Q1 2024 Turtle Beach Corp Earnings Call

Participants

Alex Thompson; Investor Relations; Gateway Group

Cristopher Keirn; Chief Executive Officer, Director; Turtle Beach Corp

John Hanson; Chief Financial Officer, Treasurer, Secretary; Turtle Beach Corp

Mark Argento; Analyst; Lake Street Capital Markets

Jack Vander Aarde; Analyst; Maxim Group

Sean McGowan; Analyst; ROTH MKM

Presentation

Operator

Welcome to the Turtle Beach First Quarter 2024 conference call. My name is TD, and I will be your operator for today's call. (Operator Instructions) Today's prepared remarks are Chris Keirn, Chief Executive Officer; and John Hanson, Chief Financial Officer. In their prepared remarks, management team will open the call up for any questions. As a reminder, conference is being recorded.
I will now turn the call over to Alex Thompson from Investor Relations.

Alex Thompson

Alex, you may begin your operator on today's call. We will refer to the press release filed this afternoon that details the company's first quarter 2024 results, which can be downloaded from the Investor Relations page at corp dot Turtle Beach.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. Future results 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 in 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 company also notes that on this call who 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 in the reconciliation tables provided in today's earnings release and presentation.
And now I'll turn the call over to Chris Kern, CEO of Turtle Beach. Chris.

Cristopher Keirn

Thank you all for joining us today on our first quarter 2024 earnings call. I'm very pleased with our continued progress in a transformative year for the Company. As expected, we have made significant progress on multiple strategic initiatives to drive profitable and sustainable growth. While we are in the early stages of integration for a recent acquisition, of PDP. This infusion of additional talent and expertise has further energized our team and we are executing to achieve both revenue and cost synergies. We look forward to maximizing the benefits of our increased scale and enhanced product portfolio in 2024 and beyond.
First quarter revenue was $55.8 million, up roughly 9% year over year which included incremental revenue contribution in the back half of March from our acquisition of P. We also realized improved profitability in the quarter, delivering $1.4 million of adjusted EBITDA compared to an adjusted EBITDA loss of $2.8 million a year ago. As we've previously communicated, we continue to see year-over-year improvements in profitability through our portfolio optimization SKU rationalization and platform product development initiatives, all of which are coming into full effect throughout this year following market gains that started in December of 2023, both the US gaming headset and gaming controller markets continued to climb with double digit year-over-year revenue growth in Q1, personal Kona combined console and PC headset markets were up 18% and gaming controllers were up nearly 20% by revenue. Third-party controllers exceeded revenue growth compared to first party controllers, driven by our new Stealth Ultra controller and increased sales of PDP. models. We remain optimistic for continued growth in the gaming accessory markets and have an exceptional lineup of new Turtle Beach products launching in just a few weeks. And then again, before the holidays. Q1 demonstrated that accessory sales at this point in the console cycle are growing as gamers who remain highly engaged with a strong lineup of titles. Over the last year, we believe another contributor to market growth in Q1 was a result of a replacement cycle lift from pandemic era accessory purchases, especially with a new generation of accessories in the market that offer upgrades to technology and features. As mentioned in previous calls, we anticipated the pandemic air replacement purchases would contribute to gaming accessory market growth in 2024 double digit market growth for key gaming category and accessory categories in Q1 was a good indicator that these replacement purchases are underway and we believe replacement purchases will continue to support market performance in future quarters.
In our headset and PC categories, we proactively reduced channel inventory and promotional activity in Q1, ahead of our significant new headset and PC product launches in Q2, channel load in for our new headsets and PC products is occurring now and channel inventory is projected to return to normalized levels once the new load-in of new products is completed in Q2 we are eager to bring these fantastic new products to our gaming customers and are confident they will deliver strong results for the business.
Our new controller in simulation models, including the premium stuff, Ultra controller and velocity one simulation products drove Q1 share gains for Turtle Beach. Our revenue share of the US flight simulation market grew from 20% in Q1 2023 to 25% in Q1 2024 as reported by silicon with additional products in development, we anticipate continued share growth over time in simulation categories. Additionally, we are pleased with the extraordinary preorders and ongoing postlaunch demand for the PDP risk master guitar controller. The risk master launch was timed to Fortnite festivals. Recent update, which added guitar controller capability with again, demand has greatly exceeded our initial supply, and our teams are working diligently to expedite deliveries of additional goods. We remain highly focused on delivering value to our shareholders and gaming customers everywhere through launching our innovative new products, maximizing the extensive benefits from the PDP acquisition and driving our initiatives, profit enhancement and growth. John will now take us through the financials in more detail. John?

John Hanson

Hey, thanks, Chris, and good afternoon, everyone. As Chris noted, our first quarter 2024 revenue was $55.8 million. That's an increase of approximately 9% compared to the year-ago period, driven by increased sales of our controller and simulation products and incremental revenue from the PDP. acquisition console headset revenue was down year over year as we intentionally reduced channel inventory levels in Q1, ahead of the launch of our new wireless headsets and re-branded PC accessories. We are currently reloading the channel to support the launch of these products in Q2.
Gross margin in the first quarter was 31.8% compared to 27.5%. That is a 430 basis point improvement from the year ago period. The increase resulted from lower freight costs, product costs, promotional spend and return reserves and is driven by the various profit improvement initiatives we have been executing over the past months.
Operating expenses in the first quarter were $23.5 million compared to $20.6 million a year ago and include $5.0 million in costs related to the acquisition of PDP. in March of this year, first quarter cash base recurring operating expenses declined approximately 6% year over year, primarily driven by ongoing proactive expense management.
Our first quarter adjusted EBITDA improved to $1.4 million compared to an adjusted EBITDA loss of $2.8 million in the year ago period. The $4.3 million year-over-year improvement is primarily driven by the revenue increase, margin improvement and cash-based recurring operating expense reductions Our first quarter net income was a positive $0.2 million or $0.01 per diluted share compared to a net loss of $6.7 million or $0.4 per diluted share a year ago.
Turning to the balance sheet. At March 31st, 2024, we had $17.8 million of cash and no outstanding borrowings on our revolving credit line. The Company secured a $50 million term loan for the PDP. acquisition, and our net debt was $32.1 million at quarter end inventories at March 31st, 2024 were $69.5 million compared to $65.2 million at March 31st, 2023, and the increase resulted from the addition of $23.8 million in inventory for PDP, partially offset by a $19.5 million reduction in Turtle Beach inventory.
Cash flow from operations was $27.3 million compared to $29 million at March 31st of 2023. Free cash flow was $26.6 million. Our ability to generate strong free cash flow from revenue growth and operational efficiency opens the door for a variety of value-creating opportunities.
And now I'll turn the call back over to Chris for some additional comments.

Cristopher Keirn

Thanks, John. As I've mentioned, we are pleased with our progress for the first quarter of 2024. We've continued our focus on driving profitable growth and are excited about our upcoming product launches and the demonstrated success of our multiple profit improvement initiatives.
From this, we are maintaining our full year 2024 outlook net revenues are expected to be in the range of $370 million to $380 million, with growth driven primarily by the acquisition of PDP. gaming accessory market growth and our expected outperformance of gaming markets with compelling new accessory launches in 2024, including synergies from the PDP. acquisition, we expect pro forma combined adjusted EBITDA to be between $51 million and $54 million dollars, which incorporates approximately nine months of operations from PDP.
I want to thank our entire team at Turtle Beach for their excellent efforts and contributions, which have delivered a strong quarter to start this very exciting year. We have a lot in store for the remainder of 2024 and remain confident about our renewed growth strategy and execution for this year and beyond to drive value for our shareholders, shareholders and gaming customers.
And with that, let's turn to Q&A.

Question and Answer Session

Operator

(Operator Instructions) Mark Argento, Lake Street Capital Markets.

Mark Argento

Hey, Chris or John just a couple of quick ones for me, Chris, maybe you could can you just delve in a little bit more in terms of kind of the product refresh or the kind of the restocking in terms of inventory and some of the new products you guys are launching, that would be helpful.

Cristopher Keirn

Sure. Hey, Mark. Thanks for the question. Yes, in Q1, so we've got coming up in Q2. We are refreshing our wireless lineup at that key $99 price point. So this is still 600 and still sub 500. We've announced that those products are going to be replaced here coming up in May, actually within a couple of weeks. And those are the most widely distributed products globally for wireless gaming headsets. So that's a significant amount of channel that we have to transition from the last generation into this new generation. So we saw that coming. If remember in Q4, we had driven a good amount of promotions, right to get that inventory in a very healthy position. And then as we went through Q1, we turned off replenishments on those on, you know, midway through Q1. And so we expected to see that channel come down. We did that proactively and we were also to the team's credit. We were also able to do that without running up with promotions running lower than last year, actually. So that is now complete. We're in the middle of reloading the channel now, and we've seen those channel inventory numbers here in Q2 return as expected, not to those levels. So we did have some transitional impact there in Q1 that will recover in Q2 as expected. Across the other categories, we're also launching new products in SIM in Q1 with a new res product, new flight sim products. And on the PDP side, that gets our controllers just been a fantastic surprise for us we knew was a great product, but the demand out there is been a pretty exceptional. So a lot of a lot of good load-ins here coming in Q2 that we feel we feel good about.

Mark Argento

I appreciate the color there. And then, John, maybe in terms of the overall guidance, including obviously a pro forma for PDP., what does that kind of imply backing out business, what does that imply for kind of the core here, products that are flattish? Is that up a little down a little what you know, how should we just be thinking about that core growth rate on the on the legacy business?

John Hanson

Yes. So thanks for the question, Mark. So the core business, certainly within our guidance is expected to grow and it's going to be in the it's going to be more to be on the single digit, mid single digit range on which which we signaled of which we signaled back in November that we felt that the core business still had or has that, that potential for growth, obviously, with the cost improvements from the laser sharp focus costs, our work cost initiative work we've done that's going to deliver is a much higher EBITDA than the business as it has realized in the past.
And then you overlay PDP. and their contribution. And that's how you drive to the $51 million to $53 million guidance for adjusted EBITDA for the calendar year 2024.

Operator

Jack Vander Aarde, Maxim Group.

Jack Vander Aarde

Okay, great. Great. Great to see the strong results guys and reiterated outlook at Midcoast as a question. Maybe on the first quarter, our revenue was definitely stronger than typically seasonally speaking, PDP contributed to that.
Maybe I will just touch on PD. view. As I think about $100 million run rate business in terms of revenue, what how much of that was was related to PDP and maybe just directionally? Thanks.

Cristopher Keirn

Sure. Yes, in Q1, it was about 5.9, I think was there 5.8 contribution. So so we get some benefit there in the back half of March. And you're correct in the historic size of that business. And we see strong growth in the PDP business come in this year. That's included in our guidance. And so when you look at the core business, we were really happy to see the markets are performing as well as they have for accessories. We've talked about before that we're entering that phase of the console cycle. Now where you're getting into folks have bought, they bought plenty of great games last year, they were finally able to get a console last year and now we're entering that phase of the of the cycle where typically you'll see accessory repurchases and particularly with the pandemic replacement purchases coming from a few years ago. So we believe that's what's driving that strong lift in both headsets in comps and controllers. And um, we are happy to see that in Q1 is pretty high double digit growth there for the markets and also for our sell-through. So as an example, on the core business, we still saw double digit value sell-through growth. But with us taking the channel inventory down, that's why you see kind of flattish results for the core business in Q1. That's a timing issue seasonally we're going to see the benefit that load-in here in Q2.

Jack Vander Aarde

Okay, great.
That's really helpful color.
And then maybe just in terms of there's another question on the product SKU rationalization maybe just specifically, does that does the SKU rationalization?
Does that the entire process and kind of strategy does this does this relate or include PDP as well?
I mean, you guys just brought brought in the acquisition, but how much of that's at the core Turtle Beach kind of console headset business versus in maybe rocket, but is PDP also involved in that and then I'm just looking at that. Qatar has obviously been a massive success, but I'm just in terms of like revenue concentration across the PDP product portfolio, is it is it similar to the revenue cost pressure across your core business product portfolio, starter motor cluttering X?

Cristopher Keirn

Yes.
No, great question. And it's exactly what we're working through on the integration of PDP. right now, we've got the benefit of PDPs business being very complementary to our core business. Historically, PDPs done a great job over the last few years are really leaning into those great licensing agreements is they've got some great development on the controller front and using those partnerships that are already established. And that controller business fits very well with our historically strong headset business. And so the two, the two combined, it's really a one plus one equals three kind of situation where we're getting the benefits of both. And so what we're working through now with the portfolio optimization and some of the SKU rationalization. It does include both because there are there are products that are out there that are complementary between the two brands portfolios and there's opportunities for us there to realize synergies, not only on the cost side, but also on the revenue side. As we talk through this with retailers, who've had a really great. So in discussions with our retailers, a lot of excitement in the channel about this acquisition and what it means for the gaming category, right? Because it really when you look at the consolidation happening in the category, and this really puts us in a different range and a different scale when we're talking to retailers now being able to offer so many categories as retailers also kind of look at what they're doing with their their category space for gaming moving forward. So we've been really excited about what we've seen so far, we're very early in the integration, obviously, but it's gone quite well.

Jack Vander Aarde

Okay. I appreciate the update there. And maybe just one more wondering if you can just touch on a status update on the share repurchase program and just kind of recent developments there.
Thanks.

John Hanson

Yes.
So Hey, Jack and John. So as we as we said in the announcement, here with Q4, we increased the size of the authorized share repurchase program. And and so it's our intention to continue to pursue opportunities to increase the value for shareholders and with a focus on capital allocation. And we said that we would we would be with that increase in the authorized share buyback that we would be opportunistic here going forward through the balance of the balance of this year. And that is that's currently our and that's currently the path we're on.

Operator

Sean McGowan, Roth.

Sean McGowan

Thank you. Good afternoon, guys. John, at the risk of being that guy, I'm going to say, hey, I know that's the first quarter. And I know that it's the smallest quarter, and I know that not a lot of dollars move some percentages, but we're talking about headsets being down in your shipments in the first quarter against industry numbers that look like probably better than I would have thought for the category. And even if you strip out flights, Sam, that would be an even bigger decrease in your shipments of headsets. How is how are you not raising the guidance for the year? Just are you expecting a massive slowdown like in the second half

Cristopher Keirn

Asia and absolutely not to the last question, not expecting a massive slowdown. If anything, we're going to see the benefit. And we already are seeing that benefit actually of that load-in on the channel. So when you look at the headsets performance, we knew going into Q1 and we've included that in our guidance that we were going to be draining the channel to get ready for these massive launches that are coming up this month. So as that occurred in Q1, we still saw double digit sell through growth in value in our US headset business for console headsets. So we still realized of that growth year over year, but you see it and sell through on the cell inside because we took all that channel inventory out and you didn't get to sell in. We're getting that sell-in in Q2 because that sell-through was sustained for Q1, right up into the transition. So we're actually very excited about how that how that panned out for us because we were able to really reduce a lot of the promotional dollars that we would typically have to spend there to clear inventory. A lot of that was already accomplished in Q4 for us. And remember, we kind of talked about that in the last earnings call. So So no, we're actually feeling very bullish about the prospects of the gaming accessories market this year. And the guidance does not assume that the market continues to be as strong as it was in Q1. We had the market pegged at moderate growth for this year kind of single digit increases. So the fact that we saw what we did in Q1 is a nice surprise. I think you'll you'll see, as we talked about, the replacement purchases from the pandemic piece are going to continue to drive accessory upgrades and the other kind of drives accessory upgrades or new tech and everything you see coming from Turtle Beach and also from the PDP. launches, they've got great new innovations and the product teams here have done a fantastic job of really presenting some some new products here this year that we know are going to drive the market and drive our performance.

Sean McGowan

Okay. So I know that you must have ended the quarter with inventories of headsets just at a very lean level and you see reloading some of that into the second quarter. Would you expect at the end of the second quarter, you'd be kind of caught up to sell through. I mean that would imply an unbelievably strong second quarter. Right.

Cristopher Keirn

We will be back up to the normal levels of channel inventory. And that's actually we're almost there now as we're kind of midway through the quarter because a lot of that load-in is happening with those launches coming up in the next few weeks. So yes, so we did actually in the quarter, quite low on inventory and we are seeing the load and happened. So you hit it right on the head there.

Sean McGowan

Okay. Question for you, John, is there anything I mean the gross margin came in a little bit higher than I had thought, but maybe that's good. Maybe that's because the sales there, too. But is there anything in that quarter mix-wise or anything else that would be kind of unsustainably high like that would have boosted it unsustainably?

John Hanson

I know the first quarter of for want of a better term was pretty clean in that regard. And what we're starting to see coming through the P&L now are are the cost improvements as them as we as our mix transitions into the new products, you're seeing lower costs, which we've been talking about now for several quarters, and that have been working their ways of way into the P&L for us. So we did signal and guide to higher margins throughout the year. And you're starting to see as you're starting to see that here in the first quarter. We do we do expect margins in the second quarter to be down slightly of potentially a point lower as we complete this transition of both the wireless and of course, the brand strength of the brand transition of rocket to Turtle Beach. We do have some higher promotions planned in Q2 that will have a small impact on the margin percentage, but then that would quickly then improve back in Q three and four. And now we're selling all of the new products that we've been working so diligently on in the last over the last six months.

Sean McGowan

Okay.
But would that would that RM cost issue that you just mentioned there in the second quarter, would that not be over what over offset by the volume related upside that you get to margin? Are you saying that we shouldn't expect?

John Hanson

Yes, down the dollars in terms of dollars.
Yes, but it's a more of a percentage game my comments were I was talking more about the percentage. So we would expect slightly lower percentage, but certainly more dollars.

Sean McGowan

Okay. Two other questions for me. One is just what do we make in the fact that there's still in the appendix of the presentation commentary about the Dutch tender that got canceled. Is that just to kind of tweak us a little bit? Or was that a preview something coming?

Cristopher Keirn

No, it has announced the tender has been replaced with the share repurchase program, so.

Sean McGowan

Okay, just as a summary, financial information following tender completion. So I didn't know if that was kind of a preview of something to come.
Okay. ast question is the 10 Q going to be out today?

John Hanson

It should be probably in the works right now. I don't know how far behind the SEC is backed up, but the Q will, in fact, be filed today.

Operator

(Operator Instructions) I'm showing no further questions at this time. I would like to turn it back to Chris Kern for closing remarks.

Cristopher Keirn

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

Operator

This concludes today's conference call. Thank you for participating, and you may now disconnect.