Turtle Beach Corporation
Q3 2021 Earnings Call Transcript

Published: 4 Nov 2021

[Operator:]

Good afternoon, ladies and gentlemen, and welcome to the Turtle Beach Third Quarter 2021 Conference Call. 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. Before we go further, I would like to turn the call over to Alex Thompson of Gateway Investor Relations, Turtle Beach's IR adviser, as he reads the company's safe harbor statement that provides important cautions regarding forward-looking statements. Alex, please go ahead.

[Alex Thompson:]

Thank you. On today's call, we will be referring to the press release filed this afternoon that details the company's third quarter 2021 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 risks -- factors that may also 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 the accounting principles generally accepted in the United States or GAAP. You can find a reconciliation of these metrics to the company's reported GAAP results and the reconciliation tables provided in today's earnings release and presentation. And now I'll turn the call over to Juergen Stark, the company's Chairman and Chief Executive Officer. Juergen?

[Juergen Stark:]

Thanks, Alex. Good afternoon, everyone, and thank you for joining us. I'm pleased to be with you today to discuss our excellent third quarter 2021 results in which we delivered the second highest Q3 revenues in our history, launched highly anticipated products, unveiled new products, and revealed new partnerships that will continue to significantly grow our consumer base. I'm especially proud to report that we remain on track to deliver full year revenue growth on top of our record year in 2020 despite global supply and logistics constraints, which are creating an extremely challenging operational environment. Our Q3 revenues were $85.3 million and adjusted EBITDA was $6.7 million, only outdone by Q3 2020's record-breaking results where we posted 141% year-over-year growth and outpaced the market and our peers, driven largely by our strong operational execution. While this Q3 faced a difficult comp against the year-ago quarter, we are now a completely different business, operating in 7 gaming market categories with addressable markets of over $8.5 billion. And for the first time, we are approaching 20% of our revenues in categories outside the console gaming headset category that we've led for over 10 years. The gaming market continues to grow, with gaming leading the entertainment world as the largest and most expansive industry, worth over $254 billion. The number of global gamers continues to grow and is expected to reach 3.3 billion gamers by the end of 2024, which drives higher demand for quality gaming products. We continue to closely follow these broader underlying trends. Also noting that per NPD U.S. market retail tracking, the console headset and PC markets are normalizing from the stay-at-home-driven demand spike. Still up year-to-date after an exceptionally strong first quarter, but down for Q3. Our U.S. market share in console headsets continues to be higher than the next 3 competitors combined, despite a small decrease compared to last year where our supply chain outperformance drove a noticeable surge in share. Importantly, as we've communicated in the past, millions of gamers have entered the market in recent years, whether through the Fortnite craze, stay-at-home orders or otherwise, and the marketplace has expanded considerably. We do not expect those new gamers to disappear as the markets normalize from the pandemic spike, but rather we believe they have permanently increased the size of our markets. This is a great market to be in, and we're excited about our opportunities ahead. In the console gaming headset category, Turtle Beach remains the fan favorite and bestselling gaming accessory brand by far, as we have been for over a decade. Now not only are we continuing to move our best-selling gaming audio business forward with new headsets like the Recon 200 Gen 2 and through unique partnerships, but we're also leveraging the brand's strength as we enter 2 large new markets

[John Hanson:]

Hey thanks, Juergen. And good afternoon, everyone. As Juergen noted, we are pleased to report yet another excellent quarter, recording our second highest Q3 in the history of the company, only outperformed by Q3 of 2020. Net revenue for the third quarter of 2021 was $85.3 million compared to $112.5 million a year ago, which was driven by the surge in demand from stay-at-home orders and our execution-driven outperformance of the market. For the 9 months ended September 30, 2021, net revenues were up 13% at $256.9 million compared to $227.2 million a year ago. At present, we are seeing many retailers loading in holiday inventory earlier than in prior years due to logistics bottlenecks and supply challenges, which resulted in higher-than-expected third quarter 2021 results. Gross margin in the third quarter was 34.3% compared to 41% reported a year ago. This decrease was primarily due to changed business mix and the higher freight cost due to the global logistics challenges and other supply chain-related cost increases. For the 9-month period, gross margin was 36.1% compared to 37.9% in the same period a year ago. Like many other companies, we continue to expect ongoing headwinds from higher logistics costs, shipping delays and challenges with component availability. Operating expenses in the third quarter of 2021 were $27.8 million compared to $21.9 million in the same quarter of 2020, supporting the larger size of our business. Selling and marketing expenses also increased to support new product launches and our entry into 3 large new product categories

[Juergen Stark:]

Thanks, John. We're very pleased with our Q3 performance, including our continued strong operational execution through challenging circumstances with semiconductor availability and global shipping. Despite our efforts, semiconductor constraints were already limiting our outlook of $385 million in revenues. And some of those constraints have worsened, further impacting our revenues, specifically in wireless headsets. Given our leadership in console headsets, we ship far more units of wireless gaming headsets than anybody else. Wireless products have been particularly hard hit by semiconductor shortages. Our team has done an excellent job making multiple rounds of changes to semiconductors used in our wireless products over the past 11 months. And those efforts have enabled us to meet most of the anticipated demand this year. However, given the high volume of wireless headsets we ship, even a modest gap has a material impact. Shipping delays have also gotten worse, resulting in both new products and existing product replenishments shipments that are taking 4 to 6 weeks longer to arrive, and affecting revenues accordingly. Between the semiconductor shortages and these shipping delays, we anticipate roughly $25 million to $30 million in revenue constraints this year. While our prior year outlook factored in some constraints, conditions have worsened. So we are revising our full year revenue outlook to a range of $365 million to $380 million, from $385 million. This anticipated year-over-year growth remains our -- above our original 2021 revenue outlook at the midpoint. And we are providing a range, given the dynamic market conditions that are prone to sudden changes throughout the holiday season. Shipping and logistics costs continue to run at multiples of normal rates. And as we noted last quarter, this will have an impact on gross margins, which flow directly through to EBITDA. Of course, if there are significant product stock shortages across the overall market, promotional spending could be lower and offset some of this impact, as we also noted last quarter. However, currently we are not seeing lower promotional spending across our markets. And while this could change during the holiday season, we are not counting on it in our revised outlook. As a result of the reduced revenue outlook and significantly higher freight costs, we are reducing our EBITDA outlook to a range of $36 million to $44 million, from $50 million. So while our expectations of the overall market and upcoming holiday season are positive, we expect that the overall gaming hardware market will continue to be constrained by supply chain challenges. For us, the largest constraint is on our wireless console headsets, as I discussed. As a good indicator of the benefits of our successful expansion in the new product categories, I'm very pleased that our PC accessories game controllers, flight simulation and microphone businesses continue to track with our expectations and are actually helping offset part of the constraint on our console headset business. In fact, in our ROCCAT PC category, we have continued to outpace the market growth rates in our major markets. And I mentioned that controllers are off to a great start, with more retail placements coming. Several products in the Neat microphone lineup are launching or just launched. And our VelocityOne flight simulation controller sold out the first shipment in under an hour. We expect PC gaming in these new categories are ready to track to roughly 20% of our revenues this year. That is obviously tremendous progress in diversifying into additional attractive categories since 2019. Operational degree of difficulty for every consumer electronics business is obviously high right now. This reflects to some extent the growth over the past years in categories like gaming hardware, and certainly does not detract from our view of the strong opportunities we see ahead. We expect the supply chain headwinds to abate during 2022, particularly as we complete several additional programs to engineer away from highly constrained semiconductors, to semiconductors with better supply. We expect freight costs to remain high but start to come down in the coming months. And I'm highly confident that we are on top of these challenges, acting quickly and decisively with both short-term and long-term moves to put us in the best possible position, given the industry-wide challenges. In fact, I'm excited about the console headset portfolio coming in 2022, including some of the changes driven by semiconductor shortages that could result in an even stronger console headset portfolio next year. And I'm excited about the additional ROCCAT PC products as well as products in our other new categories that we have coming next year. Not to mention the fact that the products we've launched this year will see a full year of sales in 2022 and grow from there. And as I've said many times, gaming has to be one of the best, if not the best, market to be a leader in. Finally, I want to thank our entire Turtle Beach team for another strong quarter that is a result of their continued focus and great execution. I'm very grateful for our team's ability to skillfully navigate the present industry-wide challenges and deliver great products for our retailers and consumers. There's a lot more to come, and I look forward to updating you all again in the new year. Operator, we're now ready to take questions.

[Operator:]

. And our first question will come from the line of Drew Crum of Stifel.

[Andrew Crum:]

Wondering if you're willing to discuss your share performance in console headsets during 3Q, and if you're willing to comment on your updated expectations for 2021? And then I have a follow-up.

[Juergen Stark:]

Sure, Drew. Our console headset share is tracking to our historical performance. We expect to end at above 40% where we have been for the last 10 years. We did have an abnormally high headset share last year. You might recall a couple of the Q3 months, we were actually above 50% share, in many cases because we out-executed the competition. Their share dropped, and we caught that share based on better supply and supply chain execution. So... And on top of that, we do have some constraints on our wireless headsets that will have a modest impact on share, we expect, in Q4 here. We're just in a position unfortunately where we sell far more wireless headsets than anybody else. So small amounts of additional components can cover a lot of a competitor's business in terms of keeping them in supply on wireless, but are often a tiny portion of what we need to actually stay in supply. So as I mentioned, we've gone through multiple changes of semiconductor components already, which is highly disruptive. It's a major engineering effort. The team has done a phenomenal job to actually keep us in the position that we're in. But even the small gap that we have is meaningful financially as we factored into our revised guidance, and will also have a modest impact on share this year until the semiconductor component constraints go away.

[Andrew Crum:]

Got it. And then you talked about your expectation that you'd see some relief on supply chain and logistical disruptions in the coming months or quarters. Understanding that you're not giving guidance for next year today, but how do you balance that against the company's longer-term revenue growth target of 10% to 20%? Is that something that you see as achievable next year or not, given the macro headwinds?

[Juergen Stark:]

It's hard to judge at this point, which is why we don't give guidance for the following year until we're past holiday. A lot of things can happen. Including on your share question, by the way. We don't know how supply will look for others in the market in any of the categories, right? And so in terms of thinking about next year, I expect the semiconductor industry-wide constraints to be with us for all, if not a lot, of 2022. So our efforts are -- have been for more than 11 months now, and we'll continue to be more about mitigating the impact. And the way you do that is literally redesigning the circuit boards for these headsets, particularly wireless headsets, to design out semiconductors that you don't have good visibility on supply to. And there are some by the way where the supply visibility is extremely bad, that we have already started projects to design out. And as -- our anticipation of better semiconductor supply next year has less to do with the industry and more to do with us redesigning out and engineering in semiconductors that we anticipate will have better supply. The last point there is that in our new categories, we're the entrant. We're growing. We're gaining share. There's a lot of white space for us. And we have the benefit of having lower volumes than others. So those product lines in general are not constrained, and I don't expect that they'll be constrained next year.

[Operator:]

Next question comes from the line of Mark Argento of Lake Street.

[Mark Argento:]

Juergen, John, nice quarter. Just wanted to -- you made a statement in your prepared remarks about the diversification of the portfolio. I just wanted to understand that statement. So the -- did you say 20% of the revenue are coming from non-console products at this point, Juergen? Could you just kind of reiterate that or peel the onion a little?

[Juergen Stark:]

Yes, happy to. There's actually two interesting points on diversification of the business. We've launched 34 new products so far this year, 22 in the ROCCAT PC portfolio. The 34 would include the controllers, mics and flight simulation. And Q3 is not quite 20% of revenue, but we're actually tracking to almost 20%. And as a result of the efforts here, we expect the year to be roughly 20% outside of our core console headset business. The other note I made on diversification relative to the investments we've made that are really paying off nicely is we have allocated some investment to Asia, and specifically Japan and Korea. We haven't talked much about that in the past specifically, because I frankly wanted the results to start to come in and start to be more meaningful to the business. And that's what's happening. So those businesses are well more than double now year-over-year and are tracking to additional good growth, which is further helping the diversification of the business in a geographic way.

[Mark Argento:]

I appreciate the additional color there. And then in terms of the -- looking at some supply chain issues, I know you guys one thing and -- you've invested in your supply chain over the last 3 or 4 years. Given the volatility in demand profile that you guys have seen, how onerous is it to have to try to go in and reengineer some of these headsets? And are you doing that quickly? Is that the normalization of kind of the components cycle? Is that going to be a big extra benefit for you guys when that comes back around in terms of gross margin pickup? And then in terms of the ports, like are you guys air shipping stuff at this point? Or were you guys able to get stuff made a little earlier, given the demand that -- the retailers buying earlier this year?

[Juergen Stark:]

Sure. So on the semiconductors, as I mentioned, wireless headsets are the primary culprit there. Particularly Bluetooth-enabled headsets, which we have a very large franchise in with our Stealth 700s. Those are the -- some of the same semiconductors that automotive guys are trying to get and paying -- willing to pay way more than any in our category can afford to pay. It is highly disruptive to reengineer the products and swap out wireless semiconductors. It's almost like a new headset. So -- but we have been very on the ball, including going back to late next -- last year already. Think about that. This was well before the semiconductor supply constraints were well known. Doing multiple things, the redesigns I talked about, also putting in orders and securing component availability far in advance. Including at this point for many of the components, all the way through 2022. So there -- it's an industry-wide issue. In all our goal, like every other time we faced complex operational dynamics, is just to perform and execute well to through whatever those challenges are. And I think we have a good record of doing that in the past. And I think we're doing that on the semiconductor front as well. And then in terms of shipping, we have done a great job of diversifying the manufacturing supply, so that now more than half of our supply this year already is coming from outside of China. That's a multiyear effort. The problem is that the products still need to come into the U.S. and they still need to come into Europe. And particularly the U.S. is where all the bottlenecks are. And you can't do anything about that. You can't ship into some other -- you can ship into different ports. We've been very active. The team is phenomenal at figuring out alternatives, including using airfreight selectively where we have to. And yes, we do have to use more air freight. That is a key impact on the financials for holiday here. Because when the container vessels are taking 4 to 6 weeks longer, that's your alternative. And we're doing it. So on that front, I think the team is doing an excellent job identifying alternatives, both short term to give us the best possible supply at the best cost, but also looking at longer-term efforts like we did when we diversified manufacturing outside of China. We're continuing to look at other opportunities longer term there, where if we do have these shipping issues, they're less of an impact.

[Mark Argento:]

Great. And just one quick one for John in terms of what was the number of shares that you had mentioned that you bought back? And what's the remaining authorization?

[John Hanson:]

So 169,000 shares were repurchased. And so the authorization is a total of 25 million. We've actually used about 7.5, so there's roughly 16 million remaining, 16 million, 17 million remaining.

[Mark Argento:]

Great. Appreciate it. Good luck the rest of the way, guys.

[Operator:]

Next question comes from the line of Victoria James of D.A. Davidson.

[Victoria James:]

So I've got one and then a follow-up. So firstly, it looks like you started selling the microphone, so congratulations on the launch. How should we think about the gross margin for that product compared to the rest of your portfolio?

[Juergen Stark:]

Victoria, just to clarify, we launched both the Torch mic under the ROCCAT brand, which is integrated with the ROCCAT ecosystem as well as the Neat microphones. Are you asking about the Neat microphone?

[Victoria James:]

Yes, sorry, I'm asking about the Neat microphones.

[Juergen Stark:]

Okay, yes, sure. So actually I guess the same answer would apply across the board. The product lines that we have are generally all in our mid-30s gross market margin target band. There might be some exceptions where they're a bit lower because of logistics and freight costs and all that. But in normal environments, there isn't any significant deviation on these new categories from our target range.

[Victoria James:]

And then my follow-up would be with both the Neat and the Torch microphones. How do you think about product expansion beyond your current lineup, now that you've launched both of those microphones?

[Juergen Stark:]

Sure. So one key difference by the way, because obviously they are microphones, one under the ROCCAT brand, one under the Neat brand, is that the ROCCAT microphone integrates into their PC ecosystem. So many gamers that also want to be streaming, they've got the ROCCAT keyboard, mouse, headset. They want to use a mic. And the advantage of the Torch microphone is that it integrates in terms of lighting and control software and all of that. Portfolio expansion in microphones underneath is really targeted at professional streamers and also just musicians and video conferencing, audio conferencing. And there are a number of additional microphones coming in the first part of next year as part of that first tranche of Neat microphones. And then we will be continuing to expand the portfolio over time under the Neat brand.

[Operator:]

Next question comes from the line of Angie Song of Oppenheimer.

[Angie Song:]

This is Angie Song on behalf of Martin Yang. So there's been some speculation in the marketplace regarding the fact that Turtle Beach is pursuing a sale. And we've seen transactions for comps like SteelSeries and HyperX at robust valuations. So can you update us on your thoughts regarding potential private market and strategic interest in the company?

[Juergen Stark:]

Angie, that's not something we're going to comment on. No company makes comments on strategic processes, should anything be underway. So that's not something I'll -- I'm going to comment on, other than the obviously the statement we posted about Donerail's interest in the company in late August.

[Operator:]

Next question comes from the line of Jack Aarde of Maxim Group.

[Jack Aarde:]

Great. Guys, congrats on the solid results. I'm juggling multiple calls tonight, so I hope my questions aren't too redundant. But Juergen, I'll start with the question, just given your comments on industry macro challenges and the related impact on overall Turtle Beach product sales. It sounds like these industry conditions are having less of an impact maybe, if I heard this correctly, on your non-console products. Can you maybe just talk about specifically which of your non-console products are the most and the least impacted in your view as it relates to this semiconductor kind of shortage?

[Juergen Stark:]

Sure. My comment was actually that in a very positive way, the non-console headset business is actually helping make up some of the constraints on the console headsets. In general, the way to think about the semiconductor issue impact on product is the product -- the more semiconductors that a product has, the more it's at risk of having supply disrupted or limited supply. Wireless headsets have a lot of semiconductors, including the wireless radios. So they're kind of at the top of the stack in terms of the products that we do. Other -- the next kind of level of product impact would be products that are powered because they have some semiconductors. And then the least impacted, or products that are not impacted, are products like passive headsets that don't have any power and don't have any wireless radios. That's a big part of our console headset portfolio. But given our -- the fact that we are shipping more wireless headsets than anybody else by far, that's a category where our volumes are high. So to the extent that others can scrounge some supply of semiconductors, it might cover a lot of their business. But it covers only a small amount of our business, given that our volumes in many cases are multiples of competitors in the category. So our non-console headset business, the volumes that we do in keyboards and mice and microphones and all that are smaller than obviously than our console headset business. So even the products that have semiconductors are less impacted, because smaller amounts of incremental supply can make up a bigger portion of our expected volume.

[Jack Aarde:]

Great. That's really helpful, and I appreciate the clarity. And then just maybe another question on the initial preorder success with the new flight simulator products. This was one of the most preordered products. And I'm looking for context behind the statement, in Turtle Beach's history? And what are these other products that is -- that were also top performers or most successful from preorders?

[Juergen Stark:]

So we -- yes, good question. I think actually the most exciting stat on VelocityOne is the 21,000 people who've signed up to be notified for preordering and all that. The most preordered part is in there because we had a reasonable first shipment of supply. And all the supply got snapped up globally in an hour, and actually in the major markets in under 15 minutes. So that's what made it one of the most preordered products where the preorder quantity was sold out the fastest. We've had -- I couldn't even tell you. Over the years, we've had multiple products that have had preorders. And it's not normal for preorders to sell out, period. But we've had others that have sold out. Like the Dr Disrespect, those are limited quantity, limited edition, those -- a couple of those sold out quite quickly. I think the -- on the flight sim, it's just a strong testament to how enthusiastic that community is about the product. And indeed that's the feedback we've gotten across the board from professional reviewers who have been looking at the product, as well as a number of ex-pilots that we have given sample products to and all of that. I'm really excited about it.

[Jack Aarde:]

Great. Well, I appreciate the color. I'm going to hop back in the queue.

[Operator:]

Currently, this concludes our question-and-answer session. I would now like to turn the call back over to Mr. Stark for closing remarks.

[Juergen Stark:]

Thank you. We hope everybody is staying safe. And we look forward to speaking with our investors and analysts again when we talk in 2020. I hope everyone has a great holiday season. I really appreciate your interest in the company, and wish you a very good day. Thank you very much.

[Operator:]

This concludes today's conference call. You may disconnect your lines at this time. Thank you for your participation. Have a great day.