What changed in this filing

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Item 2. Management’s Discussion and Analysis

2023-11-07 compared with 2023-08-07 · 74 added, 72 removed, 177 unchanged (45% of the section changed)

64 unchanged sentences

As a result, Turtle Beach continues to take proactive steps to limit the impact of these challenges and are working closely with our manufacturing and freight providers to reduce costs.

Key Performance Indicators and Non-GAAP Measures

Management routinely reviews key performance indicators, including revenue, operating income and margins, and earnings per share, among others.

In addition, we believe certain other measures provide useful information to management and investors about us and our financial condition and results of operations for the following reasons:

(i) they are measures used by our Board of Directors and management team to evaluate our operating performance;

(ii) they are measures used by our management team to make day-to-day operating decisions;

adjustments made are often viewed as either non-recurring or not reflective of ongoing financial performance and/or have no cash impact on operations;

and (iv) the measures are used by securities analysts, investors and other interested parties as a common operating performance measure to compare results across companies in our industry by adjusting for potential differences caused by variations in capital structures (affecting relative interest expense), and the age and book value of facilities and equipment (affecting relative depreciation and amortization expense).

These other metrics, however, are not measures of financial performance under accounting principles generally accepted in the United States of America (“GAAP”) and given the limitations of these metrics as analytical tools, should not be considered a substitute for gross profit, gross margins, net income (loss) or other consolidated income statement data as determined in accordance with GAAP.

We consider the following non-GAAP measures, which may not be comparable to similarly titled measures reported by other companies, to be key performance indicators:

Adjusted EBITDA is defined as net income (loss) before interest, taxes, depreciation and amortization, stock-based compensation (non-cash) and certain non-recurring special items that we believe are not representative of core operations.

Cash Margin is defined as gross margin excluding depreciation and amortization, and stock-based compensation.

We believe that the presentation of Adjusted EBITDA is appropriate to provide additional information to investors about our operating profitability adjusted for certain non-cash items, non-routine items that we do not expect to continue at the same level in the future, as well as other items that are not core to our operations.

Further, we believe Adjusted EBITDA provides a meaningful measure of operating profitability because we use it for evaluating our business performance, making budgeting decisions, and comparing our performance against that of other peer companies using similar measures.

However, Adjusted EBITDA is not a measure of financial performance under accounting principles generally accepted in the United States of America (“GAAP”) and, given the limitations of these metrics as analytical tools, should not be considered a substitute for gross profit, gross margins, net income (loss) or other consolidated income statement data as determined in accordance with GAAP.

Adjusted EBITDA (and a reconciliation to Net income (loss), the nearest GAAP financial measure) for the three and six months ended June 30, 2023 and June 30, 2022, are as follows:

Three Months Ended

Six Months Ended

(in thousands)

Interest expense (income)

Depreciation and amortization

Stock-based compensation

Income tax benefit

Restructuring expense

CEO transition related costs

Proxy contest and other

Adjusted EBITDA

Comparison of the Three Months Ended June 30, 2023 to the Three Months Ended June 30, 2022

Net loss for the three months ended June 30, 2023 was $(15.9) million with Adjusted EBITDA of $(5.6) million, compared to $(17.8) million with Adjusted EBITDA of $(12.1) million for the prior year, due to higher revenue and improved margins that were positively impacted by a less promotional environment, lower freight costs and lower recurring operating expenses.

Net loss for the six months ended June 30, 2023 was $(22.6) million with Adjusted EBITDA of $(7.9) million, compared to $(24.3) million with Adjusted EBITDA of $(17.8) million for the prior year, due to higher revenue driven by consumer demand, lower freight costs and lower recurring operating expenses.

Results of Operations

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Three Months Ended

Six Months Ended

Nine Months Ended

September 30,

(in thousands)

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Operating loss

Interest expense (income)

Interest expense

Other non-operating expense, net

Loss before income tax

Income tax benefit

Income tax expense (benefit)

Net Revenue and Gross Profit

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Three Months Ended

Six Months Ended

Nine Months Ended

September 30,

(in thousands)

Cash Margin (1)

(1) Excludes depreciation and amortization, and stock-based compensation

Comparison of the Three Months Ended June 30, 2023 to the Three Months Ended June 30, 2022

Net revenue for the three months ended June 30, 2023 was $48.0 million, a $6.7 million increase from $41.3 million as consumer demand for our products increased and channel inventory levels stabilized led by console gaming headsets and flight simulation products.

For the three months ended June 30, 2023, gross margin increased to 24.7% from 19.1% in the comparable prior year period driven by lower freight costs including air freight, a less promotional environment and business mix.

Comparison of the Six Months Ended June 30, 2023 to the Six Months Ended June 30, 2022

Net revenue for the six months ended June 30, 2023 was $99.4 million, a $6.7 million increase from $88.0 million reflecting a stronger U.S.

console gaming headset market and increased consumer demand.

For the six months ended June 30, 2023, gross margin increased to 26.2% from 24.9% in the comparable prior year period as a result of lower freight and logistics costs, partially offset by higher promotional spend.

Comparison of the Three Months Ended September 30, 2023 to the Three Months Ended September 30, 2022

Net revenue for the three months ended September 30, 2023 was $59.2 million, a $7.9 million increase from $51.3 million driven primarily by an increase in North America sales led by console gaming headsets and flight simulation products, as well as the impact of share gains across key categories and geographies.

For the three months ended September 30, 2023, gross margin increased to 29.9% from 14.1%, or 24.5% excluding $5.3 million of excess components and product inventory impairment charges from pandemic related supply chain challenges, in the comparable prior year period driven by lower freight costs and less promotional spend.

Comparison of the Nine Months Ended September 30, 2023 to the Nine Months Ended September 30, 2022

Net revenue for the nine months ended September 30, 2023 was $158.6 million, a $19.3 million increase from $139.3 million as consumer demand for our products increased and channel inventory levels stabilized led by console gaming headsets and flight simulation products.

For the nine months ended September 30, 2023, gross margin increased to 27.6% from 20.9%, or 24.8% excluding $5.3 million of excess components and product inventory impairment charges, in the comparable prior year period as a result of lower freight and logistics costs as the elevated freight rates caused by the pandemic normalized.

Operating Expenses

Three Months Ended

Six Months Ended

Nine Months Ended

September 30,

(in thousands)

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Selling and Marketing

Selling and marketing expenses for the three and six months ended June 30, 2023 totaled $10.4 million and $19.9 million, respectively, compared to $11.6 million and $22.4 million for the three and six months ended June 30, 2022, respectively, due to more targeted marketing spend to drive sales growth.

Selling and marketing expenses for the three and nine months ended September 30, 2023 totaled $10.6 million and $30.5 million, respectively, compared to $10.6 million and $33.0 million for the three and nine months ended September 30, 2022, respectively, due to alignment of marketing to support demand and product launches.

Research and Development

Research and development costs for the three and six months ended June 30, 2023 were $4.2 million and $8.3 million, respectively, compared to $5.1 million and $10.4 million for the three and six months ended June 30, 2022, respectively, due to expense management initiatives during the prior year to align headcount with new product and portfolio expansion strategies.

Research and development costs for the three and nine months ended September 30, 2023 were $4.4 million and $12.7 million, respectively, compared to $4.4 million and $14.8 million for the three and nine months ended September 30, 2022, respectively, due to expense management initiatives during the prior year to align headcount with new product and portfolio expansion strategies.

General and Administrative

General and administrative expenses for the three months ended June 30, 2023 totaled $13.1 million compared to $12.5 million for the three months ended June 30, 2022.

Excluding certain non-recurring executive compensation, proxy contest and shareholders' litigation costs, expenses decreased $1.3 million primarily due to lower non-cash stock-based compensation and employee expenses.

General and administrative expenses for the six months ended June 30, 2023 totaled $20.1 million compared to $18.8 million for the six months ended June 30, 2022.

General and administrative expenses for the three months ended September 30, 2023 totaled $5.2 million compared to $6.0 million for the three months ended September 30, 2022 as a result of lower corporate legal costs and non-cash stock-based compensation.

General and administrative expenses for the nine months ended September 30, 2023 totaled $25.4 million compared to $24.8 million for the nine months ended September 30, 2022.

Excluding certain non-recurring executive compensation, proxy contest and shareholders' litigation costs, expenses decreased $2.3 million primarily due lower non-cash stock-based compensation, employee expenses and certain corporate legal costs, partially offset by higher professional services costs.

Income tax benefit for the six months ended June 30, 2023 was ($0.1) million at an effective tax rate of 0.5% compared to income tax benefit for the six months ended June 30, 2022 of ($7.4) million at an effective tax rate of 23.3%.

The effective tax rate for the six months ended June 30, 2023 was primarily impacted by a true-up to foreign incomes tax payable, partially offset by the change in U.S.

valuation allowance, foreign taxes and interest on uncertain tax positions.

Income tax benefit for the nine months ended September 30, 2023 was $0.4 million at an effective tax rate of (1.5%) compared to income tax benefit for the nine months ended September 30, 2022 of ($11.8) million at an effective tax rate of 24.5%.

The effective tax rate for the nine months ended September 30, 2023 was primarily impacted by the change in U.S.

valuation allowance, foreign taxes, state tax and interest on uncertain tax positions.

Key Performance Indicators and Non-GAAP Measures

Management routinely reviews key performance indicators, including revenue, operating income and margins, and earnings per share, among others.

In addition, we believe certain other measures provide useful information to management and investors about us and our financial condition and results of operations for the following reasons:

(i) they are measures used by our Board of Directors and management team to evaluate our operating performance;

(ii) they are measures used by our management team to make day-to-day operating decisions;

(iii) the adjustments made are often viewed as either non-recurring or not reflective of ongoing financial performance and/or have no cash impact on operations;

We believe that the presentation of Adjusted EBITDA, defined as net income (loss) before interest, taxes, depreciation and amortization, stock-based compensation (non-cash) and certain non-recurring special items that we believe are not representative of core operations, is appropriate to provide additional information to investors about our operating profitability adjusted for certain non-cash items, non-routine items that we do not expect to continue at the same level in the future, as well as other items that are not core to our operations.

Further, we believe Adjusted

EBITDA provides a meaningful measure of operating profitability because we use it for evaluating our business performance, making budgeting decisions, and comparing our performance against that of other peer companies using similar measures.

Adjusted EBITDA (and a reconciliation to Net income (loss), the nearest GAAP financial measure) for the three and nine months ended September 30, 2023 and September 30, 2022, are as follows:

Three Months Ended

Nine Months Ended

September 30,

(in thousands)

Interest expense (income)

Depreciation and amortization

Stock-based compensation (1)

Income tax expense (benefit)

Inventory and component related reserves (2)

Restructuring expense (3)

CEO transition related costs (4)

Proxy contest and other (5)

Adjusted EBITDA

(1) Increase in stock-based compensation in the nine months ended September 30, 2023 over the comparable prior year period primarily driven by $4.0 million charge related to the accelerated vesting of equities associated with the separation of our former CEO.

(2) Inventory and component related reserves includes (a) $3.3 million of costs associated with certain component parts that resulted from the effects of the global constrained semiconductor availability due to the Covid 19 pandemic and (b) $2.0 million of reserves primarily related to the buildup of excess inventory in the distribution channels.

(3) Restructuring charges are expenses that are paid in connection with reorganization of our operations.

These costs primarily include severance and related benefits.

(4) CEO transition related expense includes one-time costs associated with the separation of its former CEO.

Such costs included severance, bonus, medical benefits and the tax impact of vesting of stock-based compensation.

(5) Proxy contest and other primarily includes one-time legal, other professional fees, as well as employee retention costs associated with proxy challenges presented by certain shareholder activists.

Comparison of the Three Months Ended September 30, 2023 to the Three Months Ended September 30, 2022

Adjusted EBITDA for the three months ended September 30, 2023 was $1.0 million, compared to $(6.9) million for the prior year, due to higher revenue and improved margins that were positively impacted by less promotional activity, lower freight costs and operating expense control actions.

Liquidity and Capital Resources

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The following table summarizes our sources and uses of cash:

Six Months Ended

Nine Months Ended

September 30,

(in thousands)

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Operating activities

Cash provided by operating activities for the six months ended June 30, 2023 was $24.2 million, an increase of $65.5 million as compared to cash used for operating activities of $41.2 million for the six months ended June 30, 2022.

The increase is primarily the result of market-driven inventory management activity, higher gross receipts and expense management initiatives during the prior year.

Cash provided by operating activities for the nine months ended September 30, 2023 was $7.9 million, an increase of $77.5 million as compared to cash used for operating activities of $69.5 million for the nine months ended September 30, 2022.

The increase is primarily the result of lower working capital driven by reductions in inventory levels, higher gross receipts and expense management initiatives.

Investing activities

Cash used for investing activities was $1.3 million for the six months ended June 30, 2023, which was related to certain capital investments, compared to $1.2 million for the six months ended June 30, 2022.

Cash used for investing activities was $1.9 million for the nine months ended September 30, 2023, which was related to certain capital investments, compared to $1.9 million for the nine months ended September 30, 2022.

Financing activities

Net cash used for financing activities was ($18.7) million during the six months ended June 30, 2023 compared to net cash provided by financing activities of $16.2 million during the six months ended June 30, 2022.

Financing activities during the six months ended June 30, 2023 consisted primarily of $19.1 million revolving credit facility net repayments.

Net cash used for financing activities was $5.1 million during the nine months ended September 30, 2023 compared to net cash provided by financing activities of $45.2 million during the nine months ended September 30, 2022.

Financing activities during the nine months ended September 30, 2023 consisted primarily of $5.8 million revolving credit facility net repayments and $1.0 million of common stock repurchases, partially offset by $1.7 million of stock option exercise proceeds.

Management assessment of liquidity

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In addition, the Company monitors the capital markets on an ongoing basis and may consider raising capital if favorable market conditions develop.

Foreign cash balances at June 30, 2023 and December 31, 2022 were $4.3 million and $6.5 million, respectively.

Foreign cash balances at September 30, 2023 and December 31, 2022 were $3.2 million and $6.5 million, respectively.

Revolving Credit Facility

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In addition, Turtle Beach is required to pay a commitment fee on the unused revolving loan commitment at a rate ranging from 0.375% to 0.50% and letter of credit fees and agent fees.

As of June 30, 2023, interest rates for outstanding borrowings were 10.75% for base rate loans and 6.50% for LIBOR rate loans, which reference interest rates were still in effect prior to the Libor Transition Amendments.

As of September 30, 2023, interest rates for outstanding borrowings were 11.00% for base rate loans and 8.90% for LIBOR rate loans, which reference interest rates were still in effect prior to the Libor Transition Amendments.

The Company is subject to quarterly financial covenant testing if certain availability thresholds are not met or certain other events occur (as set forth in the Credit Facility).

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The Company does not use derivative financial instruments for speculative or trading purposes.

As of June 30, 2023 and December 31, 2022, we did not have any derivative financial instruments.

As of September 30, 2023 and December 31, 2022, we did not have any derivative financial instruments.

Foreign Currency Exchange Risk

The Company has exchange rate exposure primarily with respect to the British Pound and Euro.

As of June 30, 2023 and December 31, 2022, our monetary assets and liabilities that are subject to this exposure are immaterial, therefore the potential immediate loss to us that would result from a hypothetical 10% change in foreign currency exchange rates would not be expected to have a material impact on our earnings or cash flows.

As of September 30, 2023 and December 31, 2022, our monetary assets and liabilities that are subject to this exposure are immaterial, therefore the potential immediate loss to us that would result from a hypothetical 10% change in foreign currency exchange rates would not be expected to have a material impact on our earnings or cash flows.

This sensitivity analysis assumes an unfavorable 10% fluctuation in the exchange rates affecting the foreign currencies in which monetary assets and liabilities are denominated and does not take into account the offsetting effect of such a change on our foreign currency denominated revenues.

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Inflationary pressures can also have a negative impact on demand for the products we sell.

Reduced or delayed discretionary spending by consumers in response to inflationary pressures has reduced consumer demand for our products, resulting in

reduced sales.

Reduced or delayed discretionary spending by consumers in response to inflationary pressures has reduced consumer demand for our products, resulting in reduced sales.

In 2022, we experienced a higher rate of inflation than in recent years resulting in higher cost of goods, selling expenses, and general and administrative expenses.

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At the conclusion of the period covered by this Quarterly Report on Form 10-Q, we carried out an evaluation, under the supervision of our Principal Executive Officer (or PEO) and our Principal Financial Officer (or PFO), of the effectiveness of the design and operation of our disclosure controls and procedures.

Based upon that evaluation, our PEO and PFO concluded that our disclosure controls and procedures, as defined in Rule 13a-15(e) of the Exchange Act, were effective as of June 30, 2023.

Based upon that evaluation, our PEO and PFO concluded that our disclosure controls and procedures, as defined in Rule 13a-15(e) of the Exchange Act, were effective as of September 30, 2023.

Changes in Internal Control over Financial Reporting

In our annual report on Form 10-K for the year ended December 31, 2022, we identified a material weakness in internal control related to the proper design and implementation of certain controls over our income tax provision and management’s review of the income tax provision.

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Corporation's annual or interim financial statements will not be prevented or detected on a timely basis.

Management implemented its plan to remediate the material weakness described above, which consisted of the following elements:

Management, with the assistance of a third party, performed an evaluation of the processes and procedures around the Company’s tax provision processes, internal control design gaps, and recommend process enhancements.

Implemented enhancements and process improvements, including the design and implementation of well defined controls and related control attributes regarding tax law changes, deferred taxes, uncertain tax positions and income tax disclosures.

Developed a detailed timeline of the tax provision calculation, to ensure that sufficient time is allocated to complete the process as designed.

As of June 30, 2023, management has determined that the material weakness identified has been remediated.

Other than the material weakness remediated above, there have been no changes in our internal control over financial reporting during the period covered that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

There have been no changes in our internal control over financial reporting during the period covered that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Our process for evaluating controls and procedures is continuous and encompasses constant improvement of the design and effectiveness of established controls and procedures and the remediation of any deficiencies, which may be identified during this process.

10 unchanged sentences

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis