Anne Rakunas – Investor Relations Juergen Stark – Chief Executive Officer, President and Director John Hanson – Chief Financial Officer, Treasurer and Secretary.

Sean McGowan - Needham & Company Mark Argento - Lake Street Capital Markets Joshua Reilly - Northland Capital Markets.

Good day, ladies and gentlemen, and welcome to the Turtle Beach Fourth Quarter and Full Year 2014 Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session, and instructions will follow at that time. [Operator Instructions] As a reminder, this conference is being recorded.

I would now turn the call over to your host, Anne Rakunas. Please go ahead..

Thank you. Good afternoon everyone and welcome to the Turtle Beach Corporation’s fourth quarter and full fiscal 2014 earnings call to discuss the financial results.

Before we get started, we will be referring to the press release filed today with details of the results which can be downloaded from the Investor Relations page of our website at corp.turtlebeach.com. In addition, we posted a supplemental presentation to accompany our remarks, which is also available on our IR website.

Shortly after we end this call, a recording of the call will be available as a replay in the Investor Relations section of the company’s website. Please be aware that some of the comments made during our call may include forward-looking statements.

They involve risks and uncertainties regarding our operations and future results that could cause Turtle Beach Corporation’s results to differ materially from management’s current expectations.

We encourage you to review the Safe Harbor statement contained in today’s press release and on our filings with the Securities and Exchange Commission, including without limitation, our most recent Form 10-Q and our other periodic reports as well as our proxy statement on schedule 14-A filed with the SEC on April 24, 2014, which identifies specific risk factors that also may cause actual results or events to differ materially from those described in forward-looking statements.

We also note this call contains non-GAAP financial information. We’re 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 our reported GAAP results in the reconciliation table provided in today’s earnings release. And now, I’ll turn the call over to Juergen Stark, the company’s Chief Executive Officer..

Advanced Warfare kiosks at Best Buy during the fourth quarter. The feedback from Best Buy and consumers on this new form of retail display which creates three-dimensional audio in a beam in front of the display has been very positive. We’re continuing to explore similar opportunities with other major brands and retailers both in the US and overseas.

As we plan 2015, our top priority for HyperSound is successfully executing launch of a living room audio product that uses the benefits of HyperSound technology to enable people with hearing loss to better understand and enjoy TV, music and other media. We call the product HyperSound Clarity.

Under the leadership of Rodney Schutt who joined us in October from Widex, a leading hearing aid company, we have made great strides on all fronts towards this goal.

On the products side, we are now past the working beta product stage and are in the process of establishing a full supply chain, including the mass production of the HyperSound system and all its components. Mass production of the ultrasound emitter used in HyperSound’s healthcare product has never been done before.

That will another first for our company. On the channel front, Rodney and team have been working with major prospective channel partners. We are working through all of the details on preference trials, distribution strategy and launch plans. We’ve had the first few audiology offices show HyperSound Clarity to their patients.

They believe the response has been very positive. More real office demonstrations will be conducted over the next few months and will help us estimate revenues and supply requirements. The other area of progress with respect to HyperSound business is on the team front.

We’ve hired four additional hearing aid industry veterans to lead our sales and clinical efforts. Continuing to build a great team ahead of and for the product launch will be a key focus area for us over the next few quarters. Looking ahead, we remain bullish on the long-term prospects for Turtle Beach in the gaming headset market.

We’re excited to start the year with a broadest and most feature-rich portfolio of next generation headsets for both Xbox One and PlayStation4. Later this year, we plan to selectively expand our product offering with additional new gen headsets that further enhance the gaming experience and advance our position as the industry leading innovator.

While we expect our overall top line results this year to continue to be influenced by the decline of old gen headset revenues relative to the rise of new gen headset revenues, we expect that balance to become more favorable in 2016 and beyond as the installed base of new consoles, new gen consoles exceed the installed base of old gen consoles.

So our top priority continues to be ensuring that our product portfolio for new generation consoles is comprehensive, industry-leading and well thought of by consumers. Let me give you a better idea of the market dynamics we are operating under.

In 2015, we are projecting our new gen console product portfolio revenues to grow by over 20%, which comes on top of the large initial selling of the line last year. That’s a great indication of our brand strength.

If our old gen business remained flat year over year, we would project our total headset business to be growing at over 15% as an indication of why we believe we will see stronger growth in the coming years as the impact of the old gen decline goes away. On the international front, we have solid plan in place to steadily and profitably build share.

In Europe, we started the New Year with solid momentum in each of our key markets. Our new product lineup featuring some of the most advanced console and PC gaming headsets ever and our new lineup of PC accessories will help us accomplish our goals there.

That said, we do expect a negative impact from the strong dollar and weak euro both on top line revenues and on gross margins in 2015, particularly from our European sales.

In addition to a great product portfolio, we have an explicit goal to improve operating efficiency and manage expenses to produce higher net margins on our headset business and enhance overall profitability. These include three major items.

First, transitioning from a China-only manufacturing partner to a large new manufacturing partner with a global footprint to lower our costs. This process actually began in 2014 and included some initial startup costs with our new supplier as well as line-down cost with our previous partner, which John will outline in his section.

We’ll start to see the benefit from this change late this year, but the real contribution to margins will begin in earnest in 2016. Number two, diligently managing spend in the headset business. Our OpEx as a percent of revenues is actually very lean.

The manufacturing transition I just spoke of will add some incremental costs on a one-time basis and we may modify some distribution agreements in Europe to take over regional marketing, but we expect to continue to run lean with only modest increase in overall OpEx. Number three, prioritizing margins over market share gains.

Our goal is to maintain a dominant share position, but we will be more selective on pursuing sales that don’t meet our margin requirement and putting more focus on ensuring that our marketing spend including our partnerships and trade shows is highly productive in driving revenues.

With respect to the HyperSound business, as I mentioned, our core focus is on the successful launch of the HyperSound Clarity product for people with hearing loss. That launch will create a new type of product for roughly 48 million people in the US and 350 million people worldwide with hearing loss.

We are very pleased with the progress and are on track to launch that product late this year with an early Q4 target timeframe. Our focus is on creating a large new product category that builds into a significant business for our company overtime.

So we will launch that product, when all of the pieces, channel, partners, product and manufacturing are ready to our satisfaction.

To support those efforts, we will be carefully expanding staff and resources for the HyperSound business over the coming quarters, with a target to end the year with no more than $9 million of net investment for 2015 in HyperSound. I will continue to report on the exciting progress of HyperSound in the coming quarters.

I’ll now turn the call over to John..

Thanks, Juergen. In my presentation, I will be discussing the combined results for the fourth quarter and full year 2014. It is important to note that results for the year ago period represent Turtle Beach headset business on a stand-alone basis.

Now starting with the top line, net revenue in the fourth quarter of 2014 totaled $92.3 million, an increase of 7.1% over revenue of $86.1 million in the fourth quarter of 2013.

The increase in revenue was driven by strength in our Xbox One and PlayStation4 compatible or next gen headsets, partially offset by a decline in sales of certain older generation headsets as the user base for Xbox 360 and PlayStation3 has fallen off faster than we or the industry had projected.

For the full year, revenue increased 4.3% to $186.2 million, compared with $178.5 million last year. The sales increase was driven by our next generation headset portfolio in the US and the expansion of our international headset business, especially in the UK and Europe, partially offset by the aforementioned decline in demand for old gen headsets.

Gross profit for the fourth quarter was $25.8 million, compared to $26.7 million in the same period in 2013.

The gross margin percentage decreased 300 basis points to 28% in the fourth quarter compared with the same period a year ago, primarily due to $1.5 million in higher shipping costs associated with the West Coast port issue and a write-off of $1.5 million for some legacy contracts.

For the full year, gross profit was $50.7 million, essentially flat with 2013. Gross margin for 2014 was 27.2% compared to 28.2% in the prior year.

Excluding $2.5 million in extra costs associated with the Microsoft Xbox One chat adapter, and $1.5 million in incremental airfreight costs associated with the West Coast port issues and $1.5 million legacy contract write-off, our gross margins would have been just over 30% for the year.

As Juergen mentioned, during 2014, we embarked on several initiatives aimed at improving manufacturing efficiency and operational execution with the objective of increasing net margins in the headset business.

This included bringing on a new product refurbishing partner in the US and beginning of the transition to a new larger and global manufacturing partner. These actions will contribute positively to profitability in the future.

However, we spent roughly $0.5 million in 2014 and expect to spend a similar amount in the first half of 2015 to support these transitions. Operating expenses in Q4 were $18.6 million for the fourth quarter compared to $15.7 million in the same period in 2013.

Excluding restructuring charges and business transaction costs, operating expenses increased 26.1% to $17.9 million, due primarily to additional costs associated with being a public company including additional headcount and higher stock based compensation costs and investments of over $3 million in personnel and product development to support future growth of the HyperSound technology.

For the full year, operating expenses were $64.5 million compared to $48.7 million in 2013. Excluding restructuring charges and business transaction costs, operating expense increased to $60 million compared to $44.9 million in the same period a year ago.

The increase was driven by approximately $10 million of investment in HyperSound, over $3 million in additional public company costs, higher stock compensation expense and higher depreciation, partially offset by reduced marketing expenses.

Adjusted EBITDA in Q4 2014 was $10.4 million for the combined business as compared to $15.5 million for the headset business on a stand-alone basis in 2013. The adjusted EBITDA decrease was due to the investment in HyperSound, higher public company costs and incremental shipping costs.

The headset business delivered adjusted EBIDTA of $13.5 million for the quarter. For the full year, adjusted EBITDA on a consolidated basis totaled $2 million, compared to $13.9 million for the headset business on a stand-alone basis in 2013.

The year over year adjusted EBITDA decline was driven by the planned roughly $10 million investment in HyperSound, $1.5 million in the extraordinary airfreight expenses detailed earlier, over $3 million in public company costs and $2.5 million related to the logistics costs related to the Microsoft headset chat adapter in the first quarter of 2014.

This was offset by organic growth in our headsets and improvement in our headset margins. Adjusted EBITDA for the headset business was approximately $12 million in 2014, reflecting an adjusted EBITDA margin of roughly 6.5%, including several unusual expenses related to the Xbox One chat adapter, logistics and port issues.

There were approximately 42 million total shares issued and outstanding as of 12/31/2014. Please note that we provided a reconciliation of GAAP reported results to adjusted EBITDA in the accompanying tables at the end of the press release we issued today.

Now turning to the balance sheet as of December 31, 2014, cash and availability under the revolving credit facility totaled $22.9 million. Outstanding debt, defined as the revolving credit facility, term loan and subordinated notes decreased 17.8% or $9.7 million to $44.6 million from $54.2 million at December 31, 2013.

The reduction in debt is driven by lower inventory levels consistent with our plans to improve asset utilization. Total inventory as of December 31, 2014 decreased 23% to $38.2 million from the end of last year as a result of our inventory reduction initiatives.

Our accounts receivable increased $12.5 million to $61.1 million, while accounts payable decreased $8.5 million at December 31, 2014, compared to the same period in 2013.

During the year, we made significant progress improving our capital structure, culminating with our announcement in December that we replaced our subordinated debt utilizing lower interest borrowings from our global ADL with Bank of America.

The final piece to our balance sheet liquidity improvement initiative is securing roughly $15 million of long-term debt which is in process and expected to be completed in the near future.

Based on current information, we expect interest expense in total inclusive of the pending deals to be approximately $3.6 million in 2015 compared to $7.2 million in 2014. Now, turning to our outlook, for 2015 we are projecting headset revenues to be approximately flat compared to 2014.

This projection is highly dependent on our projected rate of decline of old gen headsets versus the rate of growth on new gen, how our market share evolves this year on new gen console headsets and a potential negative impact of our strong US currency. Recall that over 35% of our business is international.

Given these dynamics, headset revenues could be somewhat lower or higher than 2014. Keep in mind that even after Q1 we will have roughly 90% of our year pending from a revenue standpoint.

While we obviously aspire to drive growth, our top priority is to improve profitability with the efforts that Juergen mentioned, we expect gross margins to increase to the low 30s and will seek to manage our operating expenses to significantly improve EBITDA margins on headsets from approximately 6.5% to between 8% and 9% even on flat revenues.

With regard to HyperSound, based on the projected Q4 launch of the HyperSound Clarity, we are forecasting a few months of revenue contribution from that product. As Juergen mentioned, the priority is on executing a successful launch, which would be evidenced by a rapidly growing business.

As a result, including the commercial HyperSound business, we would expect single-digit millions in HyperSound revenues this year. Our gross margin target for HyperSound remains 50% or better.

Note that we will be increasing resources for HyperSound in preparation for the launch as we progress through the year, but intend to manage the spend to have a net investment of no more than $9 million at an adjusted EBITDA level.

For the first quarter, we expect net revenue for our headset business to be in the range of $18 million to $20 million, which represents approximately 10% to 12% of our projected annual revenue.

This is consistent with our historical results excluding last year when the first quarter was abnormally strong given the initial launch of our Xbox One headset.

Gross margin for the first quarter is expected to be in the range of 26% to 28%, which is down year over year as a result of the fixed cost to leverage on lower revenues, but is in line with an average gross margin for the year in the low 30s.

Given fixed cost leverage in operations, lower quarter’s typical average lower gross margin and Q4 typically generates a much higher gross margin to bring the average in line. Net loss for the first quarter is projected to be between $7.5 million and $9.5 million and adjusted EBITDA is expected to be between a loss of $7 million to $9 million.

Looking further out, we do anticipate quarterly revenue results on a year over year basis to improve starting in the second quarter as revenues revert back to a more normalized quarterly breakdown. We typically generate between 10% to 14% of annual revenues in the second quarter.

This will drive improved adjusted EBITDA for headsets, partially offset by $1 million to $2 million in planned HyperSound investment. And now, I’ll turn it back to Juergen for some closing comments..

Thanks, John. Let me end by summarizing our three key goals for this year. Number one, to continue to lead in product portfolio, breadth and innovation for the new generation consoles. Number two, to improve margins and profitability of our headset business, including cost reductions in our old generation console headsets.

Number three, to successfully launch the HyperSound Clarity product. Despite the fact that the console transition has taken longer to turn into a net positive, we remain confident that the success of the new consoles will be a strong catalyst for sales and earnings growth in the coming years.

At the same time, HyperSound represents a very compelling growth vehicle that will provide the company with higher margin revenue stream as it ramps up following the launch of our healthcare product later this year.

We started 2015 in a solid financial position, thanks to the work we did last year to strengthen our balance sheet and improve liquidity. This has provided us the flexibility to execute on our growth plans which we believe will generate significant value for our shareholders.

I would like to thank the fantastic team at Turtle Beach for successfully managing through the first year of the new generation consoles with a continued strong industry-leading position, while fully integrating the new HyperSound business and advancing that business in preparation for the exciting launch later this year.

With that, I would like to thank you again for joining the call, and will turn it over to take questions.

Operator?.

[Operator Instructions] Our first question comes from Sean McGowan of Needham & Company..

I have a couple of questions.

Can you describe what those legacy contracts are? What is that related to? Are there any others that you plan to change in the coming year?.

Sure. For the sake of the partners that we’re working with, I’m not going to be a whole lot more specific, but there are number of partnership deals that we have signed, some of which we signed two years ago. And the economics of those resulted in a write-off and we don’t plan to repeat the magnitude or breadth of those contracts going forward..

Can you say whether they are product-related or manufacturing-related?.

They are product-related..

Okay, thanks.

And to specify something that you said on the call, Juergen, on the expecting a modest increase in operating expenses, did you mean a modest increase in dollars or as a percentage of revenue?.

A modest increase in dollars.

There are a couple of – we’re talking about the headset business, there are a few places that the mix looks something like this, we will spend some additional money in R&D and some in supply chain as well to accommodate the transitions that we’re doing on the manufacturing front, offset partially by somewhat lower marketing expenses.

On the marketing front, a key piece to keep in mind and it’s not quite finalized yet, but we have an intention to essentially take over the marketing in some of our geographies where the distributor today would spend the marketing OpEx essentially, and that means we get some incremental margins, but we do have some incremental OpEx because we essentially spend the marketing money that the distributor would normally spend.

So with all of those mixed together and continuing to focus on running a very lean OpEx as a percent of revenues, we would expect only a modest increase year over year..

And then lastly, just had a couple of questions if you can help us with some of the assumptions behind the guidance in various categories, so like first for example, what is the exchange rate that you’re assuming when you say that headset revenue will be approximately flat for the year, what’s the forex exchange rate that you’re assuming? Similarly, do you expect the cadence of the old gen decline to be consistent throughout the year or more front-end loaded or back-end loaded? And how far down do you think the old gen will go, percentage decline?.

I’ll try to answer those. So the forex, we finalized a plan a weeks ago, so the rates continue to come down somewhat, we haven’t kind of re-estimated based on that, but it could go back up in the near term and so the thing we’re working through on forex is how exactly do we handle that.

Do we make price increases which many manufacturers are looking at because of the impact, do we, in many cases, we work through distributors as well. So we are working with them to figure out what’s the best formula in terms of revenue, revenue growth and product margins to produce the best outcome.

I would say most of it is factored into our outlook at the current rate, but we’re lacking some precision which we’ll work out over the next quarter or so as we see what our plans are in terms of dealing with it.

It is a major issue though, by the way not just in Europe, it’s also in Canada, the strength of the dollar is affecting us in multiple places and we’ve got about 35% of our business that is outside of the US.

So the second one you asked, remind me Sean?.

There are really two parts.

The cadence of the decline in old gen, is that – do you expect that to be consistent through the year or more front end or back end loaded? And then just generally, the overall magnitude of the decline, are we talking about greater than 50% decline, greater than 75%, just kind of a ballpark figure for the rate of decline of old gen?.

Sure. So I think the cadence of the decline will be pretty steady during the year, I don’t know that we’ve tried to portion it out to the quarters.

Recall, we used DSC in there console installed base forecast for the basis of our modeling, but of course, since most of the sales come in holiday, the last year we saw old gen drop off a lot more in Q4 than earlier in the year would have indicated, which is a good sign, because what it says is a lot of people are buying the new gen consoles are getting off of old gen at a faster rate.

So even if you look at the outside industry forecasts from February to October of last year, they are showing a significant reduction in their forecast for old gen and I would expect that when they come out with their next set of numbers which should be in the next month or so that we’ll see the same thing again.

The rate of decline as a percent is not that much different year to year, but obviously for our business the key thing to keep in mind is the number of dollars associated with it. It goes down every year.

So even, right, it makes sense, even if it’s like if you’re cutting the number in half every year that half gets smaller and smaller, that’s why as we look out 2016, 2017, our overall growth rate will be much more impacted by the growth rate of new gen because the dollar impact of the reduction on old gen becomes less and less meaningful as a percent of overall revenue..

Next question comes from Mark Argento of Lake Street Capital..

Just wanted to make sure from a modeling perspective I have this correct.

So you’re guiding $18 million to $20 million in revenue for Q1 and then what did you say about Q2 in particular?.

John, you can chime in, but Q1, you’re right, $18 million to $20 million and we will point out again, as we indicated on our last call, that 2014 was very unusual in terms of revenues, because of the pent up demand from the 2013 lack of Xbox One headset at all kind of got launched in Q1, and frankly even 2013, for us was abnormally high because we launched a bunch of new products at the beginning of Q1.

So for us, we went back to like 2012 and looked at the distribution of revenues, 2013 by the way also keep in mind that the rest of the year’s quarters were abnormally low because people started reacting to the new console announcements.

So we went back to 2012 and 2011, kind of the last what we would consider normal years in terms of distribution and looked at how the quarters distributed. So Q1 at 10% to 12%, Q2 is call it 11% to 14%, Q4 is somewhere in the range of 48% to 52% if you kind of look at those years and then Q3 fills in the rest.

So what that means is, for us, Q2 and onward we should start to see better results year over year on the revenue front.

Does that help?.

That’s extremely helpful.

And then in terms of did you recognize any HyperSound revenue in Q4 with the Activision endcaps at Best Buy or how did that flow through the model?.

So the answer is that was revenue in Q4 for HyperSound, but again in terms of – we’ve said it was around $0.5 million that we said was the HyperSound revenue associated with the kiosks that were sold through Activision and in Best Buy stores. And so that was principally the revenue in Q4..

Juergen, I think in your prepared remarks you had mentioned you do expect to see some HyperSound revenue coming from the Clarity product in Q4, can you talk about the distribution model of use to you go through audiologist, I can’t even pronounce it, audiologist community, what any other thoughts on go to market strategy there and typically how do they purchase equipment?.

I’d be glad to talk to that. So let me start with, from a forecasting perspective, we’re forecasting a few months of revenues from the launch and that’s based on an early Q4 target launch date.

But again with the caveat that our priority is on making sure when we launch that everything is set and buttoned up, because more important to us than whether we get a few weeks more less revenues in 2014 is their trajectory of the business and that’s based on having consumers like the product, having all the pieces set up.

So that’s how we’re kind of prioritizing it. On the channel front, the team is actually making great progress, not surprisingly since we really do have an A player team that we’ve hired starting with Rodney last year and then he has added to that with a couple of really strong industry veterans on the hearing aid.

So what they are doing and they are very much in the middle of the process is working with the large, let me say, channel owners, so large hearing aid companies have their own set of audiology offices, doctors’ offices for hearing aid essentially, look at it kind of like a Lenscraft or type equivalent might be more familiar to you and others here.

So Rodney and team have been talking to those folks showing them the product over the last few months and starting to work out launch plans, where those partners if they sign up would take on the product and sell it through their audiology offices. Those offices today typically only sell hearing aids, right.

And so all of those details are being worked out and we’re just at the starting stage of actually doing real, call them, in-store testing where some baby-units of the Clarity product are in there and their being shown to patients and we’re starting to get some reaction from the patients in terms of how much they like the solution and over the coming say 3 to 4 months, we are going to try to convert that, what I would call today a customer perception into a real indication of purchase intent.

We need that for two reasons. One is it will help us narrow down the range of revenue expectations as we launch it, but far more important frankly is to plan the supply chain so we know in an audiology office how many units a day or a week are we likely to sell based on the patient flow.

The other key piece that’s being worked out that’s important is what’s called the workflow in these offices.

So where do they demonstrate the product and once if a patient is interested in a product, how does it essentially get fitted for them, which means programmed to their specific hearing loss profile, where do they store the product, all of that’s being sorted out as well.

And it, mainly to kind of just to finish up, mainly the conversations are today with the leading channel companies in the hearing aid industry and then lastly we’re also, Rodney and team are talking to some buying groups or some other dynamics in the hearing aid industry looking at how hearing aids get sold that we are using as a proxy for our first priority, second priority and third priority channels.

That was a long explanation, but with that answer your question, Mark?.

I don’t know if it’s premature, but in terms of price point, is this a high dollar item, $1,000 item or what you’re thinking?.

I’m actually glad you asked, because I fully intended to cover that in the remarks here, because in the past few calls we said, hey, we’re not exactly sure we are going to price it yet, the team has gotten extensive feedback from these channel partners and right now what we are planning from a price standpoint is in the $1,500 range, right, $1,499, something like that, that frankly could still move around a bit.

That’s in contrast to hearing aids by the way which are $2,000, $4,000, very expensive and by the way not covered by insurance in the US, right. And so that’s part of what’s being used to settle on a good price.

Once we get more consumer feedback and channel feedback, we may still move that around a bit, but that’s kind of our target in our planning assumption today..

And then last question from me, other one on the guidance for full year 2015, the EBITDA margin guidance at 8% to 9%, I’m assuming that’s – just take that 8% to 9% relative to the $186 million-ish in revenue that you guys are forecasting assuming flat year over year, so you’re $15 million to $17 million in the EBITDA, am I interpreting it correctly?.

Yeah, two things actually. I think I said 2014 HyperSound few months revenues, I meant 2015 just to be very clear on my prior answer.

So on EBITDA range, yes, what we’ve said is that the planned revenues as roughly flat, there is a range around that though, right, and like we did last year, we’re going to try to get more precise as we go through the year knowing that 50%-ish of our revenues come in Q4.

And so that EBITDA margin range for headsets, you’d apply to a range of revenues around the $180 million that you’re indicating..

And I got one more, adapters, what are your assumptions for adapters, do adapters extensively go away at some point in the year or where we are out with that?.

That was a big one last year, big factor obviously, and an unexpected change to our forecast during the year. We are forecasting that the adapters to slowly go away over time.

We think that and we’re assuming that that was an early effort, a very consumer friendly effort to bridge consumers from the old gen, but that ultimately, those will go away in the market, at least as a standalone item from Microsoft.

We don’t know that for sure by the way, but our planning assumption is that those – the impact of those do go down over the course of the year..

Our next question comes from Joshua Reilly of Northland Capital..

So first question is on how does the profitability of the new gen headsets look versus the prior gen headsets? I just want to understand if positively maybe throughout the year that might be helpful to margins as the new gen headsets grow as a piece of the overall business?.

So the answer is that the new gen headset has a slightly higher margin than the old gen headsets. So as the mix moves more to new gen, right, from old gen then we certainly anticipate seeing margin improvement associated with that transition..

Is it materially different or is it within 500 basis points?.

No, it’s not hugely different, they are pretty close. The difference could get bigger over time as the old gen needs more discounting and all that to move the products. It’s not hugely different..

The primary margin additions that we are expecting have a lot to do with our internal efforts to reduce cost of goods sold to not have a bunch of the factors that we talk through happen in the business again, some of which we know for sure won’t happen like the adapter launch, logistics costs, all of those things....

Which are more on our control than external forces, I mean we want to be in a position to being more in control of our margin and be able to anticipate and drive that improvement..

And then on the HyperSound business, is the timing of the $9 million investment going to be determined at all by the performance of the headset business? So if you see the headset business improving sooner than you thought, could you potentially ramp up your investment or is that pretty much going to be unchanged?.

That’s a very good question actually and so let me explain how we are thinking about managing the business. So we will almost independent of the amount of revenues on HyperSound, we’re making essentially a management decision to say, look, we’re going to maximize the investment in HyperSound at a net $9 million at the EBITDA level, right.

And so as we see HyperSound revenues materializing, we have an opportunity to invest behind that, but we will and we are investing ahead of the launch.

We are not tying it directly to how the headset business is doing and in fact we are hoping to handle HyperSound as a business that we want to have a very successful launch for making the appropriate investments to make that happen. And so we are not, mentally we’re not tying the two together.

I think if the headset business, if we thought there were opportunities to make prudent investments to grow HyperSound faster generating better results than headsets might over the course of the year cost us, you know what, lets lean into this a little bit more, but that’s not factored into the current plans and into what we’ve remarked about..

And then are there any port issues that are going to carry into Q2, my understanding is that ended on February 28 or somewhere in there, so should we assume that’s pretty much done after Q1?.

Two things. First of all, the port issues, even though they signed the agreement, it will take many months for the bottlenecks to be resolved.

For us, it no longer creates the need to expedite shipments because we are now in a normal logistics process where we are not needing to hit reset dates at retail, we’re not needing to deal with weeks which in some cases have as much revenue generation and product movement as multiple months would have at this point in the year.

So we don’t believe we are going to have incremental expediting costs in the next couple of quarters associated with the port issues is the short answer..

And then my final question on the revamping the manufacturing partner, can you give us more color on that and any type of how that might help the margins in 2015, 2016, going forward, any dollar amounts?.

What we are doing is we are moving from the partner we’ve had for a long time, very good partner who is China-only manufacturing and it’s a large company, but we are moving to a company with a much larger scale and a global footprint.

Overtime, including for HyperSound, by the way, this will give us opportunities to not have all of our production in China, including for HyperSound.

So this is something we’ve thought through over the course of the coming years and try to figure out what supply chain footprint that we want to have for headsets and for HyperSound and what kind of a relationship will allow us to achieve our goals.

For headsets, it does allow us to achieve some cost reductions overtime and we’re not far enough into it to be really precise on the amount and obviously it’s going to depend on the product and the mix of products and how the mix of products change over time.

But our objective, I can be very clear about, which is global footprint and to have – use our scale economies on the headset side including on old gen to move ourselves into a position especially on old gen to have a low cost production footprint.

One other thing on this that you’ll see, it does take some incremental costs in the first part of the year as we wind down one partner and wind up another one and it also has some cash flow impact, because we are in need to invest in tooling, not recurring engineering, build ahead in some areas as buffer stock while we wind down one partner and wind up another and all of that is factored into our plans for the next two or three quarters.

Lastly, I’ll say, we do expect to be largely through that transition before we head into holidays. That’s kind of the explicit timeframe we planned..

And our last question comes from James [indiscernible] from Cowen and Company..

I had a couple of follow-up questions on the HyperSound business, various questions. Last year, I think you said $3 million of the $10 million was spent in Q4.

I would anticipate if you’re launching the product in Q4, at least the plan, should we expect such a heavy weighting in the investment spending to be Q4 weighted this year?.

A good point. So we do expect some incremental HyperSound spending in the coming couple of quarters. We mentioned the $1 million to $2 million incremental range I think in association with next quarter’s OpEx. In Q4, the net EBITDA impact will really depend on revenues more than anything.

I would expect it to be lower than the $3 million, because we do plan to generate some revenues from HyperSound which will start to offset the OpEx..

So sort of along with that is, if the launch, I would anticipate a lot of the expense goes in ahead of the launch, I guess just housekeeping, is any of that in working capital?.

Working capital, we would have some inventory buildup going into the launch. That is one of the key reasons why we want to use these early office trials to get some indication of our supply chain planning needs..

And on the business model, who will do the marketing and advertising as this rolls out?.

We will do some of it, but a lot of it will be done by the channel partners. Remember, these are audiology offices, so you have a captive audience of the patients there. So really for us, this is not TV commercials or anything like that, this will be people getting demonstrations in these offices when they’re in there getting their hearing evaluated..

And then again along the same lines with the question about the timing on the $9 million, does any of it relate to the upcoming products in consumer or in commercial in two years?.

Good point. So we are not planning any consumer revenues from HyperSound this year. We’ve said all along for more than a year now, that’s kind of 2016, 2017 timeframe. And the commercial revenues, they’re ramping slowing, consistent with normal commercial enterprise sales cycles which go from six months to 18 months.

But as I mentioned, we are explicitly shifting some focus from commercial to the healthcare side of the business.

That doesn’t mean we’re not going to do commercial, but when we have to make resource trade-offs internally, our focus is on launching the healthcare product because that one looks like it could very quickly overtake commercial from a net revenue standpoint..

Let me just ask, I think I might have misled you with my question, I was talking about the $9 million that you are planning to invest in HyperSound this year, how much of that is being spent on those out-year projects?.

We do have an R&D team and they have been and continue to drive forward-looking product developments and frankly they are making extremely good progress on that and they also drive all of our patenting work.

So that’s in the range of a few million dollars of investment just in research and development and the continuing to push the forefront of the technology.

And then the commercial net investment in the $9 million is – I don’t know that we could cleanly break that out, because it’s a lot of the same resources that go into the development, the supply chain, all of that and the marketing..

And just one final one on the tax rate, as Europe grows in the revenue mix or in the business mix, should we expect the tax rate to remain in the high 20s or what should happen, what should we expect there?.

So for an effective tax rate for this coming year, 34% is what you should be using in thinking about. That will start to decline as international continues to grow.

Right now, in terms of how we balance the US, support cost between Europe and our Europe operations, we’re rather 34% effective tax rate that will continue to decline though and especially we have other initiatives underway here in 2015 that are targeted to move that effective tax rate down over the next year or so..

So can we see high 20s in the next say three years?.

Absolutely..

Okay, thanks guys, I know we’re over time. I just want to thank everybody again for joining our call. Have a good week. Thank you..

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes your program. You may now disconnect. Everyone have a great day..