Turtle Beach Corp (TBCH) FY 2024 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Results of Operations
Management Overview
In 2024, we acquired Performance Designed Products (“PDP”), another leading gaming accessory brand with a robust slate of products, including gaming controllers/gamepads for all platforms and licensing deals with popular gaming and entertainment properties. As a result of the advantages of increased scale and diversification, Turtle Beach experienced robust revenue growth, driven by increased demand for our leading gaming accessories and the benefits of our expanded portfolio.
During 2024, primarily due to the PDP acquisition, revenues grew to $372.8 million, with strong revenue growth in headsets and controllers. This level of growth continues to be driven by the ongoing success of our portfolio and strong sales of groundbreaking products like the Stealth 700 Gen 3 wireless headset, a premium multi-platform headset using our unique cross-play technology
As a result of the execution against our strategic pillars and ongoing cost management initiatives, the overall operating environment improved throughout the year, demonstrated by improved gross profits and net income due to higher operating leverage on higher revenue levels. Looking forward, in addition to the acquisition cost synergies, we anticipate that there are long-term revenue synergies due to our enhanced product lineups and strong customer relationships that will drive our brands to continue leading gaming accessories categories with new, innovative console gaming headsets and controllers.
The following table sets forth the Company’s statements of operations for the periods presented:
| Year Ended | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| December 31, | ||||||||||||
| 2024 | 2023 | 2022 | ||||||||||
| (in thousands) | ||||||||||||
| Net revenue | $ | 372,766 | $ | 258,122 | $ | 240,166 | ||||||
| Cost of revenue | 243,784 | 182,618 | 190,979 | |||||||||
| Gross profit | 128,982 | 75,504 | 49,187 | |||||||||
| Gross margin | 34.6 | % | 29.3 | % | 20.5 | % | ||||||
| Operating expenses | 108,953 | 91,947 | 100,667 | |||||||||
| Operating income (loss) | 20,029 | (16,443 | ) | (51,480 | ) | |||||||
| Interest expense, net | 8,068 | 504 | 1,220 | |||||||||
| Other non-operating expense, net | 1,289 | 394 | 1,753 | |||||||||
| Income (loss) before income tax | 10,672 | (17,341 | ) | (54,453 | ) | |||||||
| Income tax expense (benefit) | (5,511 | ) | 338 | 5,093 | ||||||||
| Net income (loss) | $ | 16,183 | $ | (17,679 | ) | $ | (59,546 | ) |
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Net Revenue and Gross Profit
Comparison of the Year Ended December 31, 2024 to the Year Ended December 31, 2023
Net revenue for the year ended December 31, 2024 was $372.8 million, an $114.8 million, or 44.5%, increase from $258.1 million in the prior year period primarily driven by incremental revenue from the PDP acquisition.
For the year ended December 31, 2024, gross profit as a percentage of net revenue increased to 34.6%, inclusive of a $2.1 million purchase accounting driven charge to step-up the value of PDP inventory at the time of acquisition, compared to 29.3% in the comparable prior year period, as a result of higher revenue and improved operating leverage from the PDP acquisition.
In-Transit Inventory Loss
One of the Company’s third-party logistics providers experienced a loss of Turtle Beach inventory during the fourth quarter of 2024 while in transit to one of the Company’s customers which impacted the result of operations for the twelve months ended December 31, 2024. The Company recorded the loss of inventory in the amount of $3.4 million within “Cost of revenue” on the consolidated statement of operations. The Company is pursuing recovery of the value of this inventory, as well as other consequential damages, and has filed claims with its insurance carriers, although there can be no assurance as to what amount ultimately will be recovered, if any. While investigations are ongoing with law enforcement, Turtle Beach and the logistics provider have taken actions to mitigate the risk of future similar inventory losses.
Operating Expenses
| Year Ended | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| December 31, | |||||||||||
| 2024 | 2023 | 2022 | |||||||||
| (in thousands) | |||||||||||
| Selling and marketing | $ | 52,429 | $ | 43,489 | $ | 47,090 | |||||
| Research and development | 17,304 | 17,137 | 19,123 | ||||||||
| General and administrative | 28,388 | 31,321 | 32,558 | ||||||||
| Subtotal operating expenses | 98,121 | 91,947 | 98,771 | ||||||||
| Acquisition integration costs | 10,832 | — | — | ||||||||
| Intangible asset impairment | — | — | 1,896 | ||||||||
| Total operating expenses | $ | 108,953 | $ | 91,947 | $ | 100,667 |
Selling and Marketing
Selling and marketing expense for the year ended December 31, 2024 totaled $52.4 million, or 14.1% as a percentage of net revenue, compared to $43.5 million, or 16.8% as a percentage of net revenue, for the prior year. This increase in expense was primarily due to incremental intangible assets amortization and operating expenses related to the PDP acquisition, and certain integration related severance costs.
Research and Development
Research and development expense for the year ended December 31, 2024, was $17.3 million compared to $17.1 million for the year ended December 31, 2023.
General and Administrative
General and administrative expenses for the year ended December 31, 2024 decreased $2.9 million to $28.4 million compared to $31.3 million for the year ended December 31, 2023 primarily due to lower stock-based compensation and employee expenses partially offset by increased professional service costs.
Acquisition Integration Costs
Acquisition related costs include one-time costs incurred in connection with the PDP acquisition including warehouse lease impairment, professional fees, such as legal and accounting, along with other certain integration related costs.
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Income Taxes
Income tax benefit for the year ended December 31, 2024 was $5.5 million at an effective tax rate of (51.6)% compared to income tax expense of $0.3 million for the year ended December 31, 2023 at an effective tax rate of (1.9%). The effective tax rate was primarily impacted by the reversal of a portion of the Company’s deferred tax asset valuation allowance associated with the deferred tax liabilities established on PDP’s intangible assets.
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; 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 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. However, Adjusted EBITDA is not a measure of financial performance under 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
Adjusted EBITDA (and a reconciliation to Net income (loss), the nearest GAAP financial measure) for the years ended December 31, 2024, 2023 and 2022 are as follows:
| Year Ended | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| December 31, | ||||||||||||
| 2024 | 2023 | 2022 | ||||||||||
| (in thousands) | ||||||||||||
| Net income (loss) | $ | 16,183 | $ | (17,679 | ) | $ | (59,546 | ) | ||||
| Interest expense | 8,068 | 504 | 1,220 | |||||||||
| Depreciation and amortization | 11,391 | 4,839 | 5,816 | |||||||||
| Stock-based compensation (1) | 6,172 | 11,983 | 7,984 | |||||||||
| Income tax benefit (2) | (5,511 | ) | 338 | 5,093 | ||||||||
| Impairment charge (3) | — | — | 1,896 | |||||||||
| Restructuring expense (4) | 1,967 | 1,061 | 556 | |||||||||
| CEO transition related costs (5) | — | 2,874 | — | |||||||||
| Acquisition related cost (6) | 10,832 | 653 | — | |||||||||
| Incremental costs on acquired inventory (7) | 2,084 | — | — | |||||||||
| Loss on inventory in transit (8) | 3,398 | — | — | |||||||||
| Proxy contest and other (9) | 1,833 | 1,921 | 7,092 | |||||||||
| Adjusted EBITDA | $ | 56,417 | $ | 6,494 | $ | (29,889 | ) |
(1)
Increase in stock-based compensation in the year-ended December 31, 2023 primarily driven by $4.0 million charge related to the accelerated vesting of equities of the Company's former Chief Executive Officer.
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(2)
An income tax benefit of $7.6 million was recorded as a result of the reversal of a portion of the Company’s deferred tax asset valuation allowance.
(3)
Impairment charge includes costs related to impairment of intangible assets. See Note 5 to our consolidated financial statements included elsewhere in this Annual Report.
(4)
Restructuring charges are expenses that are paid in connection with reorganization of our operations. These costs primarily include severance and related benefits.
(5)
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 accelerated vesting of stock-based compensation.
(6)
Acquisition related costs include one-time costs we incurred in connection with acquisitions including warehouse lease impairment, professional fees such as legal and accounting along with other certain integration related costs.
(7)
Costs relate to the step up of acquired finished goods inventory to fair market value as required under purchase accounting. This step up in value over original cost is recorded as a charge to cost of revenue as such inventory is sold.
(8)
Reflects a loss of Turtle Beach inventory while in transit that occurred in the fourth quarter of 2024.
(9)
Proxy contest and other primarily includes (a) a $1.7 million judgment in an insolvency dispute in Germany and (b) one-time legal and other professional fee associated with proxy challenges presented by certain shareholder activists in 2023 and 2022. See Item 3 – Legal Proceedings above.
Liquidity and Capital Resources
Our primary sources of working capital are cash flow from operations and availability of capital under our revolving credit facility. We have funded operations and acquisitions in recent periods with operating cash flows and proceeds from debt and equity financings.
The following table summarizes our sources and uses of cash:
| Year Ended | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| December 31, | ||||||||||||
| 2024 | 2023 | 2022 | ||||||||||
| (in thousands) | ||||||||||||
| Cash and cash equivalents at beginning of period | $ | 18,726 | $ | 11,396 | $ | 37,720 | ||||||
| Net cash provided by (used for) operating activities | 5,761 | 27,044 | (41,846 | ) | ||||||||
| Net cash used for investing activities | (82,208 | ) | (2,159 | ) | (3,549 | ) | ||||||
| Net cash provided by (used for) financing activities | 71,051 | (17,846 | ) | 19,706 | ||||||||
| Effect of foreign exchange on cash | (335 | ) | 291 | (635 | ) | |||||||
| Cash and cash equivalents at end of period | $ | 12,995 | $ | 18,726 | $ | 11,396 |
Operating activities
Cash provided by operating activities for the year ended December 31, 2024 was $5.8 million, a decrease of $21.3 million as compared to $27.0 million for the year ended December 31, 2023. The decrease is primarily the result of certain acquisition related business costs, including integration costs and related severance, and higher inventory procurements reflective of the larger business and additional product offerings.
Investing activities
Cash used for investing activities was $82.2 million for the year ended December 31, 2024, which was primarily related to the acquisition of the Performance Designed Products business, compared to $2.2 million in 2023.
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Financing activities
Net cash used for financing activities was $71.1 million during the year ended December 31, 2024 compared to net cash provided by financing activities of $17.8 million during the year ended December 31, 2023. Financing activities during the year ended December 31, 2024 consisted primarily of $49.4 million net borrowings, the $50 million term loan and $3.4 million of stock option exercise proceeds, partially offset by $27.8 million of share repurchases, $2.9 million of debt issuance costs and $1.0 million of term loan repayments.
Management assessment of liquidity
Management believes that our current cash and cash equivalents, the amounts available under our revolving credit facility and cash flows derived from operations will be sufficient to meet anticipated short-term and long-term funding for working capital and capital expenditures including amounts to develop new products, fund future stock repurchases and to pursue strategic opportunities. Significant assumptions underlie this belief, including, among other things, that there will be no material adverse developments in our business, liquidity or capital requirements, or strategic opportunities that require additional capital.
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 December 31, 2024 and December 31, 2023 were $4.5 million and $8.0 million, respectively.
Revolving Credit Facility
On March 5, 2018, Turtle Beach and certain of its subsidiaries entered into an amended and restated loan, guaranty and security agreement (the “Credit Facility”) with Bank of America, N.A. (“Bank of America”), as administrative agent, collateral agent and security trustee for Lenders (as defined therein), which replaced the then existing asset-based revolving loan agreement. The Credit Facility was amended on each of December 17, 2018, May 31, 2019, and March 10, 2023. The Credit Facility, as amended, expires on March 13, 2027 and provides for a line of credit of up to $50 million inclusive of a sub-facility limit of $10 million for TB Europe, a wholly-owned subsidiary of Turtle Beach.
On March 13, 2024, the Company entered into a Fourth Amendment, dated as of March 13, 2024 (the “Fourth Amendment”), by and among the Company, VTB, TBC Holding Company LLC, TB Europe, VTBH, the financial institutions party thereto from time to time and Bank of America, as administrative agent, collateral agent and security trustee for the lenders.
Among other things, the Fourth Amendment provided for, among other things: (i) the acquisition of PDP; (ii) the revision of the calculation of the U.S. Borrowing Base to include certain acquired assets of PDP equal to the lesser of (a) the sum of the accounts formula amount and the inventory formula amount (each as defined in the Fourth Amendment), (b) $15,000,000, and (c) 30% of the aggregate Revolver Commitments; (iii) the extension of the maturity date of the Credit Facility from April 1, 2025 to March 13, 2027; and (iv) updates to the interest rate and margin terms such that the loans will bear interest at a rate equal to (1) SOFR, (2) the U.S. Base Rate, (3) the Sterling Overnight Index Average Reference Rate (“SONIA”) for loans denominated in Sterling, and (4) the Euro Interbank Offered Rate (“EUIBOR”) for loans denominated in Euros, plus in each case, an applicable margin, which is between 0.50% and 2.50% for Base Rate Loans and 1.75% and 3.50% for Term SOFR Loans, SONIA Rate Loans and EUIBOR Loans.
The maximum credit availability for loans and letters of credit under the Credit Facility is governed by a borrowing base determined by the application of specified percentages to certain eligible assets, primarily eligible trade accounts receivable and inventories, and is subject to discretionary reserves and revaluation adjustments. The Credit Facility may be used for working capital, the issuance of bank guarantees, letters of credit and other corporate purposes.
Amounts outstanding under the Credit Facility bear interest at a rate equal to (i) a rate published by Bank of America or the U.S. Bloomberg Short-Term Bank Yield Index (“BSBY”) rate for loans denominated in U.S. Dollars, (ii) the Sterling Overnight Index Average Reference Rate (“SONIA”) for loans denominated in Sterling, (iii) and the Euro Interbank Offered Rate (“EUIBOR”) for loans denominated in Euros, plus in each case, an applicable margin, which is between 0.50% to 2.50% for base rate loans and UK base rate loans, and 1.75% and 3.50% for U.S. BSBY rate loans, U.S. BSBY daily floating rate loans and UK alternative currency loans. 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 December 31, 2024, interest rates for outstanding borrowings were 8.10% for base rate loans and 6.19% for Term SOFR loans.
The Company is subject to financial covenant testing if certain availability thresholds are not met or certain other events occur (as defined in the Credit Facility). The Credit Facility requires the Company and its restricted subsidiaries to maintain a fixed charge coverage ratio of at least 1.00 to 1.00 as of the last day of each fiscal quarter.
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The Credit Facility also contains affirmative and negative covenants that, subject to certain exceptions, limit our ability to take certain actions, including our ability to incur debt, pay dividends and repurchase stock, make certain investments and other payments, enter into certain mergers and consolidations, engage in sale leaseback transactions and transactions with affiliates and encumber and dispose of assets. Obligations under the Credit Facility are secured by a security interest and lien upon substantially all of the Company’s assets.
As of December 31, 2024, the Company was in compliance with all the financial covenants under the Credit Facility, as amended, and excess borrowing availability was approximately $30.3 million.
Term Loan
On March 13, 2024, Turtle Beach and certain of its subsidiaries entered into a new financing agreement with Blue Torch Finance, LLC, (“Blue Torch”), for an aggregate amount of $50 million (the “Term Loan Facility”), the proceeds of which were used to (i) fund a portion of the PDP acquisition purchase price; (ii) repay certain existing indebtedness of the acquired business; (iii) to pay fees and expenses related to such transactions and (iv) for general corporate purposes. The Term Loan Facility amortizes in a monthly amount equal to 0.208333% during the first two years and 0.416667% during the third year and may be prepaid at any time subject to a prepayment premium during the first year of the interest payments payable during the first year plus 3.00%. The Term Loan Facility is secured by substantially all of the assets of the Company and its subsidiaries which are party to the Term Loan Facility.
The Term Loan Facility (a) matures on March 13, 2027; (b) bears interest at a rate equal to (i) a base rate plus 7.25% per annum for Reference Rate Loans and Secured Overnight Financing Rate (“SOFR”) plus 8.25% per annum for SOFR Loans if the total net leverage ratio is greater than or equal to 2.25x and (ii) a base rate plus 6.75% per annum for Reference Rate Loans and SOFR plus 7.75% per annum for SOFR Loans if the total net leverage ratio is less than 2.25x; and (c) is subject to certain affirmative, negative and financial covenants, including a minimum liquidity covenant and a quarterly total net leverage ratio covenant. As of December 31, 2024, interest rates for outstanding borrowings were 12.44%.
On August 7, 2024, the Company and Blue Torch amended the Term Loan Facility to, among other things, permit the Company to repurchase Company common stock in an aggregate amount not to exceed $30 million prior to March 31, 2025, subject to the satisfaction of certain conditions. The other material terms of the Term Loan Facility were unchanged.
As of December 31, 2024, the Company was in compliance with all the financial covenants under the Term Loan Facility.
Critical Accounting Estimates
Our discussion and analysis of our results of operations and capital resources are based on our consolidated financial statements, which have been prepared in conformity with GAAP. The preparation of these consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses and the disclosure of contingent assets and liabilities. Management bases its estimates, assumptions, and judgments on historical experience and on various other factors that it believes to be reasonable under the circumstances.
Different assumptions and judgments would change the estimates used in the preparation of the condensed consolidated financial statements, which, in turn, could change the results from those reported. Management evaluates its estimates, assumptions, and judgments on an ongoing basis.
Based on the above, we have determined that our most critical accounting policies are those related to revenue recognition and sales return reserve, inventory valuation, asset impairment, and income taxes.
Revenue Recognition and Sales Return Reserve
Net revenue consists primarily of revenue from the sale of gaming headsets and accessories to wholesalers, retailers and to a lesser extent, on-line customers. These products function on a standalone basis (in connection with a readily available gaming console, personal computer, or stereo) and are not sold with additional services or rights to future goods or services. Revenue is recorded for a contract through the following steps: (i) identifying the contract with the customer; (ii) identifying the performance obligations in the contract; (iii) determining the transaction price; (iv) allocating the transaction price to the performance obligations; and (v) recognizing revenue when or as each performance obligation is satisfied.
Each contract at inception is evaluated to determine whether the contract should be accounted for as having one or more performance obligations. The Company's business activities were determined to be a single performance obligation with revenue recognized when obligations under the terms of a contract with its customer are satisfied; generally, this occurs at a point in time when the risk and title to the product transfers to the customer which can be at the time of shipment or the product reaches its customer at the point of destination. The Company's standard terms of delivery are included in its contracts of sale, order confirmation documents, and invoices. The Company excludes sales taxes collected from customers from “Net revenue” on the consolidated statements of operations.
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Certain customers may receive cash-based incentives (including cash discounts, quantity rebates, and price concessions), which are accounted for as variable consideration. Cash-based incentive allowances are based on historical and expected performance of the customers, types and levels of promotions including any contractual commitments, claims received and forecasted economic trends in comparison to historical trends. The Company also has provisions for sales returns that are recognized in the period of the sale and are recorded based upon the Company's prior experience and current trends and forecasted economic trends in comparison to historical trends. As of December 31, 2024 and 2023, the Company had an allowance for cash-based incentives of $32.6 million and $28.6 million, respectively, and an allowance for sales returns of $7.7 million and $8.4 million, respectively. These amounts are recorded as a reduction of accounts receivable on the consolidated balance sheets.
Inventory Valuation
Inventories consist primarily of finished goods and related component parts and are stated at the lower of cost or net realizable value using the first in, first out (“FIFO”) method. The Company maintains an inventory allowance for returned goods, slow-moving and unused inventories based on the historical trend and estimates. Inventory write-downs, once established, are not reversed as they establish a new cost basis for the inventory. Inventory write-downs are included as a component of cost of revenue on the consolidated statements of operations.
Income Taxes
We account for income taxes using the asset and liability method. Under the asset and liability method, deferred tax assets and liabilities are recognized based on the differences between the financial statement carrying value of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates and laws expected to be in effect when the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date. Inherent in the measurement of these deferred balances are certain judgments and interpretations of existing tax law and other published guidance as applied to our operations. Our effective tax rate considers our judgment of expected tax liabilities in the various jurisdictions within which we are subject to tax.
The determination of the need for a valuation allowance on deferred tax assets requires management to make assumptions and to apply judgment, including forecasting future earnings, and the reversal pattern of deferred tax assets and liabilities.
The tax effects of uncertain tax positions taken or expected to be taken in income tax returns are recognized only if they are “more likely-than-not” to be sustained on examination by the taxing authorities based on the technical merits as of the reporting date. The tax benefits recognized in the financial statements from such positions are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. We recognize estimated accrued interest and penalties related to uncertain tax positions in income tax expense.
Business Combinations
During the year ended December 31, 2024, the Company completed the acquisition of PDP for total consideration of $116.9 million. The transaction was accounted for under the acquisition method of accounting whereby the total purchase price was allocated to assets acquired and liabilities assumed based on the estimated fair value of such assets and liabilities.
Accounting for the acquisition of PDP required estimation in determining the fair value of identified intangible assets for tradenames, customer relationships and developed technology. Estimation was utilized as it relates to inputs to the valuation techniques used to measure the fair value of these intangible assets as well as the sensitivity of the respective fair values to the underlying assumptions. The significant assumptions used to estimate the fair value of the acquired intangible assets included revenue assumptions, earnings assumptions, royalty rates and discount rates. These assumptions are forward-looking and could be affected by future economic and market conditions.
There have been no material changes to the critical accounting policies and estimates. See Note 1, “Summary of Significant Accounting Policies,” in the notes to the consolidated financial statements for a complete discussion of recent accounting pronouncements. We are currently evaluating the impact of certain recently issued guidance on our financial condition and results of operations in future periods.
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