Q4 2023 Turtle Beach Corp Earnings Call
Participants
Alex Thompson; IR; Gateway Group
Terry Jimenez; Chairman; Turtle Beach Corporation
Chris Keirn; Interim CEO & SVP, Global Sales; Turtle Beach Corporation
John Hanson; CFO; Turtle Beach Corporation
Sean McGowan; Analyst; Roth MKM
Drew Crum; Analyst; Stifel Nicolaus and Company, Incorporated
Jack Codera; Analyst; Maxim Group, LLC.
Martin Yang; Analyst; Oppenheimer & Co., Inc.
Presentation
Operator
Hello, and thank you for standing by, and welcome to Turtle Beach Fourth Quarter 2023 conference call. (Operator Instructions) I would now like to hand the conference over to Alex Thompson, Gateway Investor Relations. You may begin.
Alex Thompson
Thank you, Towanda and today's prepared remarks are from Terry Jimenez, Chairman of the Board have Chris Keirn, Chief Executive Officer; and John Hanson, Chief Financial Officer.
On today's call, we will be referring to the press release filed this afternoon that details the company's fourth quarter and full year 2023 results, which can be downloaded from the Investor Relations page at corp.turtlebeach.com, where you'll also find the latest earnings presentation that supplements the information discussed on today's call.
Finally, a recording of the call will be available on the Events and Presentations section of the company's website later today.
Please be aware that some of the comments made during this call may include forward-looking statements within the meaning of the federal securities laws. Statements about the company's beliefs and expectations containing words such as may, will, could, believe, expect, anticipate and similar expressions constitute forward looking statements. These statements involve risks and uncertainties regarding the company's operations and future results that could cause Turtle Beach Corporation's results to differ materially from management's current expectations. While the Company believes that its expectations are based upon reasonable assumptions. Numerous factors may affect actual results. It may cause results to differ materially, so the company encourages you to review the safe harbor statements and risk factors contained in today's press release and in its filings with the Securities and Exchange Commission, including without limitation, its annual report on Form 10 K and other periodic reports which identifies specific risk factors that also may cause actual results or events to differ materially from those described in our forward-looking statements. The Company does not undertake to publicly update or revise any forward-looking statements after this conference call. The Company also notes that on this call, we'll be discussing non-GAAP financial information. The companies providing that information as a supplement to information prepared in accordance with accounting principles generally accepted in United States or GAAP. You can find a reconciliation of these metrics to the company's reported GAAP results in the reconciliation tables provided in today's earnings release and presentation. And now I'll turn the call over to Terry and then as the Company's Chairman of the Board.
Terry?
Terry Jimenez
Thanks, Alex, and thank you all for your interest in Turtle Beach. On behalf of the Board of Directors of Turtle Beach, I would like to share a number of exciting announcements today. These actions that we believe will fundamentally change Turtle Beach for the better first, after a lengthy and comprehensive process of assessing strategic alternatives, we have announced an acquisition that will provide a much larger, more resilient and more diversified foundation on which to grow the business.
Today, we announced our acquisition of performance designed products for PDP. As the industry knows that we have acquired PP. for an enterprise value of $118 million in a combination consisting of roughly one-third stock and two-thirds cash. PDP. is a leader in video game accessories among market leading share and controllers and other product categories with PDP. being a leader in controllers and Turtle Beach being the leader in console headsets. We believe that we've created a powerhouse gaming accessories platform. In addition to the significant scale benefits that come with diversifying our revenue base in tangential categories with the same partners and consumers, we believe we will realize significant cost synergies in the deal. These synergies alongside PDP's attractive standalone profile have allowed Turtle Beach to acquire PDP at a highly attractive multiple, both on a pre and post synergy basis, we expect the first 12 months of the combined company to generate $390 million to $410 million in revenue and between $60 million to $65 million of adjusted EBITDA. This acquisition will significantly increase our profitability and free cash flow generation throughout the cycle, better minimize our earnings and free cash flow volatility and create a global powerhouse in the gaming category.
Additionally, we are pleased to have announced today our intention to launch a significant return of capital to shareholders by way of a reverse Dutch tender offer. We intend to repurchase up to $30 million of our common stock at a price range between $13.75 to $15 per share. This tender auction, which will end following our first quarter earnings results in May is set to launch next month and will provide shareholders that are seeking liquidity, a chance to sell some or all of their stock back to the Company at a minimum premium of 25% from today's closing share price versus the former owners of PDP. as well as each member of the sort of each management team and Board of Directors have committed to not tender a single share of stock, highlighting the confidence that we all have that this deal will create significantly more value to shareholders than the top end of the tender range provides. We have listened to shareholders and providing this liquidity option. It was an important consideration for our board as part of the transaction with PDP., we have entered into a debt facility that will have less than one times leverage for the pro forma company at close, assuming the tender of $30 million is fully utilized, our never our net leverage level will sit at just 1.2 times next 12 months EBITDA. And importantly, pro forma for the transaction. As we have detailed in our slide deck, Turtle Beach is currently trading at less than half the enterprise value over the next 12 months. Ebitda multiple of its closest peer. We expect this gap to narrow over time as shareholders recognize the massive transformation that has happened happened at the Company over the past year, culminating with today's announcements allowing significant value to be created for our shareholders as we now focus on execution with the transaction comes a great set of complementary assets, products and team members as well as a new board member. We welcome Dave MuSK hotel to our Board, and we are thrilled to have someone with such deep gaming market experience join our Board. And finally, after a comprehensive and exhaustive search. We are pleased to announce Chris Kern as our next Chief Executive Officer. The Board guided by a search consultant, ran our broad and sweeping review the external demand for this role was significant and the Board engaged deeply with a number of remarkable candidates at the end of the search, it became quite clear that the Board believe that Chris's deep understanding of the existing Turtle Beach business. His understanding of PDP. and his ability to execute on the Company's strategy gave us the best chance to succeed both near and long term. We are enthusiastic about this new refresh and transform Turtle Beach and its future prospects for shareholders, employees and customers. The Board has been hard at work over the past year, and we are excited about the future for the Company and its shareholders.
With that, I will turn it over to our Chief Executive Officer, Chris Keirn.
Chris Keirn
Thanks, Terry, and thank you all for joining us today on our fourth quarter and full year 2023 earnings call. First, I'd like to thank the Board for placing their trust in me to lead the business as CEO. moving forward, since assuming the interim CEO role last summer, we worked closely together to best position Turtle Beach for future success.
I also want to thank the great team that we have here at Turtle Beach and recognize their tremendous efforts together with the Board and the entire team. I look forward to advancing our strategy to ultimately drive increased return for our shareholders.
Next, I want to discuss the exciting news that we announced separately from our earnings release earlier today. As Terry noted, we announced the execution of a definitive agreement to acquire PDP., a leading gaming accessories provider. PDP. is a leader in video game accessories, including controllers, headsets, power cases and other categories. The transaction creates a powerhouse with the combination of industry leading teams and expertise, significant product momentum and proven track records of delivering profitable growth, bringing PDP's leading gaming controller category to Turtle Beach will provide additional scale and create future development opportunities. In addition to an estimated $10 million to $12 million in cost synergies and meaningful revenue synergies, the acquisition of PDP. adds significant financial benefits to Turtle Beach that fundamentally transforms the financial profile of the Company.
Considering this transformational development, let me now state our full year 2024 outlook before recapping 2023 and for the full year 2024, including the PDP. contributions and synergies for nine months, we expect to generate revenue in the range of $370 million to $380 million and generate adjusted EBITDA in the range of $51 million to $54 million. Further in the first four quarters of operation as in Q2 2024 to Q1 2025, pro forma business expects net sales to be in the range of $390 million to $410 million and adjusted EBITDA to be in the range of $60 million to $65 million. This is a tremendous outcome, and I want to welcome the fantastic PDP. team to Turtle Beach. We look forward to achieving great success together.
I'll now move into the fourth quarter and full year 2023 commentary. Turtle Beach's resilience and adaptability in 2023 has elevated our leadership position across gaming accessories. Our 2023 full year net revenue increased by 7.5% year over year as a result of significant share gains across multiple categories and geographies, including our core business of console gaming headsets with post print genomic transitional effects to gaming markets and our business.
Now behind us. We are looking forward to a strong era of exciting new products and growth. We also returned to profitability in 2023, generating $6.5 million of adjusted EBITDA compared to an adjusted EBITDA loss of $29.9 million a year ago. Our share benefited from the temporary higher promotional spend as our US console headset value grew 300 basis points. Our share grew 300 basis points year over year in the fourth quarter and was up for the full year 2023. The fourth quarter promotional spend was successful in preparing our inventory and the channel inventory levels for the significant upcoming new product launches throughout 2024, including groundbreaking new wireless models, higher spend has not continued in January and lower levels of promotional spend are projected through 2024 across categories, despite reduced year-over-year promotional spend in January 2024, we're seeing continued share growth in key areas, including console gaming headsets, positioning us well for our upcoming new product launches set to differentiate the gaming accessory accessories landscape in 2024 as an example, the launch of our highly acclaimed Stealth Ultra controller for Xbox and PC is just the beginning of what we believe will be a transformative year for Turtle Beach. John will now take us through the financials in more detail. John?
John Hanson
Hey, thanks, Chris, and good afternoon, everyone. As Chris noted, our full year 2023 revenue was $258.1 million. That's an increase of 7.5% compared to the year ago period, driven by revenue and share gains for both our console headset and simulation products. Fourth quarter revenues at $99.5 million were down slightly compared to the $100.9 million a year ago, driven by higher than expected promotional spend due to the softer than expected console gaming headset market.
In 2023, our gross margin was 29.3% compared to 20.5% in 2022. The increase was a result of lower freight and promotional spending during the year. As you'll recall, in the year-ago period, we recorded a $9.8 million charge for potential access components and finished goods relating to the pandemic driven supply chain impacts and a weak gaming market. Excluding these nonrecurring items, adjusted gross margin was 24.6% in 2022, which reflects a 470 basis point improvement year over year.
Operating expenses for the full year 2023 were $91.9 million compared to $100.7 million in the year ago period. Recurring operating expenses declined 10.6%, a reflection of the proactive expense management initiatives we undertook in mid 2022, as well as the alignment of marketing to support demand and our product launches.
Our full year adjusted EBITDA improved significantly to $6.5 million compared to an adjusted EBITDA loss of $29.9 million in the year ago period. The year-over-year variance is primarily driven by the items I've covered above. We continued to advance our enhancements in profitability, and we expect to deliver strong adjusted EBITDA growth in 2024.
Our full year net loss improved to $17.7 million or $1.3 per diluted share compared to a net loss of $59.5 million or $3.62 per diluted share a year ago.
Turning to the balance sheet. At December 31st, 2023, we had $18.7 million of cash and no outstanding borrowings on our revolving credit line. Inventories at December 31st, 2023 were $44 million compared to $71.3 million at December 31st, 2022. Cash flow from operations was $27 million, which was a $68.9 million improvement year over year on a year-to-date basis. Additionally, and as we communicated in our separate press release today, along with the acquisition of PDP. Turtle Beach announced that we have commenced a modified Dutch auction tender offer to purchase with cash up to $30 million in value of our common stock at a price per share, not less than $13.75 per share and not greater than $15 per share less any applicable withholding taxes and without interest using available cash on hand. On March 12th of 2024, the closing, price of the common stock was $11.3 per share. The tender offer is anticipated to commence April 10th, 2024 and will expire at 12 midnight New York City time at the end of the day on May 10th, 2024, unless extended or terminated.
And now I'll turn the call back over to Chris for additional comments.
Chris Keirn
Chris, as John has mentioned, the acquisition of PDP. significantly benefits our financial profile, gaming portfolio and industry-leading team. Together, we are a stronger business with an industry-leading product portfolio poised for growth. As such, we're energized by the trends throughout our business, and I would like to thank the entire Turtle Beach team, including our new PDP. colleagues for their tremendous efforts and performing at such a high level. In this dynamic environment, we should remain highly focused on driving enhanced value for our gamers, partners and shareholders. With that, let's turn to Q&A.
Question and Answer Session
Operator
(Operator Instructions) Sean McGowan, Roth.
Sean McGowan
Thank you, guys. So everybody a lot to digest today. So congratulations on multiple fronts, especially for you, Chris. And what can you give us some sense of how much of PDP's business is in controllers versus headsets or anything else?
Chris Keirn
Sure. And Sean, thanks so much. Appreciate the question.
When you look at the combined business. You know, we've historically talked about trying to get outside of console headsets, you know, growing our other categories to be about 20% to 25%. We're looking at about us on a stand-alone basis, about 25%. When you add in that PDP business, which is nearly 50% controllers, we're talking about a 40% plus, even pushing mid-40%s of our business being outside of that core console gaming headset category. That's a that's a huge change for us and it really helps us diversify. That's been one of the things that we've always had been striving for. And this is really a step change in diversification for us. As you know, the categories can vary year to year on on which ones may be maybe up or down. And we really believe this gives us a much better balance across the business.
Sean McGowan
Okay. Can you give us some sense of a ballpark figure of how much revenue they did on an annual basis and how that how does the margins there look relative to the rest of Turtle Beach are calculated on the same basis?
Chris Keirn
Sure. Yes, there are rough and tough. You know, looking at about $100 million net last year, thereabouts, when you look at the margin profile, you can see from our guidance, we're guiding now to 14% adjusted EBITDA percentages as a percent of reg and revenue. And historically, we've guided more we've said our targets are more around 10%. So what you can derive from that is the programs we talked about in the last earnings call. So the portfolio optimization that we've been going through, some of the SKU rationalization and the platform product development, we're seeing those now come into full effect in 2024. So our stand-alone business has really fundamentally changed, and it's also generating about a 14% and yield on EBITDA, PDP. Once you bring their business in and we realize the synergies associated with that business, it's also running at about that same 14% rate.
Sean McGowan
Okay. That's helpful. I guess if I can squeeze one more in, just a little comment on the fourth quarter in your existing business are came in below last year. Below consensus, certainly below my estimate was you, but you cited promotional spend or are you suggesting that it's just a reduction in price that drove the decrease in revenue or we bought was volume also lower than you would have thought?
Chris Keirn
Yes, great question. It's a bit of both on when you look at the markets and last holiday, we did see a pretty significant dip. If you remember, the gaming headset market was up about 2% year to date at the end of Q3, and then October November took a double digit percentage drop year over year. Fortunately, we've seen that recover and December was back to growth. And but it did that did lead to some some pressure from the market standpoint on the revenue. As part of that, we have a ton of really great launches coming up this year. And so we did take the action to go ahead and promote a bit more than we expected to make sure that those channels were clean with, say our and that our own inventory is in good shape.
John Hanson
And again, ahead of the new launches that we have coming here in 2024, Sean, which are very exciting. We mentioned the launch of our new wireless models.
Sean McGowan
Okay. If I could just tack on to that margin commentary then sounds like without that promotional spending, which you said is not not required, at least not right now, gross margins could have been quite a bit higher than what was reported in the fourth quarter, are you expecting kind of going forward gross margins to get back to that mid the low to mid 30%s level that we've seen and targeted before?
Chris Keirn
Yes, yes, exactly right, Tom. Actually for this year, we're looking at it mid-30%s for margin, even creeping up on the higher end of that. We've always kind of had the goal of getting back to that mid-30% point, and we're looking more to the mid to high 30%s for 2024.
Operator
Drew Crum, Stifel.
Drew Crum
Thanks, guys. Good afternoon. A question on the anticipated annual run rate cost synergies, I think you quantified it at $10 million to $12 million. What is the timing of that? Would you expect to recognize all of that in 24?
Is that?
Or is that over time, what is the source of those savings? And then can you quantify the incremental revenue synergies? Do you expect to get as well? And then I have a follow-up.
Chris Keirn
Great question, Drew. So when you look at the $10 million to $12 million, we anticipate that's going to be run rate. And what's driving that is a variety of OpEx, is it sort of line items there?
There's a lot of common processes between our business and the PDP business. So some there's many opportunities there because the businesses are so complementary from a computers being the main contributor and headsets being ours. There are a lot of common processes that we consolidate and so we'll be optimizing those over the next, let's say 12, 12 months. We do expect to realize that $10 million to $12 million sort of within that timeframe and things like real estate as an example. And we've got two offices now in San Diego. So obviously, we'll look down the road to consolidate that at some point.
Those type of things are really the contributors there.
So I think for this year for 2024, you know, we're looking at achieving roughly half roughly half of those synergies here for the calendar year. And then the balance of those in the coming months after that.
Drew Crum
Got it. Just any comment on the revenue synergies?
Chris Keirn
Oh, yes, great. Great point. The revenue synergy opportunities are pretty significant and we haven't really even built that in to that estimate to any great degree because that's going to take a lot of discussions with our partners, our customers, and we think there's opportunities on two fronts there. And Number one obviously, we have a lot of the same customers today and we know each other's business well and so on. We do believe there's going to be opportunities on that front. We also work with some of the same partners from a manufacturing standpoint. So we think there's cost synergy opportunities there. Again, these will take some time and to realize those, but we do see many opportunities there to go and pursue. On top of that, we do see some benefits with our partners. So we have strong license partners from a combined company across all of the first party it manufactures and we've got a terrific relationship with all three, and we're looking with the of the combined portfolio that we now have on it just it makes it much more powerful for us as we're talking to retailers and to licensed partners about what we can offer as a company.
Drew Crum
Okay. Perfect.
And then, Chris, just as a follow-up. You kind of addressed this in your preamble and or in response to Sean's question, but can you discuss what your expectations are for the legacy business in 2024 setting aside TDP. on how you what you're assuming as far as the core legacy business?
Chris Keirn
Yes, absolutely. On the last call, we talked about we believe our run rate EBITDA, while we weren't guiding for 24, we talked about our run rate EBITDA being $28 million to $33 million and incurred $31 million in that range and some when you look at that run rate, we've been able to realize those margin benefits sooner than we anticipated. So when you look at the profile and we're running at 14% of revenue from an EBITDA standpoint. Those have really come in as we expected and even a bit earlier. So we're feeling good about how that is coming out. We're seeing, you know, mid to high digit sort of growth in the core business from a revenue perspective, and we're seeing significant growth on the profitability side hitting that 14% number.
Operator
(Operator Instructions) Jack [Codera], Maxim.
Jack Codera
Your line is open as we go into a year after they are pulling in projects and a lot of Congrats on the acquisition. It seems really exciting.
Al, I wanted to ask, given that you have kind of these two new anchor segments between console headsets as well as the controllers. How should we be thinking about non console versus constant segments. I know in the prior quarter was kind of like flight simulation and some of the other PC sensor accessories segments were kind of really exciting. How should we be thinking about segmentation now?
Chris Keirn
A great, great question, Jack. And when you look across the segments, clearly headsets are working. We'll continue to do quite well there.
They'll continue to be the majority of the business, but not nearly as much as they used to be right. We're going to be probably in the 55% ish range of our business will be console headsets and controllers between controllers and other categories. We were running about 20% with our existing controllers business, flight, Sim PC, all the other categories that we've entered into over the last several years here. And so as we're going forward, you're going to see a much more balanced portfolio from us and a much more balanced contribution across those different categories. So the controllers will probably be somewhere in the range in total of maybe 25%, 30%. I'm off the top of my head here and then the balance of the rest will be in our PC and some categories.
Jack Codera
Okay. That's very, very helpful. And then I have one more just kind of general industry question on. I think you've mentioned a bit, but if you factor in historical levels and normal seasonality, can you give any more color on how the retail channel inventories are progressing in the early part of the year. And given the news today of Africa Dollar Tree and some of these other retail closures, do you expect any headwinds from retail retail stores closures? Thank you.
Chris Keirn
Sure, and you're seeing really good results with our retail partners right now from the channel. Inventory is in a very good place. It's I would characterize it as lean and it was lean even in Q4 and coming into Q1. So we're seeing good replenishments from our partners out there. It's it's good to be back in sort of, I would say, more of a normal cadence. You know, now that we're done with the pandemic that we don't have those kind of lumpy inventory issues in the channel anymore as we were trying to unwind that over the last few years, they're really in a very good place.
As far as go forward to retail, we're really excited about what this transaction means for retailers as well because of the amount of new products that we're able to offer retailer across their categories. We have seen trends of retailers really consolidating. When you think about gaming, gaming is gamers out there don't just game on one platform, nearly everyone's gaming across multiple platforms. And now we have a portfolio that can address all of those folks. And so it's really going to help us from a momentum standpoint with our retail partners. And we're seeing a good response from the market out there at retail.
Operator
Martin Yang, OpCo.
Martin Yang
Hi, good afternoon. Thank you for taking my question and congrats on the deal. Doubling down on console controller is on exciting book. Can you maybe talk about the deal rationale aside from our PPDP. being attractive assets. Is there any rationale relative to your overall view on the feature, of course, some markets.
Chris Keirn
Totally. Hey, Martin, thanks for the question. When you when you look at the rationale behind the behind the deal. One thing that we've always work towards in PDP. to work towards the same goal is scale and diversification. Those two items are so key for us and for our investors on that to have that diversification that you're not so single threaded on console headsets. And that's why we've been developing this. This is a step change for us and for PDP., taking these two very complementary young portfolios and combining them, as I mentioned, the great expertise on the teams on both sides it really gives us a competitive advantage in that space. And we've seen very strong console demand out there. We're in that middle part of the console cycle with some with all the consoles, frankly, all the first party hardware. And then we're continuing to see very strong demand even in January and early part of this year from a year-over-year comp perspective. And the way we think about it is we had this massive demand during the pandemic, and we know that that replacement cycle is about two years and a little bit of the softness.
I think that we saw in the market last year that's now recovered. There were so many great games out last year and you could finally go and buy a console and that was really the 1st year that happened in this console cycle. So a lot of those gamers we're headed towards their hardware.
They were headed towards all these great games and what we're seeing now in the market is a really great engagement model from gamers, and they're they're out there refreshing their console accessories. And part of that, too is driven by all the great new products, right that are coming out from us and from others. And we're seeing really great demand on those as we launch these new innovative headsets and controllers and simulation products and PC products just across the board. So we're feeling really good and optimistic about how that console market looks from an accessory standpoint for the next year. With all those dynamics in place.
Martin Yang
Got it. Thank you. Not a question we did the counsel is looking back at as generations. How do you feel about the mid console upgrade such as PS4 Pro, you usually tried to leverage that as a catalyst for your new product releases or how do you compare those mid console hardware upgrades?
Two are exciting. New games as a driver for your sales?
Chris Keirn
Yes, great question. It really helps lift all boats. When you've got a new new hardware out there, you've got some excitement. Some people are looking at upgrading their systems, it gets people thinking about we know what they're going to play next and what they're going to use to play those games. So it really does help sustain the we've seen this with each console cycle, it really helps to sustain that demand and carry through to that next because in the next major release, probably from from Microsoft and Sony leases still few years out. And so having those those midterm releases really helps keep the momentum moving.
Martin Yang
Thanks. And last question for me on model. Can you give us the rough sense of interest expense on an annualized basis you would incur from the new debt facility?
Chris Keirn
The annualized so from a interest perspective, cash interest expense?
Martin Yang
Yes, that's right.
Chris Keirn
Hold on.
John Hanson
Yeah, it's about [$750,000] to $1 million for 2024. That would be ABL and the term loan.
Operator
(Operator Instructions) Sean McGowan, Roth.
Sean McGowan
Thanks again. Yes, a couple of them model. Housekeeping kind of follow-ups here. So you're pegging that that guidance to second quarter of 24 is that when do you expect the deal to close? And when do you expect PDP to start contributing revenue?
John Hanson
That's today actually. Signed and closed. (multuiple speakers)
Sean McGowan
Well, congratulations on that too early, but can you give us some sense of the seasonality of PDTV.s or the seasonality of Turtle Beach. I mean, I know it's similar category, but very different price point. So is this a little bit less concentrated in the fourth quarter and can you give us some sense there?
Chris Keirn
Sure, it's very similar. When you when you look at the kind of the demand that comes in with the console cycles and the games that are out and when people are looking for new accessories, you know, from a modeling perspective, if you're safe to use our seasonality historically, you know, okay, from a phasing standpoint.
Sean McGowan
Yes, that's helpful. And then finally, can you give us a sense, John, of pro forma CapEx and free cash flow?
John Hanson
Yes. So you know, on a on a next 12 months if you look at a full 12 months for each and you know, based on our guidance, we're in the if you take EBITDA less CapEx -- CapEx is about $6 million in the combined business. So you're in the $54 million, $59 million range.
Operator
Thank you. I'm showing no further questions in the queue. I would now like to turn the call back over to Chris for closing remarks.
Chris Keirn
Thank you, Towanda, and thank you, everyone, for your participation and interest in Turtle Beach. Have a great day.
Operator
Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.
