TURTLE BEACH CORP Management's Discussion and Analysis of Financial Condition and Results of Operations (form 10-Q) – Marketscreener.com

The following discussion and analysis of our operations should be read together with our unaudited condensed consolidated financial statements and the related notes included in Part I of this Quarterly Report on Form 10-Q and with our audited consolidated financial statements and the related notes included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 2, 2022 (the “Annual Report.”)
This Report on Form 10-Q contains forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements in this Report are indicated by words such as “anticipates,” “expects,” “believes,” “intends,” “plans,” “estimates,” “projects,” “strategies” and similar expressions or negatives thereof. Caution should be taken not to place undue reliance on any such forward-looking statements because they involve risks, uncertainties and other factors that could cause actual results to differ materially from those expressed or implied in, or reasonably inferred from, such statements. Forward-looking statements are based on the beliefs, as well as assumptions made by, and information currently available to, the Company’s management and are made only as of the date hereof. The Company undertakes no obligation to update or revise the forward-looking statements, whether as a result of new information, future events or otherwise, except as required by the federal securities laws. In addition, forward-looking statements are subject to certain risks and uncertainties, including those described elsewhere in this Quarterly Report on Form 10-Q (including the effects related to the coronavirus (“COVID-19”) pandemic) that could cause actual results to differ materially from the Company’s historical experience and its present expectations or projections.
Business Overview
Turtle Beach Corporation (“Turtle Beach” or the “Company”), headquartered in White Plains, New York and incorporated in the state of Nevada in 2010, is a premier audio and gaming technology company with expertise and experience in developing, commercializing and marketing innovative products across a range of large addressable markets under the Turtle Beach®, ROCCAT® and Neat Microphones® brands. Turtle Beach is a worldwide leader of feature-rich headset solutions for use across multiple platforms, including video game and entertainment consoles, handheld consoles, personal computers (“PC”), tablets and mobile devices. ROCCAT is a gaming headset, keyboards, mice and other accessories brand focused in the PC peripherals market. Neat Microphones is a microphones brand focused on using cutting edge technology and design to create high quality USB and analog microphones for gamers, streamers, and professionals.
Business Trends
We participate in the global software and accessories gaming market, which had an estimated size of $200 billion in 2021, per updated data published by Newzoo in April 2022. The global gaming audience exceeds global cinema and music markets with over 3 billion active gamers worldwide. Gaming peripherals, such as headsets, keyboards, mice, microphones, controllers, and simulation are estimated to be an over $8.5 billion business globally with over 80% of that market in the Americas and Europe where the Company’s business is focused.
Competitive esports is a global phenomenon where professional gamers train and compete to win prize money, partner with major brands, and attract dedicated fans – similar to traditional professional sports. There were approximately 490 million esports viewers in 2021, and that is expected to increase to roughly 641 million viewers by 2025, according to a report from Newzoo. Of those 641 million projected viewers, approximately 318 million are considered “esports enthusiasts.”
Many gamers play online, where a gaming headset (which typically includes a microphone allowing players to communicate in real-time) provides a more immersive experience and a competitive advantage in the industry’s most popular games and franchises.
The Company’s results are affected by numerous macroeconomic factors including inflation, consumer spending confidence and global supply chains. In 2022, we have experienced a higher rate of inflation than in recent years resulting in higher cost of goods, selling expenses, and general and administrative expenses. Such increases have had and may continue to have a negative impact on the Company’s profit margins if selling prices of products do not increase with the increased costs.
The COVID-19 pandemic has disrupted worldwide economic markets and the extent to which the pandemic and measures adopted in response thereto continue to affect the Company’s business, results of operations and financial condition will depend on future developments, which are highly uncertain and difficult to predict. While there were likely certain one-time purchases of our products caused by stay-at-home guidance and remote working and learning, we believe millions of new gamers have joined the market which created an ongoing, larger installed base of players.
Console Headset Market
The global market for console headsets in 2021 was approximately $1.7 billion. PlayStation® and Xbox® consoles continue to be dominant gaming platforms in North America and Europe for games that drive headset usage. Consistent with a historical pattern of major new console launches every 7-8 years, Microsoft and Sony released their latest next generation consoles, Xbox® Series and PlayStation®5 platforms just ahead of the 2020 holiday season. Demand for the new consoles has continued to be very strong and exceeded supply which is a good indicator
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of the enthusiasm for the latest consoles. The demand for gaming consoles is forecasted to continue to be strong in 2022 with the additional supply of PlayStation®5 and Xbox® Series platforms expected to help the overall console market reach single digit percentage growth in 2022.
Nintendo has sold over 100 million units of the Nintendo Switch™ since its release in early 2017. Nintendo continues adding and expanding their library of games with an increased number of multiplayer chat-enabled games. Nintendo also sells the Nintendo Switch™ Lite, a follow-on product that offers gamers the hand-held only version of their popular gaming console.
While gaming on mobile/tablet devices represents about 51% of the global gaming market and headsets can be used for mobile gaming, console and PC gaming are by-far the largest drivers of gaming headset use.
PC Accessories Market
The market for PC gaming headsets, mice, and keyboards is estimated to have grown slightly in 2021 to $3.6 billion. The same gaming, work-from-home, and school-learn-from-home factors associated with the COVID-19 pandemic that benefitted the accessories market also resulted in increased consumer demand for headsets, keyboards, mice, and other accessories developed for PC gaming in recent years.
PC gaming in the U.S. has seen a resurgence in popularity the past few years and continues to be a main gaming platform internationally, driven by big AAA game launches, PC-specific esports leagues, popular teams and players, content creators and influencers and cross-platform play. While most games are available on multiple platforms, gaming on PC offers advantages including improved graphics, increased speed and precision of mouse/keyboard controls, and the ability for deeper customization. Gaming mice and keyboards are engineered to provide gamers with high-end performance and a superior gaming experience through features such as faster response times, improved materials and build quality, programmable buttons and keys, and software suites to customize and control devices and settings.
PC gaming mice come in a variety of different ergonomic shapes and sizes, are available in both wired and wireless models, offer options for different sensors (optical and laser) and responsiveness, and often feature integrated RGB lighting and software to unify with the lighting on other devices for a visually consistent PC gaming appearance. Similarly, PC gaming keyboards often deliver a competitive advantage by offering options for mechanical and optical key switches that feel and sound different and offer customizable lighting.
PC and console gaming markets are also driven by major game launches and franchises that encourage players to buy equipment and accessories. On Xbox®, PlayStation®, and PC flagship games like Call of Duty®, Destiny, Star Wars: Battlefront, Battlefield, Grand Theft Auto, and battle royale games like Fortnite, Call of Duty Warzone, Apex Legends, and PlayerUnknown’s Battlegrounds, are examples of major franchises that prominently feature online multiplayer modes that encourage communication and tend to drive increased gaming headset demand. Many of these established franchises launch new titles annually leading into the holidays and as a result can cause an additional boost to the normally strong holiday sales for gaming accessories.
Microphone Market
As of 2021, the microphone market is estimated to be $2.1 billion in size of which roughly an estimated $630 million is for digital USB microphones. The market for high-quality microphones, specifically digital microphones, has experienced significant growth as content creators on YouTube, Twitch and other popular platforms are gravitating toward using high-quality professional equipment for their workstations. Additionally, with the trend to remote work, the need for a well-performing desktop microphone has become an important tool for working and learning from home, as well as staying connected with family and friends. Turtle Beach’s acquisition of Neat Microphones in 2021 expanded the Company’s reach into the global microphone market, including, in particular, the market for digital/USB microphones that are often used by gamers, streamers, and influencers with other PC accessories.
Other Gaming Accessories Market
During 2021, the Company successfully expanded into the gaming simulation and gaming controller markets with the launch of the VelocityOne Flight™ simulation control system and the Xbox® Recon Controller, respectively. These markets increased our total addressable market by $1 billion, with third-party game controllers at roughly $600 million, and PC/console flight simulation hardware at roughly $400 million.
Supply Chain and Logistic Outlook
The ongoing global economic recovery, subsequent to the COVID-19 pandemic, as well as a surge in imports and high demand for electronics, has created significant challenges for global supply chains resulting in inflationary cost pressures and component shortages. We have also experienced logistical challenges related to transportation delays and have incurred incremental costs for commodities and components used in our products as well as component shortages that have negatively impacted our sales and results of operations. These factors resulted in the demand for such goods to exceed supply chain capacity, which drove costs and lead times higher. We expect that these challenges will continue
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to have an impact on our businesses for the foreseeable future. As a result, we continue to take proactive steps to continue to limit the impact of these challenges and are working closely with our suppliers to manage availability of products and implement other cost savings initiatives.
Key Performance Indicators and Non-GAAP Measures
In evaluating our results, management routinely reviews key performance indicators, which include non-GAAP measures as well as the operating metrics of revenue, operating income and margins, and earnings per share, among others. In addition, we believe certain other measures provide useful information to management and investors about us and our financial condition and results of operations for the following reasons: (i) they are measures used by our Board of Directors and management team to evaluate our operating performance; (ii) they are measures used by our management team to make day-to-day operating decisions; (iii) the adjustments made are often viewed as either non-recurring or not reflective of ongoing financial performance or have no cash impact on operations; and (iv) they are used by securities analysts, investors and other interested parties as a common operating performance measure to compare results across companies in our industry by adjusting for potential differences caused by variations in capital structures (affecting relative interest expense), and the age and book value of facilities and equipment (affecting relative depreciation and amortization expense). We consider the following metrics, which may not be comparable to similarly titled measures reported by other companies, to be key performance indicators:

Adjusted EBITDA is a non-GAAP measure that we believe is useful to investors to measure the operational strength and performance of our business. Adjusted EBITDA is defined as net income (loss) before interest, taxes, depreciation and amortization, stock-based compensation (non-cash) and certain special items that we believe are not representative of core operations.

Cash Margin is defined as gross margin excluding depreciation and amortization, and stock-based compensation.
We believe that the presentation of Adjusted EBITDA is appropriate to provide additional information to investors about our operating profitability adjusted for certain non-cash items, non-routine items that we do not expect to continue at the same level in the future, as well as other items that are not core to our operations. Further, we believe Adjusted EBITDA provides a meaningful measure of operating profitability because we use it for evaluating our business performance, making budgeting decisions, and comparing our performance against that of other peer companies using similar measures. However, Adjusted EBITDA is not a measure of financial performance under accounting principles generally accepted in the United States of America (“GAAP”) and, given the limitations of these metrics as analytical tools, should not be considered a substitute for gross profit, gross margins, net income (loss) or other consolidated income statement data as determined in accordance with GAAP.
Depreciation and amortization 1,577 1,430 $ 3,081 2,472 Stock-based compensation
Income tax expense (benefit) (4,740 ) (1,286 ) $ (7,379 ) 1,480 Restructuring Expense
Non-recurring business costs 6,267 987 $ 6,499 1,626 Adjusted EBITDA
Comparison of the Three Months Ended June 30, 2022 to the Three Months Ended June 30, 2021
Net loss for the three months ended June 30, 2022 was $17.8 million with Adjusted EBITDA of ($12.1) million, compared to net income of $1.7 million with Adjusted EBITDA of $5.0 million for the prior year, due to consumer spending caution across all major markets, reduced channel inventory levels at retailers, increased freight costs, business mix, and volume-driven fixed cost deleveraging.
Comparison of the Six Months Ended June 30, 2022 to the Six Months Ended June 30, 2021
Net loss for the six months ended June 30, 2022 was $24.3 million with Adjusted EBITDA of ($17.8) million compared to net income of $10.6 million with Adjusted EBITDA of $20.3 million for the prior period due to lower revenue as compared to prior year’s incremental stimulus check driven spending as well as increased freight costs.
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Results of Operations
Excludes depreciation and amortization, and stock-based compensation
Comparison of the Three Months Ended June 30, 2022 to the Three Months Ended June 30, 2021
Net revenue for the three months ended June 30, 2022 was $41.3 million, a $37.3 million decrease from $78.6 million reflecting lower customer demand as a result of a challenging macroeconomic environment, lower channel inventory levels at retailers and global supply chain issues. The comparable prior year period revenues were at elevated levels resulting from stay-at-home orders and government stimulus payments.
For the three months ended June 30, 2022, gross margin decreased to 19.1% from 36.5% in the comparable prior year period. The decrease was primarily due to higher promotional credits driven by more aggressive competitive pricing actions to reduce channel inventory levels, business mix, higher freight costs, volume-driven fixed cost deleveraging and higher warehouse costs to ensure product supply.
Comparison of the Six Months Ended June 30, 2022 to the Six Months Ended June 30, 2021
Net revenue for the six months ended June 30, 2022 was $88.0 million, a $83.7 million decrease from $171.6 million in the elevated comparable prior year period brought on by stay-at-home orders and government stimulus payments.
For the six months ended June 30, 2022, gross margin decreased to 24.9% from 37.0% in the comparable prior year period. The decrease was primarily due to higher freight costs, a more normalized level of promotional credits and volume-driven fixed cost deleveraging.
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Selling and marketing expenses for the three and six months ended June 30, 2022 totaled $11.6 million and $22.4 million, respectively, compared to $15.7 million and $27.2 million, respectively, for the three and six months ended June 30, 2021. This decrease was primarily due to lower revenue-based expenses and scaling of marketing initiatives to the consumer environment.
Research and Development
Research and development costs for the three and six months ended June 30, 2022 were $5.1 million and $10.4 million, respectively, compared to $4.4 million and $8.4 million, respectively, for the three and six months ended June 30, 2021. The year-over-year increases were primarily due to the addition of resources and infrastructure to support new product development and further global expansion.
General and Administrative
General and administrative expenses for the three months ended June 30, 2022 totaled $12.5 million compared to $8.2 million for the three months ended June 30, 2021. Excluding certain non-recurring fees related to the proxy contest with respect to the 2022 annual meeting of stockholders and shareholder litigation costs, expenses decreased $0.8 million primarily due to lower professional fees.
General and administrative expenses for the six months ended June 30, 2022 totaled $18.8 million compared to $15.2 million for the six months ended June 30, 2021. Excluding certain non-recurring fees related to the proxy contest with respect to the 2022 annual meeting of stockholders and shareholder litigation costs, expenses decreased $1.1 million primarily due to lower professional fees and employee costs.
Income Taxes
Income tax benefit for the three months ended June 30, 2022 was $4.7 million at an effective tax rate of 21.0% and income tax benefit for the six months ended June 30, 2022 was $7.4 million at an effective tax rate of 23.3%. Income tax benefit for the three months ended June 30, 2021 was $1.3 million at an effective tax rate of (295.6%) and income tax expense for the six months ended June 30, 2021 was $1.5 million at an effective tax rate of 12.3%. The effective tax rate for the six months ended June 30, 2022 was primarily impacted by the deduction for stock option exercises, offset by certain non-deductible costs and state income tax expense.
Liquidity and Capital Resources
Our primary sources of working capital are cash flows from operations and availability under our revolving credit facility. We have funded operations and acquisitions in recent periods with operating cash flows and borrowings under our revolving credit facility.
The following table summarizes our sources and uses of cash:
Cash and cash equivalents at beginning of period $ 37,720 $ 46,681 Net cash provided by (used for) operating activities (41,247 ) 12,448 Net cash used for investing activities
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Operating activities
Cash used for operating activities for the six months ended June 30, 2022 was $41.2 million, a decrease of $53.7 million as compared to cash provided by operating activities of $12.4 million for the six months ended June 30, 2021. The decrease is primarily the result of lower gross receipts as well as higher inventory levels due to retailers compressing channel inventory and accelerated procurements to ensure product supply.
Investing activities
Cash used for investing activities was $1.2 million for the six months ended June 30, 2022, which was related to certain capital investments, compared to $5.8 million for the six months ended June 30, 2021, which included $2.5 million related to the Neat Microphones acquisition.
Financing activities
Net cash provided by financing activities was $16.2 million during the six months ended June 30, 2022 compared to $2.8 million during the six months ended June 30, 2021. Financing activities during the six months ended June 30, 2022 and June 30, 2021 consisted primarily of $15.7 million revolving credit facility borrowings and $2.8 million share-based activity, respectively.
Management assessment of liquidity
Management believes that our current cash and cash equivalents, the amounts available under our revolving credit facility and cash flows derived from operations will be sufficient to meet anticipated short-term and long-term funding for working capital and capital expenditures including amounts to develop new products, fund future stock repurchases and to pursue strategic opportunities.
In addition, the Company monitors the capital markets on an ongoing basis and may consider raising capital if favorable market conditions develop. Significant assumptions underlie this belief, including, among other things, that there will be no material adverse developments in our business, liquidity or capital requirements.
Foreign cash balances at June 30, 2022 and December 31, 2021 were $3.4 million and $10.2 million, respectively.
At-the-Market Equity Offering Sales Agreement
On August 7, 2020, the Company entered into an ATM Equity Offering Sales Agreement (the “Sales Agreement”) with BofA Securities, Inc. (the “Sales Agent”). Pursuant to the terms of the Sales Agreement, the Company may sell from time to time through the Sales Agent shares of the Company’s common stock, par value $0.001 per share, having an aggregate offering price of up to $30 million. The Company intends to use the net proceeds from the offering, after deducting the Sales Agent’s commissions and the Company’s offering expenses, to support its strategic growth plans, as well as for general corporate purposes.
There was no activity under this agreement during the six months ended June 30, 2022.
Revolving Credit Facility
On December 17, 2018, Turtle Beach and certain of its subsidiaries entered into an amended and restated loan, guaranty and security agreement (“Credit Facility”) with Bank of America, N.A. (“Bank of America”), as Agent, Sole Lead Arranger and Sole Bookrunner, which replaced the then existing asset-based revolving loan agreement. The Credit Facility, which expires on March 5, 2024, provides for a line of credit of up to $80 million inclusive of a sub-facility limit of $12 million for TB Europe, a wholly-owned subsidiary of Turtle Beach. In addition, the Credit Facility provides for a $40 million accordion feature and the ability to increase the borrowing base with a “first-in, last-out” (a “FILO Loan”) of up to $6.8 million.
On May 31, 2019, the Company amended the Credit Facility to provide for, amongst other items, (i) the addition of TBC Holding Company LLC, a wholly-owned subsidiary of VTB, as an obligor and (ii) the ability to make investments in TB Germany GmbH, a wholly-owned subsidiary of TB Europe, of up to $4 million in connection with the acquisition of ROCCAT and up to an additional $4 million annually.
The maximum credit availability for loans and letters of credit under the Credit Facility is governed by a borrowing base determined by the application of specified percentages to certain eligible assets, primarily eligible trade accounts receivable and inventories, and is subject to discretionary reserves and revaluation adjustments. The Credit Facility may be used for working capital, the issuance of bank guarantees, letters of credit and other corporate purposes.
Amounts outstanding under the Credit Facility bear interest at a rate equal to either a rate published by Bank of America or the LIBOR rate, plus in each case, an applicable margin, which is between 0.50% to 1.25% for base rate loans and between 1.25% to 2.00% for U.S. LIBOR loans and U.K. loans, and between 2.00% to 2.75% for the FILO Loan. In addition, Turtle Beach is required to pay a commitment fee on the unused revolving loan commitment at a rate ranging from 0.25% to 0.50% and letter of credit fees and agent fees. As of June 30, 2022, interest rates for outstanding borrowings were 5.25% for base rate loans and 3.00% for LIBOR rate loans. As of June 30, 2022, there was $15.7 million in outstanding borrowings under the Credit Facility.
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The Company and the administrative agent entered into an amendment to the Credit Agreement (the “LIBOR Transition Amendment”) to replace the LIBOR rate as a reference rate available for use in the computation of interest under the Credit Agreement in favor of (i) the Applicable Rate (as defined in the Credit Agreement) plus Sterling Overnight Index Average (“SONIA”) or the Euro Interbank Offered Rate (“EURIBOR”). The Company expects to enter into an additional agreement to finalize the transition of the U.S. LIBOR rate prior its expiration on June 30, 2023.
The Company is subject to quarterly financial covenant testing if certain availability thresholds are not met or certain other events occur (as defined in the Credit Facility). At such times, the Credit Facility requires the Company and its restricted subsidiaries to maintain a fixed charge coverage ratio of at least 1.00 to 1.00 as of the last day of each fiscal quarter.
The Credit Facility also contains affirmative and negative covenants that, subject to certain exceptions, limit our ability to take certain actions, including the Company’s ability to incur debt, pay dividends and repurchase stock, make certain investments and other payments, enter into certain mergers and consolidations, engage in sale leaseback transactions and transactions with affiliates, and encumber and dispose of assets. Obligations under the Credit Facility are secured by a security interest and lien upon substantially all of the Company’s assets.
As of June 30, 2022, the Company was in compliance with all financial covenants under the Credit Facility, as amended, and excess borrowing availability was approximately $22.0 million.
Critical Accounting Estimates
Our discussion and analysis of our results of operations and capital resources are based on our consolidated financial statements, which have been prepared in conformity with U.S. GAAP. The preparation of these consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses and the disclosure of contingent assets and liabilities. Management bases its estimates, assumptions and judgments on historical experience and on various other factors that it believes to be reasonable under the circumstances.
Different assumptions and judgments would change the estimates used in the preparation of the condensed consolidated financial statements, which, in turn, could change the results from those reported. Management evaluates its estimates, assumptions and judgments on an ongoing basis. For a discussion of the critical estimates that affect the condensed consolidated financial statements, see “Critical Accounting Estimates” included in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report.
See Note 2, “Summary of Significant Accounting Policies,” to the unaudited condensed consolidated financial statements contained herein for a complete discussion of recent accounting pronouncements. We are currently evaluating the impact of certain recently issued guidance on our financial condition and results of operations in future periods.
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