Many of the same features but at a more affordable price.

The response to our first wave of Xbox and PC controllers continues to be very positive and from this we've now launched our first cloud and mobile gaming controllers. The <unk> cloud hybrid controller, which takes the recon controllers excellent ergonomic shape and adds a unique phone clip and lagged pre Bluetooth so gaming.

On compatible Android devices can experience the same game winning controls while gaming on the go the recount cloud also works as a wired controller with Xbox and Windows Pcs and offers offers gamers turtle Beach exclusive audio features like superhuman hearing.

Our second mobile product is the recently announced Adam controller. The atom is an ultra portable mobile gaming controller with a unique versatile two piece design that fits any Android phone the two pieces magnetically clipped together for compact travel.

For the gaming simulation category, we launched the velocity, one rudder, which perfectly complements the award winning a velocity one flight yoke and throttle quadrant and gives fans and enthusiasts. The ultimate modern stimulation control setup for large and small planes of every type for.

For gamers that want to fly fighter Jets and space simulation, we announced the velocity one flight stick, which combines the latest technologies with an incredible array of buttons and controls and customizable lighting to take flight sticks into the future.

Leveraging our global business as a leading gaming hardware provider the successful expansion and diversification of our portfolio over the past years from council of gaming headsets into a broad array of counsel and PC gaming accessories is enabling us to continue to expand revenues outside of our market leading counsel head.

That business to what we expect will be over 30% of revenues in Q4.

I will return with more commentary on the remainder of the year and thoughts on 2023 after John takes us through the financials John .

Hey, Thanks, Juergen and good afternoon, everyone for the third quarter revenue was $51 3 million down as expected from the second highest third quarter in our history.

The year over year decline reflects lower demand as consumers cut back on their discretionary spend and retailers continue to reduce channel inventories as we stated on the Q2 earnings call. We increased promotional program spend in Q3 due to these market conditions.

In the third quarter gross margins were 14, 1%, including an incremental inventory provision for a potential excess component and product inventory relating to pandemic driven supply chain and logistics impacts excluding this provision gross margin.

<unk> were 24, 5% compared to 34, 3% in the year ago quarter.

The decrease increase was primarily due to the highly promotional retail environment high freight costs and reduction in fixed cost leverage.

High freight rates relative to pre pandemic levels reduced gross margins by roughly 5%.

Freight rates have been declining recently, which will reduce that impact as products are arriving at the lower freight rates move through inventory.

Operating expenses in the third quarter were $21 million compared to 27 8 million in the year ago period, a decrease of 24% third quarter recurring operating expenses declined 16% year over year, a result of the proactive expense management program.

<unk> that we initiated earlier in the year as well as alignment of expenses to lower market demand.

Our third quarter adjusted EBITDA loss was $6 9 million compared to an adjusted EBITDA of $6 7 million in the year ago period. The year over year variance is primarily driven by the items I've covered above plus a $2 3 million adverse impact from foreign exchange.

Adjusted net loss for the third quarter 2022 was $7 7 million or <unk> 47 per diluted share compared to adjusted net income of $4 8 million or <unk> 26 per diluted share in the year ago period, we expect our effect.

<unk> tax rate for the full year to be approximately 25%.

And our Q4 share count of approximately $18 5 million and full year average share count of approximately $17 million.

Turning to the balance sheet at September 32022, we had $10 5 million of cash and $44 6 million of borrowings outstanding on our revolving credit line inventories.

Inventories at September 32022 were $118 4 million compared to $113 3 million at September 32021, the elevated inventory levels reflect lower than expected consumer demand later than normal holiday loaded and lower retail inventory levels.

As well as our goal of maintaining product availability amidst continuing global supply chain and logistics challenges.

We continue to expect a significant reduction in our inventory by the end of the year and so our inventory levels transitioned back to more normalized levels.

As we noted in the earnings release, the company intends to file its Form 10-Q pending completion of a goodwill analysis that may impact goodwill evaluation on the balance sheet and have a noncash impact on GAAP net income and GAAP EPS accordingly.

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

Thanks, John we expect the confluence of factors, including consumer spending caution channel inventory compression abnormally high competitive discounting and exorbitant freight rates, which have impacted our business and many others. This year to subside during 2023 that combined with strong new product launches and our <unk>.

Proactive reductions in spend should enable us to return to revenue growth and positive EBITDA in 2023, even if consumer demand remains subdued and.

In light of the market and operational conditions. We've discussed we expect full year 2022 revenues to be approximately $250 million within but at the low end of our previously communicated guidance range of $2 50 to $2 $75 million. This reflects an expectation that retailers will keep their inventory.

<unk> well below normal through holiday we.

We expected adjusted EBITDA to be approximately negative $15 million with gross margins in the mid <unk> range.

I mentioned that the gaming accessory market is showing improvements in the year over year sell through comps over the past few months and we believe those will continue into the fourth quarter, particularly given how weak the fourth quarter of 2021 was for gaming.

Thinking forward to 2023 in addition to lower Opex freight rates have come down significantly, but those lower costs really start flowing through the P&L next year, while we don't expect freight rates to return to pre pandemic levels. When you would expect the five plus percent gross margin impact to come down significantly.

With the resulting benefit to EBITDA promotional.

Activity has been much higher than usual this year as the entire category has worked to reduce inventory levels. We expect that to improve in 2023 as inventories continue to come down and.

And we believe that the retail inventory reductions.

Made in 2022 have reset retailer inventories to a very low level, so that even flat sell through in 2023 would result in revenue growth in fact, if consumer demand for gaming accessories starts to pick up which we believe is possible next year retailers may increase their inventory levels in there.

Thereby provide an incremental benefit to revenue just as a retail inventory reductions. This year are having an incremental negative impact on revenue.

While it's difficult to predict macroeconomic conditions for 2023, we believe that gaming is a category can perform well even in a recession as it has in the past and the industry analysts are forecasting growth in gamers and gaming markets, including Dfc expect Playstation five sales to set a record next.

Year.

Those factors combined with our continued strong product launches are why we expect revenue growth and a return to positive EBITDA in 2023, even if consumer demand remained subdued.

Our priorities right now are straightforward.

A liver the best possible financial results in a very difficult and challenging environment, while continuing to execute on our long term strategy to position us even better when the gaming market rebounds.

The key pillar of that strategy remain the same first continues to lead the counsel of gaming headset market, where we have maintained leadership by far for 12 consecutive years.

<unk> continued to expand our PC gaming portfolio of headsets keyboards, and mice and grow our share in the $3 $6 billion PC accessories market.

Third drive continued growth in gamepad controller and gaming simulation categories that we entered in 2021 and.

And fourth continue to identify and selectively evaluate other growth opportunities, including new product categories and expanding in target geographies as we have with Korea and Japan.

The overall objective is to drive growth in line with our 10% to 20% annual long term growth target and do so at 10 plus percent EBITDA margins.

Finally, I want to thank the great team at Turtle Beach for their continued hard work and dedication.

With that let's turn to our Q&A.

Thank you we will now begin the question and answer session.

If you have a question. Please press star one one on your Touchtone phone.

If youre using a speakerphone you may need to pick up the handset first before pressing the numbers. Once again, if you have a question at this time. Please press star one on your Touchtone phone.

One moment for our first question.

And our first question comes from.

Jack Vander <unk> with Maxim Group. Your line is now open.

Okay.

Great. Thanks.

Thanks, Hi, Juergen, Hey, John I appreciate the update thanks for taking my questions.

So youre going to I appreciate the helpful color on 2023.

Just just wondering maybe if I could dig into a little bit more.

Just in terms of how you see it playing it out.

How the year plays out assuming consumer demand is gradually begin to improve.

And retail inventories are slightly increasing throughout the year.

Any particular seasonality changes in terms of revenue mix, how you would expect that to bounce out and then I'll have a follow up.

Sure Jack Hi, <unk>.

First of all on seasonality.

It's always hard to judge as you go into the year. This year has been somewhat unusual with a very slow Q1, driven by a weak Q4 for the whole category.

Holiday 2021, so I think the.

Best modeling assumption right now is that the seasonality will be.

Normal next year, but.

But I do believe that the overall market will continue to improve next year in gaming a key barometer by the way for Q1 through Q3 next year is Q4 this year.

Recall that that Q4.

Is impacted by how well the games do and that our strong holiday.

Typically foreshadows a strong Q1 through Q3 and the opposite happens as well Q4 is weak then the following year until the new games launch also are impacted by that so I mentioned that the new call of duty release has much better reviews, and we were very pleased to see that that had set an opening.

<unk>, we can record. It also broke the record I believe on the Playstation five store. So thats a good first sign there is more good games coming.

But I think that'll have a positive effect on 2023.

One other important dynamic in terms of the topline that I mentioned.

You have this double negative effect when demand goes down.

Because not only do you need to sell less products to retailers to fulfill the demand, but they also take their inventory levels down even if they maintain the same weeks of supply.

Retailers haven't maintained the same weeks of supply on top of all of that this year, they've reduced anywhere from two to eight weeks of supply from their normal targets that has a large incremental effect on our revenues because on top of the decline in sell through and.

Reduction in normal inventory Youre also not selling as they as they wind their inventory levels, which are now well below normal.

So we expect that they will retailers will run through holiday conservatively and lean not lean to the point of stocking out by the way, but just below.

What we expect will be many weeks below their normal target levels. So if next year I mentioned, even if sell through is flat next year. The fact that there is not that negative impact from additional channel retail channel inventory compression because you reach limits the retailers can't keep taking weeks of supply out of there.

<unk> and <unk>.

We think we're at those limits now.

And we.

We could have a double positive effect as well if sell through starts going up and they become a less conservative on the inventory and then you are selling in not only the higher consumer demand, but also a increase in the weeks of supply for retailers. So sorry for the long answer, but that's kind of an overview on the top.

Next year excuse me.

No I appreciate the added color.

Assuming one of those is positive or even if you get the double positive effect.

Is there a chance we see 2023 revenue look similar to 2020 in 2021 or.

I guess I don't want to get ahead of my skis here, but it seems like that's possible if demand returns in these <unk> double positive play out.

That's going to depend a lot on how the overall economy does that's why we were even citing that at flat sell through next year. So similar consumer demand, we still see a revenue increase it's way too early before holiday to make a call on.

How the overall industry and the games environment Theres going to be next year.

Got it and just one more for me.

Mentioned as part of your long term plan and what Youre focused on youre exploring entering new product lines or categories, which you've done quite successfully.

Recently.

Just any idea of what you might be looking at or what can we maybe expect.

Natural or.

Something that makes sense that you don't currently have today.

Sure. So this year.

Late last year, we entered flight simulation as a new category and the first council controllers, and we obviously expanded our PC accessories lineup and also launched a set of mikes. So those are some new categories next year or last year and an expansion in the PC category. This year, we've continued to expand.

In PC and we've launched.

Mobile controllers. So those are what we just recently announced.

A separate additional Tam for mobile gamers and one natural extension, which we fully have in the works for next year is racing simulation same types of products and skills and engineering that we've demonstrated the ability to do extremely well with in the flight simulation.

Category really kind of raising the bar in redefining simulation products for flight Simmers, and we're working on doing that with the racing simulation with a target of sometime late next year.

There are other hardware categories, including controllers for other platforms that will look at and and we've got kind of a strategic map of where else. We can go that's complementary to our current businesses and like the rest of our expansion can fully leverage the global leadership position we've had for me.

Any years and counsel gaming headsets with all those retail relationships and all the fans we've generated.

From that.

Excellent well I. Appreciate you again, thank you I'll hop back in the queue. Thanks.

Thanks, Jack Thanks, Eric.

Thank you.

Our next question comes from.

Andrew <unk> with Oppenheimer. Your line is now open.

Okay.

Hi, This is Andrew on for Brian Thanks for taking the questions.

Just have two.

First.

Should we think about the puts and takes for gross margins in 2023, and then second one could you. Please comment on the choice of a new board member Teri gymnast and why haven't we seen.

Our principal from Donna <unk>, and it's a good point yet.

Sure. So on the gross margins. So this year's gross margins were heavily impacted by two factors one is a very competitive.

Promotional environment to reduce inventories.

We expect that that will get better next year. So that should have some positive impact on gross margins. The other big factor we discussed was.

High freight rates.

<unk>.

Rates have come down quite a bit freight rates. This year, we expect we will have over 5% negative impact on gross margins.

So we don't expect freight rates to go back to pre pandemic levels, but they have been coming down quite a bit in the past few months and you don't you won't see that in the P&L yet in Q4, because those products have to arrive go through the inventory and get sold out to retail so we'd expect gross margin impact from freight rate.

It's to start coming down next year in both of those items have significant impact on gross margins.

And then the New Board member Teri. He has joined now that is in place of a dozen real person at their recommendation. So we brought him on as the fourth New Board member.

He is.

Joined our first board meeting last week.

Great. Thank you.

Thank you once again, if you have a question at this time. Please press star one on your Touchtone phone.

Our next question comes from Franco Granda with da Davidson. Your line is now open.

Hi, good afternoon, everyone. Thanks for letting me ask a couple questions here.

Zero again.

Earlier in the call you talked about some of the new releases being beneficial to fourth quarter.

And enter into next year do well eventually.

Although there is a long way to go to be able to gauge how well the game will do as you mentioned.

Column three they just had a record first weekend.

Have you seen any data on what that did for your own sales for the weekend.

Okay.

I won't comment on recent sales because we're recovering the numbers through the end of Q3, but I will tell you that in the past when we've seen highly successful game launches or not successful game launches.

It has a flow through impact on how the whole market does it's not a direct impact. So we've had I remember some years ago I believe it was 2016, but it might have been 2015.

Where call of duty sales were down something like 40%.

And the impact on the overall market for counsel gaming headsets was about 10% in Q4, so it's not a perfect comp, but there is maybe about a quarter.

Flow through into India Council headsets, the reason for that by the way is that council.

Counsel headset a lot of the sales are existing gamers, who upgrade models throughout the year and some new gamers and highly successful game launch will tend to either prompt people who are.

<unk> and you really want to have a headset for call of duty because it's multi player and also attract some new gamers and so for us having having call of duty.

We have much better reviews and set some records.

Right out of the gate is a positive indicator.

I appreciate all that color is really helpful.

That case.

I guess this your guidance for $2 50 for the year does that contemplate.

Once that happened this past weekend with call of duty.

So it can be.

Victor.

So we take obviously our guidance reflects the latest available information sell through channel inventory all of that we try to provide the most accurate read that we can with all of the latest information.

Got it okay perfect.

Then.

Just one more from me.

Recently announced a lot of products for mobile and obviously, you're still growing your PC and line up quite a bit.

Can you I guess are you at the point, where you could parse out the revenue composition across multiple console and PC.

So, we just announced and launched one and I think the other product is still.

We've announced it but it's still coming to mobile controllers. So.

Way too early to report anything on mobile separately and note that while mobile it's got a set of customers that are mobile gamers, both or the weekend, a cloud controller, which is really cloud and mobile also works on Xbox.

It's kind of a very very unique in that you can get an Xbox.

Player, who wants to use it or an Xbox within it has.

Very good capability to take it with and play the same games on mobile that they play on the Xbox So.

It's also not clear that you can kind of clearly draw a line between those two the expansion into mobile is really just.

A nice addition to the controller portfolio that allows gamers to be use using controllers for cloud and mobile gaming.

And I guess I was referring mainly to be.

The fact that you had already announced some mobile headphone earlier this year.

That answers my question. Thank you so much honestly, yes, I get it same thing with mobile headphones by the way I mean, you can use them for non mobile gaming right. So it's just an additional product set to give.

Our fans and our customers a way to also use products when they are solely mobile.

Helpful. Thank you.

Thank you once again, if you have a question at this time. Please press star one on your Touchtone phone.

Again that is star one one on your Touchtone telephone.

Okay.

Yes.

I would now like to turn the conference back over to Juergen Stark for any closing remarks.

Thank you and we look forward to speaking with our investors and analysts again next year on our fourth quarter earnings call and we hope you all have a great holiday season. Thank you.

This concludes today's conference call.

Thank you for participating you may now disconnect.

The conference will begin shortly to raise your hand during Q&A you can dial one one.

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