Turtle Beach Corporation (TBCH) Earnings Call Transcript & Summary

Welcome to the Turtle beach First Quarter 2023 Conference Call. My name is Latif, and I will be your operator for today's call. [Operator Instructions] Delivering today's prepared remarks are Non-Executive Chairman of the Board, Terry Jimenez; 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 Thompson from Investor Relations. Alex, you may begin.

Thank you, operator. On today's call, we will be referring to the press release filed this afternoon that details the company's first 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 Investors 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'll 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 in the reconciliation tables provided in today's earnings release and presentation. The company, its directors and certain of its executive officers are participants in the solicitation of proxies from the company's shareholders in connection with its 2023 Annual Meeting. The company intends to file a definitive proxy statement and a white proxy card with the SEC in connection with any such solicitation of proxies. Shareholders are strongly encouraged to read the proxy statement accompanying proxy card and all the other documents filed with the SEC carefully and in their entirety when they become available as they will contain important information, including information regarding the identity of the participants in association and their direct and indirect interest by security holdings or otherwise. Next, we'll give a statement from Terry Jimenez, the company's Non-Executive Chairman of the Board of Directors.

Thanks, Alex, and good afternoon, everyone. I'm pleased to make a statement on the call this afternoon to briefly cover our CEO transition plan and governance actions, all of which was announced in our press release earlier this week, on Monday, May 1. The Board has taken a series of actions consistent with its commitment to acting in the best interest of its shareholders and ensuring best-in-class governance practices. From this, the Board has implemented a CEO succession plan with the transition date of June 30, 2023. We separated the Chairman and CEO roles going forward. I was elected as the new independent Chairman. Accepted the decision by 2 long-tenured directors, Juergen Stark and William Keitel, do not stand for reelection at the 2023 Annual Stockholder Meeting. The Board intends to appoint a shareholder representative in Mr. Keitels' place to be nominated for election at the 2023 Annual Meeting. The Board organized -- reorganized the composition of the Board committees, including new committee chairs, notably all of whom are women. And importantly, the Board continues to be focused on value-enhancing or strategic actions that would be in the interest of all shareholders. Further details of our announcement can be found in our separate release referenced earlier. On behalf of the Board of Directors, I want to thank Juergen for his leadership over the past 10 years. He has overseen the company's transformation into a leading accessory maker poised for growth across valuable gaming categories. I also want to thank Bill Keitel for his many years of service and contributions as a director. Finally, I am honored to take on the role of Board Chair and to continue working closely with my fellow Board members, and management to engage with and enhance value for all Turtle Beach shareholders. I believe there is significant value and upside for the company and its shareholders, and I look forward to working with the team and the Board to unlock that upside value. With that, I will pass it over to Juergen to cover the first quarter's results.

Good afternoon, everyone, and thank you for joining us. I'm pleased to discuss our first quarter 2023 results, which came in above expectations and provide the context for our increased 2023 outlook. During the first quarter, we delivered net revenues of $51.4 million and an adjusted EBITDA loss of $2.3 million. Year-over-year revenues are up 10%, consistent with the growth prospects, strong strategic positioning and progressive recovery of the gaming market that I articulated in March. Adjusted EBITDA has improved consistent with our expectation to return to positive adjusted EBITDA after last year's market-wide challenges. After all, this business generated $190 million in adjusted EBITDA in the 5 years from 2017 through 2021. I'll start with some observations on the state of the market and our business through the first 3 months of the year. Both the gaming market and operating environment have improved compared to last year when the industry and economy faced significant macroeconomic challenges, some headwinds still remain, such as higher-than-normal promotional activity and discretionary spending caution among consumers, given the economic issues at hand, including inflation, rising interest rates and the continued threat of recession. However, we are encouraged by the latest industry data as gaming accessories sales benefited from a strong tailwind in console sales. In fact, Sony reported that PlayStation 5 shipments in Q1 were the highest of any console in gaming history, up over 4 million units compared to the year ago period. U.S. Circana, formerly known as NPD, reported U.S. console headset sell-through increased over 7%. Additionally, U.S. channel inventory improved in Q1. Our inventory levels are at the lowest since the pandemic surge. The PC gaming market recovery is trailing console with heavy discounting levels, but we expect this to subside as we progress through the year. We're encouraged by the improvements we are seeing in the gaming market. Looking at our performance across respective gaming accessory categories, we continue to lead the console headset category by far as Turtle Beach console headset brand outperformed the broader headset market's growth based on U.S. Circana data. Our highly acclaimed wireless Stealth 600 headset continued to be the best-selling headset series by revenue in the quarter and the Recon 50X and 50P headsets were the best-selling models by units. I mentioned our exciting product plans on our call in March, and we've recently launched our ultra-premium Stealth Pro multi-platform gaming headset, which brings gamers the absolute pinnacle of gaming audio and quality and comfort. At $329.99 MSRP, the Stealth Pro continues to collect praise from gaming review outlets. GamesRadar gave it a 5 of 5 rating, along with their Editor's Choice Award and called it "a masterpiece of an all-in-one multipurpose gaming headset." Importantly, this headset line is multiplatform, working perfectly across Xbox and PlayStation consoles as well as PC and for mobile gamers. While still very early in the launch, we are extremely pleased with the response from consumers and resulting early sales, which were coming in above our expectations. Looking at our PC accessories category, the market recovery is lagging console headsets with U.S. Circana reporting PC gaming headset, keyboard and mice sales down approximately 13% year-over-year for Q1. Despite this, our ROCCAT brand products have posted year-over-year sales growth in all 3 categories. We continue to launch compelling new PC gaming products. We released the Magma Mini 60% gaming keyboard, which has a smaller footprint that is perfect for PC gamers with large mouse movements and is fully illuminated with 5 programmable zones, showcasing ROCCAT's stunning AIMO RGB lighting. We have exciting plans for our PC category ahead and look forward to continuing our progress. Our flight simulation and gamepad controller products performed well during the quarter, and we are proud to have our first flight simulation product VelocityOne Flight launched late 2021, continue to post the #1 sales position in the U.S. for flight simulation products. The U.S. gamepad controller market was down roughly 13% year-over-year in Q1, but sales of our products grew over 25%. We have more exciting product launches in these categories as well. Our long-term strategy of becoming a top provider of gaming accessories across multiple categories and on all platforms is tracking well, as shown by the above highlights and our outperformance of the market this quarter. Our strong brand, innovative high-quality products and operational execution allows us to capitalize on the additional opportunities created during a market improvement. This is reflected not only in our first quarter results, but also in our increased outlook of 10% to 12% revenue growth, as I'll discuss shortly. I'll now pass it over to John to cover the financials, after which I'll provide additional comments on the quarter and outlook. John?

Thanks, Juergen, and good afternoon to everyone. For the first quarter, we reported revenue of $51.4 million, a 10% year-over-year growth compared to $46.7 million a year ago, reflecting a stronger U.S. console gaming headset market, increased consumer demand and strong product performance. The double-digit year-over-year increase is a good start towards the 2023 revenue growth guidance of 10% annual growth we provided in March. Gross margin in the first quarter was 27.5% compared to 30.1% in the year ago period, reflecting higher promotional spend in light of continued competitive discounting, which was partially offset by lower freight and logistics cost. The higher competitive discounting really started in Q2 last year, and while it's improving, it was a headwind in Q1 as we expected. As mentioned previously, freight costs continue to decline, and we have already started seeing the benefit in this quarter with higher sales accelerating the inventory pace to lower rates and actual rates tracking a bit lower than expected. Operating expenses in the first quarter were $20.6 million compared to $22.3 million in the year ago period. First quarter recurring operating expenses declined nearly 13% year-over-year, which was primarily driven by the expense management initiatives we undertook in 2022 as well as lower marketing spend to align with our product launch and sales plans. Our first quarter adjusted EBITDA loss was $2.3 million compared to a loss of $5.7 million in the year ago period. The year-over-year improvement is primarily driven by higher revenue as well as the operating expense management initiatives we implemented last year. We are on plan to generate adjusted EBITDA improvements throughout the year. Non-GAAP net loss for the first quarter was $4.4 million or $0.27 per diluted share compared to non-GAAP net loss of $6.3 million or $0.39 per diluted share in the year ago period. We expect our effective tax rate for the full year to be approximately 20%. Turning to the balance sheet. At March 31, 2023, we had $20.6 million of cash and no outstanding borrowings on our revolving credit line. Inventory at March 31, 2023, were $65.2 million compared to $117.4 million at March 31, 2022. Worth noting and as Juergen mentioned, our inventory levels at quarter end are at their lowest levels since the pandemic surge. Cash flow from operations was $28.8 million in the quarter, which was an improvement of $42 million year-over-year. And now I'll turn the call back over to Juergen for additional comments. Juergen?

Thanks, John. As I said, we're pleased to deliver first quarter results above our expectations, particularly given the still challenging environment, which demonstrates our team's commitment to executing well on our strategy in an improving gaming market. On our March call, I discussed the positive underlying trends in gaming. I'll reiterate a few. According to Newzoo, the number of global gamers is expected to grow by 335 million through 2025. Gamers are also spending more on gaming hardware with annual spend per gamer up over 20% since 2020. Even in last year's slump, consumer spending on video game hardware content and accessories, all continued to trend well above pre-pandemic levels throughout the year. We also remain encouraged by the higher-quality slate of AAA games with several setting franchise records and the strong outlook for games this year. We continue to expect new generation Xbox and PlayStation supply to significantly improve with DFC forecasting a 60% increase in PlayStation 5 sales for 2023 versus 2022. Sony setting an all-time shipment record versus all consoles in Q1 is a great start. As we communicated on our last call, we continue to expect a progressive improvement in our financial performance in light of a healthier gaming market and strong portfolio of existing and new products. Given our performance in Q1 and positive outlook for the year, we are increasing our revenue outlook to a range of $265 million to $270 million, which would reflect growth of 10% to 12%. This is mainly driven by our expected outperformance of gaming markets in specific categories. The share gains in the first quarter provided a good start on that and the phenomenal launch of our ultra-premium Stealth Pro multi-platform headset as well as the exciting launches yet to come are expected to contribute. We are increasing our adjusted EBITDA guidance to a range of $6 million to $8 million, driven by an increase in expected revenues and continued tight cost management. As we've noted, this still includes significant headwinds, which we expect will abate as we progress through the year and, therefore, provide for a much better level of profitability in 2024. For Q2, we expect a similar level of revenues as Q1 and somewhat higher marketing spend to support the recently launched Stealth Pro line. As I said, I'm pleased with the strong execution we displayed in the first 3 months of the year and the positive momentum that has created for the balance of the year. As we say every quarter, gaming is a great market to be a leader in, and we continue to position ourselves to capitalize on the additional opportunities as the market recovers. The key pillars of our strategy remain intact. First, continue to lead in the $1.4 billion console gaming headset market where we have maintained leadership by far for over 13 consecutive years. In addition to the recent Stealth Pro launch, we have a very strong portfolio plan through 2024 to expand our market leadership position. Second, continue to expand our PC gaming portfolio of headsets, keyboards and mice and grow our share in the $3.2 billion PC accessories market. As multi-platform gaming trends continue to rise, we feel we're in a good position to offer gamers the portfolio of accessories for all platform experiences. While the PC accessories market was very challenged for all participants this past year, we are encouraged by our share gains this year and have exciting plans for this category well into 2024. Third, drive continued expansion and growth in our gamepad controller and simulation products that we successfully entered in 2021. These adjacent gaming accessory categories allow us to leverage the core competencies of Turtle Beach and expand the markets we can generate revenues from. And fourth, continue to identify and selectively evaluate other growth opportunities to increase our addressable markets, including new product categories and expansion in target geographies as we have with Korea and Japan. As I said on our March -- call in March, this strategy has and will continue to enable us to take full advantage of the compelling long-term trends in the global gaming market and fulfill our objective to drive profitable growth. Our goal is to continue to create shareholder value by executing on our strategy and delivering on our long-term targets of 10-plus percent annual growth at 10-plus percent adjusted EBITDA margins. Given that I will be stepping down on June 30, this will be my last Turtle Beach earnings call. I'd like to first thank Bill Keitel for his valuable contributions over the past 9 years. I still recall being told we'd, "never be able to get him on to our board given his stature as one of the most highly regarded CFOs in the country." Thank you, Bill. Thank you as well to an amazing team here at Turtle Beach. It's been an honor to lead the company for over 10 years. With the excellent team in place here, this is a good time for me and a good time for the company to make a transition. In the past 10 years, we've worked ourselves out of a debt-laden balance sheet and managed through multiple years with challenging market conditions, including 2022. We have executed well through as the opco analyst put it, "violent demand-supply swings, including significantly outperforming the market in the 2018 Fortnite and 2020 pandemic-driven surges." This team has led our continued dominance in console headsets, while diversifying into adjacent gaming categories to enable our long-term growth. Our current business and portfolio plans through 2024 are the most exciting we've ever had. I'm confident the business is well positioned for success and in good hands to drive value creation going forward for all of our stakeholders. While I'm excited to have time to spend on other activities, I will really miss the team and the company. With that, let's turn to our Q&A.

[Operator Instructions] Our first question comes from the line of Mark Argento of Lake Street.

Juergen, congrats on a new chapter. It's been fun working with the company over the last 10 years. But looking forward to the next chapter and hopefully to experience a little bit more of that great country we got and getting to your point and do a little bit more flying. So exciting times for you. But hats off. Just wanted to drill in a little bit on a couple of things that stuck out to me in the quarter, in particular, the inventory levels, seems like you guys worked inventories down fairly nicely. I guess the question is, in terms of refill cycles, do you feel like you got enough inventory here as hopefully things pick back up going throughout the year?

Yes. Thanks, Mark, and I appreciate your comments. You're one of the folks I'm also going to miss, frankly, after more than 9 years of working together, and I certainly appreciate your great coverage of the company. On the inventory, so our inventory, lowest level since the pandemic surge starting in April 2020. So we are in a good position. It will still -- we still plan to end the year with lower inventory, but it will come up depending on holiday load in the next couple of quarters.

Function phasing?

Yes, just a phasing of the revenues and the load-in.

Great. And then in terms of the overall buying patterns, obviously, some pretty good console sales here in the front half of the year. What's the typical attach rate in terms of when you see a console gets sold through and you could actually attach a headset there? So should we see more of a pickup in Q3, Q4? Is that more of a 2024 event?

Yes. That's a good question. There is a percent of consumers who will buy a console and accessorize it, mainly the new -- some of the new entrants. That's not a huge effect, but it does have an effect. And I think the much better supply situation for PlayStation, for sure, setting a quarter record, which was quite a surprise as well as Xbox contributed to the over 7% growth that we saw in the U.S. on console headsets. And we do expect that the console supply will continue to improve. I think, frankly, they're out of it -- they're out of the phase of the console constraints, and that certainly will have a positive effect on the market this year.

Great. And just one last one. In terms of gross margins, nice improvement, at least relative to kind of where we were or where our model was. What's kind of the new normal would you think in terms of kind of run rate gross margins in, I call it, not a highly promotional but more kind of a normalized environment?

Yes, good question. I'm glad you're asking. We are maintaining our long-term target of mid-30s gross margins, right? This year, we expect -- still expect 28% to 30% gross margins, and that's really driven by continued freight costs that are higher than normal, but rapidly coming down. So that's a very reliable improvement that I think will be well passed going into 2024 and higher competitive discounting, which still remains some in console and more severe, I would say, in PC that we also expect to improve over time. But those 2 things are going to have an effect, still about $10 million on the gross margin line and $10 million on the EBITDA line that I'm hopeful going into 2024 will be kind of completely out of our system.

Our next question comes from the line of Martin Yang of OpCo.

Juergen, it's been long covering the company and we'll definitely miss you on future calls. I first want to ask about the Stealth Pro products. It's been a while since you take position in the ultra-high premium segment. So 2 questions on that. First, why does it take so long for you to address this segment again? And then the second question is how meaningful it is this segment to you or to Turtle Beach?

Yes. Thanks, Martin. A long time ago, we dominated the highest price tier as well. And we have continue to really lead by far the mid and the upper mid-tier. But you're right, we haven't been in that highest tier. And I will tell you, we have had plans for more than 1.5 years, 2 years to reenter that market. The reason we haven't done it is because the pandemic created such a headache with semiconductors that we had to divert engineering to replatform wireless headsets and essentially protect that very large revenue stream for the business, which we did successfully, but call it, an emergency redirection of R&D that really started late in 2020 and continued through 2021, frankly. That forced us to divert resources from the Stealth Pro. And so we just as a matter of priorities had to make that move. And frankly, we're very excited that at long last, we can take over what we think will be the king of wireless in the premium tier. And certainly, the reviewers are -- some of them are even saying, that's a fair claim that they're making King of Wireless. So very excited. The top tier is about, I believe, about 12% of the revenues for the overall market. So it's meaningful. And given that we've had no share above 200, that 12%, all of the share gains will be accretive to the overall economics of the business and our overall market share.

Got it. My second question is about potential new products and your view on new emerging product categories. I'm referring to the handheld gaming trends where Steam Deck plus other PC-like gamehelds and cloud handhelds hardware or emerging other market seems to have certain positive initial feedback from the players. Do you have a view on that? And if Turtle beach were to play a role in that segment, what are the angles?