Good day, ladies and gentlemen and welcome to the Turtle Beach Third Quarter 2019 Conference Call. At this time, all participant lines are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded.

[Operator Instructions] Before we get started, we'll be referring to the press release filed today that details the company's third quarter 2019 results, can be downloaded from their Investor Relations page at corp.turtlebeach.com.

On that website, you will also find an earnings presentation that supplements the information to be discussed on today's call. Finally, a recording of the call will be available under Investor Relations section of the company's website later this evening.

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.

The company encourages you to review the safe harbor statements and risk factors contained in today's press releases and in their filings with the Securities and Exchange Commission.

Including without limitation, their most recent quarterly report on Form 10-Q, Annual Report on Form 10-K and other periodic reports which identify specific risk factors that also may cause actual results or events to differ materially from those described in forward-looking statements.

The company does not undertake to publicly update or revise any forward-looking statements after the date of this conference call. The company also notes that on this call, they 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 reported GAAP results in 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 Chief Executive Officer, Juergen?.

Good afternoon, everyone, and thank you for joining us. We're pleased with our results for the third quarter which came in just ahead of our expectations in the published consensus estimate.

We posted the second highest level of Q3 revenue in the company’s history up 30% compared to Q3 2017 and down 37% compared to last year's extraordinarily strong Q3 sales. This is consistent with the results we previously reported for the first half of the year.

In fact, as we look at the console headset market and our position in it, as well as our emerging presence in the PC gaming accessories market, through the first nine months, things are tracking pretty closely to what we predicted when we laid out our initial outlook for 2019, 2019 is shaping up to be the second biggest year for console gaming headsets ever second only to last year.

We continue to lead this market as we have for 10 years with a powerful high quality and innovative portfolio of headsets for all levels of gamers.

And our continued growth in the PC gaming accessories market has gone well with our PC gaming headset market share increasing due to both the ROCCAT line of accessories as well as our own line of PC headsets.

As a reminder, the three main components of our outlook at the beginning of the year were one, that the industry-wide console headset sales would be significantly higher than the level seen in 2017 but would decline from 2018’s record levels, two that we would continue to have the clearly leading share of the console headset market, which had risen to 46% in 2018, compared to 42% in 2017 but our share would normalize somewhat this year, and three that our sales of PC accessories would increase significantly driven by the Turtle Beach line of Atlas PC headsets, and the addition of ROCCAT’s PC gaming mice, keyboards and headsets.

All three of these are unfolding as expected. I'll add a bit more color on these three points before turning it over to John for details on Q3 financials. Last year, millions of new gamers bought headsets to play games like Fortnight and PUBG. This generated a first time buy effect that causes the console gaming headset market to increase by 70%.

Note I'm using U.S. NPD data for growth and share stats. We predicted those gamers would join the installed base of gaming headset users who upgrade and replace their headsets over time. The net effect would be a significantly larger console gaming headset market versus 2017 and going forward but a drop from 2018. This is playing out as we predicted.

We expected our market in console headsets share to decline a bit because it got a boost last year from our relatively better in-stock position in the face of competitive inventory shortages and the fact that we had over 50% share in the entry level price segments.

With that segment making up less of the overall market, there is a mix impact that reduces our share somewhat plus we lose the in-stock advantage from last year.

This is also playing out roughly as we expected with our year-to-date share higher than 2017 but lower than 2018 and most importantly, our share continues to be higher than the next three competitors combined.

Let me emphasize on the above two points, that we are three quarters into the year and both the console headset market overall and our console revenues are tracking quite well to our original forecast. While others may be surprised, we’re seeing what we expected to see with no surprises.

As you know, we launched our push in PC headsets about a year-ago and amplified that effort by adding a great portfolio of PC gaming keyboards and mice with our acquisition of ROCCAT in June.

The PC gaming headset market for headsets, keyboards and mice has a TAM of roughly $2.7 billion versus the TAM of $1.4 billion for the console gaming headset market we lead by far.

These are global market estimates from Newzoo, our PC accessories sales, while still a small part of our overall business nearly tripled year-over-year in Q3 due to the growth in sales of our Atlas line of PC headsets and the addition of ROCCAT product revenues. We've also made good progress leveraging ROCCAT’s presence in Asia.

Over the past four months, we've worked to integrate the ROCCAT team, align many of the internal processes, reviewed and modified the plans for the combined PC product portfolio, developed our approach to branding and solidified our overall multi-year PC market attack plan.

I’m proud of the cross-company teamwork to accomplish those items and excited about the plan for the coming years.

I'll have more to say about the console, headset environment, our PC plans and our outlook after John walks through our third quarter financial results, John?.

Hey, thanks, Juergen and good afternoon to everyone. Moving right into our third quarter results.

net revenue in the third quarter of 2019 was $46.7 million or $47.1 million on a constant currency basis, reflecting the increased installed base of gaming headset users who are now part of the core market, Q3 2018 net revenue was $74.4 million while customer demand remains above historic levels, this Delta was the result of the expected decline in demand given the tough comps from last year as Juergen just covered.

Note that the somewhat higher than expected revenues in Q3, are largely the result of revenue timing between Q3 and Q4, which as we've mentioned each year can vary significantly as retailers prepare for holidays. Gross margin in the third quarter was 32.2%, compared to 41% in the third quarter of 2018.

This expected decrease was primarily due to a more normal level of promotional activity compared to 2018, when promotional activity was very light, given the record setting period as well the impacts of product mix, revenue driven fixed costs leverage and the impact of purchase accounting inventory costs step-up from the ROCCAT acquisition.

Operating expenses in the third quarter of 2019 increased as expected and plan to $17.6 million from $14 million in the same quarter of 2018.

This was primarily due to incremental ROCCAT operating costs, ROCCAT acquisition and integration costs, and digital marketing and sponsorship initiatives, partially offset by decreases in revenue based compensation as compared to the 2018 period.

Net loss in the third quarter of 2019 was $3.1 million compared to net income of $14.9 million in the year-ago quarter, reflecting the commentary I just covered.

Net loss per share in the third quarter of 2019 was $0.22 on 14.5 million weighted average diluted shares outstanding compared to net income per share of $0.91 on 16.2 million weighted average diluted shares outstanding in the year-ago quarter.

Adjusted net loss which excludes transaction and integration costs incurred related to the acquisition of ROCCAT was $2.6 million or $0.18 per diluted share, compared to net income of $14.7 million or $0.91 per diluted share in the 2018 period. Adjusted EBITDA was $0.3 million compared to $17.6 million in the year-ago quarter.

Now turning to the balance sheet, at September 30, 2019, we had $7 million of cash and cash equivalents with $26.6 million of outstanding debt under our revolving credit line.

This compares to $6.2 million of cash and cash equivalents and $31.4 million of outstanding debt at September 30, 2018 which consisted of $15.4 million in subordinated notes, $12.5 million in term loans, and $3.5 million of revolving debt.

During the quarter, we continued our share repurchases, since our share repurchase program was announced on April 10, 2019, we have repurchased approximately 206,000 shares for $1.9 million, or an average of $9.43 per share.

The timing of our buyback activity will of course be subject to regulatory parameters, market conditions and our cash flow and we will continue to prioritize investing in growth and business development.

Inventories at September 30, 2019 were $67 million compared to $73.3 million at September 30 last year and is tracking in line with our expectations. This includes new inventory from the ROCCAT acquisition, as well as some early buying to help mitigate the impact of tariffs. The effective tax rate for the full-year is expected to be approximately 19%.

Now I'll turn the call back over to Juergen for some additional comments.

Juergen?.

Thanks John. I would now like to turn to some comments on how we see the console market evolving over the next few years, our PC plans and our outlook. We continue to be very excited about the upcoming launches of PlayStation 5, and Microsoft's next Xbox system, both of which are expected to be in market for the 2020 holiday season.

PlayStation 5 is expected to have custom 3D audio designed to excel with headsets. Xbox is working on integrated cloud gaming to lower the barrier to entry for playing new games. Both are exciting developments on the new consoles that will of course also set a new bar for graphics and processing power.

Meanwhile, the older consoles will continue to constitute a strong installed base of headset buyers. Last quarter, PlayStation 4 hit the 100 million mark for cumulative units sold and Xbox One to hit about 50 million according to DFC.

I believe this is the first time that new consoles had been announced ahead of the prior holiday season, so it'll be interesting to see how this impacts the market.

Many in the industry are on the lookout for potential price reductions from Sony and Microsoft to make a last push on the existing consoles which could boost sales of games and accessories for these legacy systems. We believe the market for video game consoles and accessories will get a big boost with the new console launches.

And as we mentioned before, the launch year 2020 in this case is a transition year and we already see retail channel inventories at relatively low levels, we believe in anticipation of next year's console transitions.

In fact, given the console gaming market continues to track to our forecast, we've responded to some low retail stock levels, which also contributed to Q3 revenues coming in a bit above our expectations.

If this new console cycle follows the pattern we'd expect, the first year or two after launch will show higher than average growth rates for consoles and for console accessories.

In fact, DFC has said that with the launch of the new systems, and continued sales of the current consoles, it forecasts that the combined hardware sales will set records in 2021 and 2022.

Our console product portfolio plans also reflect 2020 as an important transition year with a focus to have key new Xbox and PlayStation products launched next year ahead of the expected uptick in 2021, very exciting. Nintendo continues to do very well.

According to DFC, Switch is at 42 million units and growing, Switch is the best selling platform and the only platform showing growth this year and it got a boost in September from the launch of Switch Lite. While it's the same driver of headset sales relative to Xbox and PlayStation, it is indeed becoming a third platform for gaming headset use.

And of course we have a great portfolio of headsets for those Switch gamers. Turning now to our PC plans, as I said earlier, we continue to be very enthusiastic about the addition of ROCCAT and the opportunities for the combined portfolio in the years to come.

PC gaming headsets, keyboards and mice represent a market size that is two times the size of the console gaming headset market. And Newzoo predicts double-digit market growth for the PC accessory market. So we believe the PC gaming accessory market can be a great source of growth for us in the coming years.

We know full well that it's a competitive market, which of course we're used to in our console headset market and we know that it will take some time to do this right.

So we've developed a product portfolio plan that will span the next few years with the goal to have the best ecosystem of PC gaming headsets, mice and keyboards for gamers who want to play better and enjoy their gaming experience.

We've also done extensive work examining the strength of the ROCCAT brand and determined that ROCCAT’s reputation for high quality German engineer product fits well with the vision for our PC gaming portfolio. And that it's a great compliment to the recognized leadership of the Turtle Beach brand in the console market.

So we’ll be transitioning to the ROCCAT brand for our PC products. Our first target, as we've stated on prior calls is to reach $100 million in PC accessory revenues in the coming years. We plotted our plans to get there and we're off to a good start.

As I mentioned earlier, both our Turtle Beach PC headsets and the ROCCAT PC products have shown strong growth in Q3 and year-to-date with our PC accessory revenues nearly tripled versus the first three quarters of last year based on the growth of Turtle Beach PC headsets, plus the ROCCAT revenues.

Before I get to our outlook, let me comment briefly on tariffs since we get asked about it frequently. Like other consumer electronics companies, our China manufacturer products are either currently subject to the new tariffs, or are expected to be tariff later this year, if current tariff plans stay in place.

We have been taking a number of steps to mitigate the impact of tariffs this year, including bringing in some products early with the goal of not disrupting holiday sales with price increases. Those efforts had mitigated about half of the impact this year, including the increase in the tariff rates that happened in September.

Going into 2020, we expect to have non-China production for some of our products with a Q2 timing target and plan to increase our diversification outside of China during the course of 2020. Of course, there's a chance that the leadership of both the U.S.

and China will come to an agreement that eliminates tariffs, as was hinted earlier today, but we're preparing as though that won't happen. Now turning to our outlook for 2019, we expect our full-year revenue to be in a range of $236 million to $242 million.

Our narrowed and slight reduced revenue guidance range reflect console revenues tracking roughly to plan and our expectation that ROCCAT revenues will come in toward the lower end of the $16 million to $20 million range we gave last quarter based on the later timing of transaction close and our intentional reduction of ROCCAT product channel inventory as we align the same process to the analytical sell-through based model we use at Turtle Beach.

We expect the remaining impact of tariffs to be approximately $1 million to $1.5 million, which will be reflected in the fourth quarter. While we expect to be in our prior gross margin range of 33% to 34%, we expect the tariff impact to move us down in that range a bit.

We've also made the decision to increase the investments in marketing and promoting our brand and product in Q4 both in support of our console, products and PC business. The above items give us an expected adjusted EBITDA range of $23 million to $25 million, GAAP EPS of $0.50 to $0.60 and adjusted EPS of $0.65 to $0.75.

These EPS figures are based on 15.7 million shares and per John's comment, the EPS numbers also reflect the higher estimated tax rate for the year. We have a terrific position in a great market.

Gaming including eSports streaming and influencers continues to be an exciting market that we believe is the best global consumer segment to be participating in today.

We have a strong brand and leadership position in console gaming headsets, which are additionally benefited from the continued increase in multiplayer and social gaming, and the new Xbox and PlayStation consoles could drive incremental growth after they launch next year.

I'm also very pleased with the opportunity we see in the large PC accessory market as I discussed. We positioned ourselves well to drive future growth with a long-term target of 10% to 20% per year in revenue, and 15% to 30% per year in EBITDA. A few closing notes that are people related.

Yesterday, we announced that after more than nine years as our Chairman, Ron Doornink has decided to retire and will be leaving the board at the end of the year. It has been my personal privilege to work with Ron over these years, and I can't thank him enough for his contributions and partnership.

The board and I will miss him and we wish him well in his retirement. As we also reported yesterday, the board has appointed me to the Chairman role while also continuing as CEO.

We have a great board including the addition of Kelly Thompson in August with her strong retail background, and I'm delighted to take on the additional responsibilities of Chairman. As is often the norm, when the Chairman and CEO roles are combined, the board appointed Bill Keitel as the lead independent director.

Bill is the retired CFO of Qualcomm and has been a board director with us since 2014. I look forward to continue to work closely with Bill and the rest of our excellent board to execute on our plans and drive shareholder value.

And finally, a big thank you to the fantastic team of colleagues across the company for the great work they do and their dedication to delivering the best gaming products for our customers. I'm really grateful to be working with all of you and appreciate all you do. Operator, we're now ready to take questions..

Thank you, sir. [Operator Instructions] And our first question will come from the line of Mark Argento from Lake Street Capital. You may proceed..

Hey guys, just wanted to dig in a little bit on the guidance, I know looks like the revenue level for the full-year coming in a little bit and then the EBITDA guidance as well coming down.

Can you talk a little bit, I know you broke out the tariff impact $1 million, $1.5 million but the kind of the magnitude of the incremental marketing spend where you're going to spend those dollars and then maybe some puts and takes into kind of the roll-up in your top line forecasts on the guidance on the revenue side, please. Thanks..

Sure, Mark. Hi, so on the revenue line, yes, we reduced the range somewhat and narrowed it and the midpoint of the range is down about 2% and is actually by coincidence centered right around the analyst consensus of 239.

The key drivers are you'll recall, we took the ROCCAT revenues down to 16 to 20 last time based on the delayed or closed and we had expected that factors in and that also has an impact on EBITDA.

We have taken some intentional actions to align the way we sell ROCCAT products into retail, by using the Turtle Beach process which looks extensively at sell-through and basis sell-in on sell-through, so that took us a couple, a little bit of time to get that going but we like channel inventory to be right where we wanted to be at, so that revenues don't move around unexpectedly over time.

So that's been now implemented on the ROCCAT side with lower channel inventory but that does take a little bit out of the sell-in, in a transitory few months period. Those are the two biggest drivers on the revenue line console now, we've narrowed our range of expected outcomes and it's tracking roughly where we have expected.

But the net-net of all those as you can see a very small adjustment to the full-year revenues. Okay, on EBITDA line it's pretty simple.

So the revenue reduction results impact EBITDA to the tune of a few million dollars, we've got tariffs in there for just over $1 million and then we're spending about $2 million more on marketing and promoting our products, both in our brand both for Q4 frankly and to help us in terms of momentum into 2020.

That's a decision we feel good about and we believe will pay long-term dividends. And so we've executed on those moves..

And what kind of marketing spend, is promotional activity, what kind of marketing dollars you guys plan?.

It's across the board. So its promotions getting some additional placements of retail and some additional media and straight up marketing spend in Q4. Again both on the console side and PC side..

Okay.

And one quick follow-up in terms of what you guys anticipate kind of peak borrowings looking like as you work through the holiday season?.

Yes, so probably just under $40 million for the year would be the peak. That's about where our models show us today Mark, which would be below last year..

Great, thanks guys..

One, maybe one follow-on comment to that. Keep in mind that that's a very normal level for the revolver.

It typically goes to zero in the early part of the following year, and the revolver also reflects buying ROCCAT for cash, a few months ago, and remember when you look relative to last year in the meantime, from the last year comp, we paid-off all of our long-term debt..

Thank you. [Operator Instructions] Our next question will come from the line of Sean Henderson from D.A. Davidson. You may proceed..

Hi, guys, thanks for taking my questions. So just on, first on ROCCAT when we think about the distribution of ROCCAT both in the U.S.

and internationally, when should we expect all the ROCCAT products to be fully rolled out on a retail basis, is that now soon prior to the holidays, just on the timing front of that?.

That's a great question, Sean. Thanks, thanks for that. So the ROCCAT portfolio and how it moves into distribution is something that we’ll, that we've now laid-out over frankly, the next couple of years. You don't want to be in retail too early and try to like grab too much shelf space if the portfolio is not complete.

So kind of it comes in, I would say three phases. Phase one, we've already implemented which is to make some easy moves to increase the points of distribution with the current product portfolio. By the way, you can't get in everywhere and this late in the year.

So there are just some natural barriers to what you can do shelf space wise, that we haven't started the process kind of early in the year. So kind of phase 1 is going well, we've got some additional points of distribution.

we're leveraging also the ROCCAT presence in Asia on the Turtle Beach side of the business, the Turtle Beach headset side, that's all going to plan, on a Phase 2, I would characterize as an expansion of the portfolio and driving some additional placements.

And we expect that to happen in 2020 and then Stage 3 is, I would call it the complete version one of the PC portfolio with the headsets, keyboards and mice that we want and again, done carefully to enable us to have what we feel will be the best ecosystem of those three types of products. And the goal is to have that in place for 2021.

And then over time, you continue to drive as those products succeed, distribution, points of distribution, if you're successful will continue to expand, you obviously then start adding and updating various products but that's kind of how we see it rolling out. And back to my comments about now having a multi-year plan that I'm really excited about..

Great, thank you. And then just one quick follow-up.

I noticed a good amount of activity in the Athlete Brand Ambassador program since the last earnings call, just want to know kind of what your long-term outlook is on that program and how you guys will be ramping investments into it?.

Yes, love that, thanks Sean. So yes, we signed a number of athletes, pro-athletes who are big gamers. And that's been super exciting because they're using the Turtle Beach products. They like the Turtle Beach products.

And it's not an expensive kind of proposition by the way, but it's been very productive as a way to expand the brand into new consumer segments because these pro-athletes have a lot of followers as an influencer and so, we're I'm personally really excited about it. I think it's really good move.

And we're really the team's really having a great time working with these athletes and providing them with gaming products..

Got it. Appreciate the color, thank you..

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

Okay, well, again, thank you very much for joining us. We look forward to speaking with our investors and analysts when we report our fourth quarter and full-year results in March of next year. Thank you very much..

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation..