Turtle Beach Corp (TBCH) 2015 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen and welcome to the Turtle Beach fourth-quarter and full-year 2015 conference call.

(Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the call over to your host, Mr. Cody Slach.

Please go ahead, sir.

Thanks, Kristy; and good afternoon, everyone, and welcome to Turtle Beach Corporation's fourth-quarter and full-year 2015 earnings call.

Before we get started, we will be referring to the press release filed today with details of our results, which can be downloaded from the Investor Relations page of our website at corp.turtlebeach.com.

In addition, a recording of the call will be available on the Investor Relations section of the Company's website later this evening.

Please be aware that some of the comments made during our call may include forward-looking statements within the meaning of the federal securities laws.

Statements about our beliefs and expectations containing words such as may, could, believe, expect, anticipate, and similar expressions constitute forward-looking statements.

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

We encourage you to review the Safe Harbor statements and risk factors contained in today's press release and in our filings with the Securities and Exchange Commission, including without limitation our most recent annual report on Form 10-K and our other periodic reports which identify specific risk factors that may also cause actual results or events to differ materially from those described in forward-looking statements.

We do not undertake to publicly update or revise any forward-looking statements after the date of this conference call.

We also note that on this call we will be discussing non-GAAP financial information.

We are providing that information as a supplement to information prepared in accordance with accounting principles generally accepted in the United States, or GAAP.

You can find a reconciliation of these metrics to our reported GAAP results in the reconciliation table provided in today's earnings release.

And now I will turn the call over to Juergen Stark, the Company's Chief Executive Officer.

Juergen?

Thanks, Cody; and good afternoon, everyone.

First I'll share some highlights of our business before passing the call to our CFO, John Hanson, who will provide details on our financial performance.

I will then expand on our operations and our outlook for 2016.

We delivered revenue and adjusted EBITDA above our guidance range in the fourth quarter, driven by strong holiday sales in our headset business.

New-gen -- that's Xbox One and PlayStation 4 -- headset sales increased 31% compared to the year-ago quarter driven by the launch of five new core models for the holiday season, each of which performed well at retail and drove our market share higher.

These results were despite the negative impact of the strong dollar on our international business and a more rapid than expected decline in old-gen -- that's Xbox 360 and PlayStation 3 -- headset revenues, which were down to less than 12% of our sales in the fourth quarter.

In addition, robust holiday retail sellthrough reduced channel inventory of our products and positioned us well for 2016.

In fact, sellthrough trends have remained strong during the first quarter, driven by strong sales of our completely transitioned new-gen portfolio and increased traffic in the retail channel.

We believe we remain well positioned to continue this progress throughout the year, especially as old-gen is now expected to be well under 10% of our headset business in 2016.

We expect this will help drive improved margins and increased profitability this year.

Late October marked the launch of HyperSound Clear 500P, our revolutionary new home audio system designed to help people hear the television better.

Our two primary goals of the launch were to ensure customer satisfaction and demonstrate success in a small amount of hearing healthcare offices, and we believe we've accomplished those goals.

The small group of hearing healthcare offices that are fully trained and actively selling the product have provided early customer survey feedback indicating high satisfaction.

In addition, those offices are converting prospects to customers at a rate of over 20%.

In late February we launched HyperSound Clear 500P in Europe, a market which is actually slightly larger than the US in terms of hearing aid revenues.

Since HyperSound Clear 500P is a medical product, there were extensive requirements and certification activities that needed to be accomplished to enable us to start selling there.

So to be up and running in Europe is a big win for us.

Our focus with HyperSound will continue to be on training a growing group of hearing healthcare offices and actively refining our targeting approach, product messaging, and selling tools based on our learnings in the early innings of commercializing this revolutionary new type of living room audio product.

I'll provide more context on the headset and HyperSound business after John's discussion of our fourth-quarter financial results.

John?

Thanks, Juergen, and good afternoon, everyone.

Jumping right into the numbers, net revenue in the fourth quarter of 2015 was $84.6 million, compared to $92.3 million in the same year-ago quarter.

The decrease was primarily attributable to an overall decline in sales of old-gen headsets and softer international sales, partially offset by a 31% increase in new-gen revenues.

As Juergen mentioned, old-gen continues to be a smaller part of our business and stood at under 12% of revenues in the fourth quarter, in contrast to the vast majority of our business just two years ago.

For 2016 we believe that old-gen headsets will take a final large drop, offset by strong growth in our new-gen headset business.

As a result we would expect a lower amount of retail credits in 2016 and higher headset margins.

Gross profit in the fourth quarter was $24.6 million, compared to $25.8 million in the year-ago quarter, reflecting higher gross profit on somewhat lower revenues.

Gross margin increased 110 basis points to 29.1%, primarily due to a product mix shift to the higher-margin new-gen headsets, including the release of our new models for the holiday season; the continued channel mix shift to higher-margin domestic revenues; as well as our successful supply chain initiatives to reduce cost of goods sold.

This was partially offset by approximately $1.1 million in HyperSound amortization costs due to the launch of the healthcare product during the fourth quarter.

We expect this amortization amount to increase each quarter as the business ramps in 2016.

On a quarterly basis we realized approximately $3 million to $4 million in fixed costs relating to supply chain, logistics, depreciation, amortization, and stock compensation expense.

The fixed cost for amortization will rise quarter to quarter, based upon the HyperSound revenue scaling.

Gross margins will be lower in the first two quarters of the year due to fixed cost deleveraging but are expected to expand for the full year, driven by higher revenue during the higher holiday season.

Fourth-quarter operating expenses, excluding a non-cash goodwill impairment charge, were $18.3 million, down from $18.6 million in the same-year-ago quarter.

The decrease was attributable to cost reductions in the headset business, which more than offset investments to ramp HyperSound sales efforts.

We continue to watch our expenses very carefully in both businesses.

Adjusted EBITDA on a consolidated basis was $9.9 million, reflecting investments of approximately $4.1 million in the HyperSound business, compared to adjusted EBITDA of $10.4 million in the year-ago quarter when we invested $3.3 million into HyperSound.

Adjusted EBITDA for the headset business increased 2% to $14 million compared to the year-ago quarter, again, a higher measure of profitability on a somewhat lower revenue base, with revenues expected to increase in the remainder of the year as we enter our peak selling season for headsets in Q4.

And with better gross margins and lower OpEx, we would naturally expect to flow through more EBITDA from the headset business.

To remind everyone, the Company was required to record a full valuation allowance against deferred tax assets in Q3 of 2015 due to US GAAP reporting requirements, so tax expense will not be realized until the net operating loss carryforwards are realized.

As of December 31, 2015, we had $44.6 million of federal and $20.6 million of state net operating loss carryforwards that will offset taxable income and don't begin to expire until 2029.

Excluding the goodwill impairment charge, our net income in the fourth quarter increased 39% to $3.3 million or $0.08 per diluted share, compared to $2.4 million or $0.06 per diluted share.

US GAAP requires periodic analysis of the implied value of goodwill and intangibles related to our acquisition of Parametric Sound in 2014.

The lower market capitalization of the Company required us to value the long-lived assets acquired in the Parametric merger and resulted in a $49.8 million non-cash goodwill impairment charge.

Reported net loss including this charge was $46.5 million or $1.09 per diluted share.

Now turning to the balance sheet, we ended the year with cash and cash equivalents of $7.1 million compared to $7.9 million at December 31, 2014.

Inventories were down 32% to $26.1 million compared to the end of 2014, due to the strong 2015 holiday sellthrough and improved internal inventory management processes.

Accounts payable were down 50% to $17.7 million compared to December 2014, due to solid inventory management, particularly lower payables to our contract manufacturers.

Both balance sheet items support our strong 2016 outlook Juergen will speak to momentarily.

Outstanding principal debt at December 31 was $68.1 million compared to $44.6 million at December 31 of 2014.

The debt consisted of $32.5 million of borrowings under our revolving credit facility.

The outstanding balance historically fluctuates throughout the year, and in past years has been close to zero in Q1, then ramping up ahead of the holiday season.

Today we have a zero balance on our revolver portion of the ABL.

Subordinated debt totaled $17.2 million, and term loans totaled $18.4 million.

The addition of the term loans and subordinated debt in 2015 provided the Company permanent capital, reducing our dependency on the ABL revolver.

We believe that the term loans and subordinated debt coupled with the revolver provide sufficient capital to fund our business plan.

Our net AR to accounts payable, or AP, balance, was approximately $14 million higher at the end of 2015 versus 2014.

As you may recall, 2014 was unusual because we delayed some payables due to limits on our borrowing capacity.

On February 5 of 2016 we completed a follow-on public offering of 5 million shares and a concurrent private placement of 1.7 million shares, for a total of $6.2 million in net proceeds, over half of which were purchased by insiders, including our largest shareholder, SG VTB Holdings, our Chairman, and our CEO.

We have used the net proceeds from the transactions for working capital and general corporate purposes, including applying the proceeds against the outstanding principal balance of our working capital line of credit.

Prior to the follow-on public offering, the Company had approximately 42.5 million average shares outstanding; and following the raise, the fully diluted shares were approximately 46.6 million average shares outstanding.

Since this share count is a full-year average, the full impact of the new shares is not fully reflected in this number.

Now I will turn the call back over to Juergen for some additional comments on the business and our updated outlook.

Juergen?

Thanks, John.

October marked the final set of our new-gen product, launches with the introduction of our PX24 headset, which has our killer Superhuman Hearing feature and works across both PlayStation 4 and Xbox One, plus mobile and PC platforms; and our series of Recon headset models for the entry-level gamer category.

After two and a half years our next-gen portfolio is now complete, with 16 models launched, representing a level of innovation and accomplishment that we believe would compare to the rest of the console gaming headset industry combined.

As we've discussed many times, winding down products is messy and expensive from a margin standpoint.

So we believe to be nearly complete with our old-gen/new-gen transition process positions us well for the years to come.

Of course, we will still be launching new products this year and end-of-lifing others, but the pace is more normalized versus compressing into a two and a half year time frame as was recently the case for us.

As we mentioned in our 2015 preannouncement in January, we experienced strong holiday sellthrough that outpaced sell-in -- that's retail sellthrough versus our sales -- by several million dollars, resulting in lower channel inventory.

We experienced strong performance across all our major retail categories, both brick-and-mortar and online, and we continue to be the clear category leader from their standpoint and across all sales and operational metrics.

Recent NPD sellthrough data supports these results, with market-share gains for our brand.

For example, according to NPD US retail data, Turtle Beach continued as the clear 2015 leader in the console gaming headset market, with an overall US market revenue share of 42% for the year, 44% in Q4, and 45% in December.

Our strong fourth-quarter results were partially offset by a more rapid than expected decline in old-gen revenues, which ended the year at approximately $31 million versus the $40 million we expected.

As John mentioned, this drop was even more severe than industry analysts expected.

For example, in October 2014 DFC, who does the industry forecasting on consoles, had predicted old-gen console sales in 2015 at 1.5 million units.

However, old-gen console sales actually ended at 1 million units, a 500,000 unit or 33% shortfall.

While a decline in old-gen puts some pressure on inventory, we are closely monitoring the situation and continue to expect 2016 to mark the final large drop in old-gen sales.

Of course, old-gen decline is due to new-gen console adoption success, which is a good long-term trend for us.

As you may recall from our third quarter, the strong dollar has impacted our international business in ways that are not captured by constant currency calculations.

This was really the only major part of our headset business that did not perform to our expectations last year, but it was a large impact.

In most European countries as well as Australia, we sell through distributors, and those partners buy our products in dollars.

The strong dollar increases their product cost in local currency, reducing their margins or forcing them to raise prices, which may lower our sales.

A $79 retail price product in the US, for example, can run $109 in France.

We also saw weakness in our UK business, where we sell direct to retailers, in 2015.

However, we've not been sitting still.

In addition to actively working with our distributors we moved two large pan-European retail accounts to a direct sales model during 2015.

That transition created some short-term revenue gaps last year, but we've already started to realize increased margins and market-share benefits.

Our UK business is also showing share gains and strong sellthrough.

Similar to the pattern we are seeing in the US, our UK year-to-date sellthrough in dollars is up over 20% versus last year and outpacing the market, resulting in increased dollar share for our brand.

We will continue to look for opportunities to improve our international results in the face of a strong dollar, with a focus on Europe and Australia.

We've de-prioritized China for now in light of this, as well as the fact that the console market has not yet begun a meaningful ramp, which analysts attribute to lack of compelling multiplayer games.

We remain confident that our international markets provide compelling long-term growth opportunities for our gaming headset business.

Europe continues to be a strong market for us, and we believe that we've absorbed the impact of the strong dollar in 2015 and are taking the right actions to grow from there.

And we believe China still represents a great long-term growth opportunity, which we will tackle as we see the planned growth and profits from our core markets.

The momentum in our headset business from the fourth quarter has continued into 2016, as sellthrough has remained strong and the market response to our portfolio has been excellent.

According to recent NPD data, in the first two months of 2016 our revenue share is up 3% compared to the same period in 2015 and our Recon series has driven a very strong share gains in the under-$50 retail price segment, as intended.

Also, according to NPD, while the console headset market is up 18% in revenue so far this year, we've gained 26% year-over-year.

And while the console headset market is up 22% in units, we've gained 40%.

This strong sellthrough has resulted in some low channel inventory levels, and we are focusing our operational efforts on increasing supply as quickly as possible.

I will tell you, given all the work we've done managing down the old-gen business over the past years, it's really nice to be putting work into chasing strong demand on next-gen.

Among several other leading product propositions, we continue to have the top models in the gaming industry as confirmed by NPD for the first two months of 2016.

The top five selling third-party headsets are all Turtle Beach, and our XO FOUR Stealth is the highest selling third-party headset, followed by XO ONE.

Launched in October 2015, Recon 50X is already among the top five best-selling Xbox One headsets in the US market by revenue, and among the top three best-selling third-party Xbox One headsets by revenue so far in 2016.

Elite 800X was the best-selling Xbox One headset in the premium -- or greater than $200 retail price -- tier year to date in 2016.

Launched in October 2015, Recon 60P is already among the top five best-selling PlayStation 4 headsets in the US market by revenue, and among the top three best-selling third-party PlayStation 4 headsets by revenue year to date in 2016.

As I've said in the past, we pride ourselves on delivering high-quality headsets to our gamers at all price levels with industry-leading innovations that provide them with a more enjoyable gaming experience and a competitive advantage: Hear everything, defeat everyone.

Retailers recognize that and continue to benefit with strong sales and happy customers buying Turtle Beach product.

Everybody wins, and we love that.

And that's not all.

We have some more good stuff coming on the product front this year.

As I mentioned, 2016 will be our first normalized year of product introduction since 2012.

We expect to launch several exciting new products during the course of the year; and with old-gen expected to be under 10% of our revenues in 2016, we expect to start improving profitability consistent with the outlook we provided in January.

It's also worth noting that new-gen consoles continue to grow at a rate that far exceeds the prior console generation.

According to the latest DFC report, current new-gen units sold over the 26-month period following the launch of new consoles are up 56% to almost 55 million units, compared to the prior new-gen cycle in the same amount of time, which shows our growing addressable market.

This has, of course, impacted our business negatively over the last few years as old-gen has consequently declined faster than expected -- but we believe also provides a very positive outlook for the future, given our clear leadership in product portfolio, retail strength, and market share on new-gen platforms.

Think back over the last few years and analyst and pundit views of console gaming.

In early 2013, when new consoles were announced, the mindset is that they would not do well due to mobile gaming.

Well, the first holiday sellthrough proved that wrong.

Then in 2014, the mindset was that sales would have to slow down.

That didn't happen.

This is part of why we and everyone else kept underestimating new-gen rise and old-gen fall.

And now in the past six months, the strong momentum of console gaming continues; eSports is taking off; for the first time ever, there is a possibility for multiplayer online games to be played across platforms.

VR is coming as a great add-on to the console experience.

This is a great market to be in, and even better to be a leader in.

And that's just the console headset market.

As we get clear of the console transition and prove our headset profitability this year, we will be able to put some focus into expanding into PC gaming, mobile gaming, and VR.

Now moving to our HyperSound business, as I mentioned late October marked the official launch of HyperSound Clear 500P.

We've outlined our approach and focus with that product, and I'll provide some additional color in a moment.

Before I do that, however, I would like to remind our investors why we are pursuing and investing in this technology.

HyperSound is a completely new type of audio delivery mechanism, period.

In fact, I would argue that HyperSound is one of the most amazing breakthroughs in audio that has come along in decades.

Good quality audio carried on an ultrasound beam with a usable level of audio in a consumer-friendly form factor has never been commercialized, and we've just done that.

In the past years, including by the excellent R&D team at Parametric Sound and then the last two years in Turtle Beach, we've figured out how to make it usable, protected it thoroughly with patents, and put it into a real consumer product.

That is a huge accomplishment, and we're just getting started.

HyperSound Clear 500P, our healthcare product, is a whole new type of living room audio product for people with hearing loss.

Nothing like it has ever been commercialized.

We believe that this first consumer product for us has an incredibly high value proposition in helping people with hearing loss hear and enjoy television, to the point where we have had certain cases of people tearing up because, quote, they can't remember hearing that well.

Based on a refreshed survey of 10 HyperSound Clear 500P early buyers, we know that consumers love the product.

90% of those products reported an improved or significantly improved TV viewing experience; and 80% reported they would recommend it to a friend.

The product got at least 4.5 out of 5 stars on the areas of improving speech clarity, ease-of-use, and overall satisfaction of these consumers.

Sample sizes are small, but we believe this clearly demonstrates a very strong value proposition.

This was first and most important goal with this launch.

We're also in the right channel to start this new market.

Hearing healthcare professionals have access to consumers who are having difficulty hearing, and have the capability to target the right consumers and explain our product and its benefits.

We've seen success in a small but growing number of hearing health offices across the country.

Those couple dozen offices have been fully trained and are now actively selling the product.

A challenge -- and one we underestimated, frankly -- is that many hearing healthcare offices are so focused on selling hearing aids that it is taking much more effort and training to get them to be able to integrate this new product into their daily office workflow.

Many offices have also been highly reliant on the hearing aid manufacturers to provide extensive support, from training to collateral to marketing activities.

We are not a multibillion-dollar hearing aid supplier that can send an army of salespeople out and support a product with millions of dollars of marketing.

So this is straining our resources in terms of rapidly scaling the number of offices that are productive in selling HyperSound Clear.

However, we believe that the hearing healthcare channels can benefit greatly from HyperSound Clear.

The success we see in some of these offices is demonstrating that.

The fact remains that the majority of incoming patients who get their hearing tested don't buy a hearing aid.

The hit rate is low, typically under 50%.

This is called tested-not-sold; and reducing this hit rate is a big win for offices.

If the offices learn to switch the pitch to HyperSound Clear, they keep a customer and wind up with a productive sale that they would have otherwise lost.

And we have strong confidence that HyperSound Clear can be a great gateway product to a hearing aid over time.

Typical tested-not-sold customers take five to seven years to get a hearing aid.

Now, imagine having eyeglasses that work great and allow you to see the TV clearly from the chair in your living room.

If the TV is always blurry without the glasses, you'd love that product.

Eventually you would want that same clear vision outside of your living room.

You'll come back and get a hearing aid without waiting the five to seven years.

So despite the early challenges we see a great long-term fit.

This is what's driving us.

In retrospect, we should have recognized and been more clear that the combination of new technology, new product in a channel that has no experience with anything like this would create some early challenges: we'd need to learn and adapt, exactly as we are doing, and day by day handle the basic blocking and tackling required to develop efficient production and educate the marketplace.

The very strong consumer reaction to the product before we launched caused us to not consider how many new and complex things we were doing in this launch as much as we should have.

Consumer excitement plus the attach rates at our steadily rising educated sellers makes us believe in the value proposition and the product and in our ability to generate substantial returns on our investments over time.

We are addressing the early challenges by focusing our resources in a small but growing pocket of offices, learning and refining our approach, and carefully managing our spend to utilize our limited capital as productively as possible.

We are also working to expand the market for HyperSound Clear and made great progress in the fourth quarter.

In February, as I mentioned, we launched in Europe, which is a significant accomplishment given the product certification requirements for medical devices.

The European market is more retail oriented, which we believe could actually prove easier to ramp than the US market.

And the Europe market is also large.

In fact, it represents nearly 40% of the global market in terms of hearing aid devices sold.

The hearing aids market global forecast expected $1.8 billion in European hearing aid device sales during 2015, compared to $1.7 billion in North America.

Europe also exceeds the US in terms of point-of-sale opportunities.

Finally, to my earlier point that we have developed and commercialized a whole new type of audio, we continue to make progress on pushing the HyperSound technology forward.

We've spoken about some of these areas we are pioneering, like transparent emitters; but there are others that we are not going to talk about until they are further along and, frankly, patents have been applied for.

We've been issued four new US patents since December 31 to protect the related innovations, bringing our total to 42 issued US patents for the HyperSound business.

So the bottom line is, we continue to be very excited about the prospects for HyperSound.

With all this in mind I'd like to now address our financial outlook for the first-quarter and full-year 2016.

Starting in Q1, based on the strong sellthrough trends we expect net revenue to increase 10% to approximately $21.7 million compared to $19.7 million in the first quarter of 2015.

We also expect gross margins to be up modestly from the same quarter last year.

We've reduced our operating expenses to more than offset the increased investments in HyperSound.

So consolidated OpEx is expected to be slightly lower than last year.

As a result, consolidated adjusted EBITDA is expected to improve to a loss of approximately $9 million compared to a loss of $9.7 million in the year-ago quarter.

Net loss for the quarter is expected to be approximately $0.32 per diluted share, compared to a net loss of $0.25 per diluted share in the first quarter of 2015.

Please keep in mind that the first quarter of 2015 included a $3.4 million tax benefit due to the valuation allowance.

Also keep in mind that our headset business is very seasonal, with roughly 50% of sales occurring in Q4.

So profitability is lower in the slower quarters like Q1 and Q2.

For the full-year 2016 we continue to expect net revenue to range between $160 million and $172 million, compared to $162.7 million in 2015.

Included within these expectations is 12% to 16% growth in new-gen headset revenues to $140 million to $145 million; a 60% to 70% decline in old-gen headset revenues to $8 million to $10 million; approximately $7 million to $10 million in HyperSound revenue; and $5 million to $7 million in other headset and accessory revenues.

Obviously the great start to 2016 reflected in our expectations for Q1 gives us confidence in our guidance range.

We also continue to expect headset gross margins to increase 400 basis points to 30% in 2016 and expect a roughly 4 times increase in the headset adjusted EBITDA to approximately $9 million for the year.

For the year we expect interest expense to be approximately $5.3 million due to: cash interest, $1.9 million; PIK interest, $2.2 million; and debt amortization, $1.2 million.

In the HyperSound business gross margin is expected to be in the 40% to 50% range, excluding amortization, by the fourth quarter, depending on revenue levels, with a modest reduction in the net investment for the year to below $14 million as revenues and operating expenses scale.

Before we turn it over for questions I like to add some perspective to my commentary on our outlook.

Over the past two years we've managed through an industry transition that took out more than 80% of our core business revenues.

It required the launch of a whole new product portfolio for Xbox One and PlayStation 4, which we have led the industry in executing.

We have an excellent new-gen portfolio that is performing well, and we plan to add a few innovative new products to that portfolio this year.

As old-gen winds down we expect our headset profitability to increase substantially.

We see this as a good place to be, particularly with the majority of new-gen console sales still expected to come.

While new-gen console sales hit approximately 55 million units sold life-to-date at the end of 2015, DFC estimates more than 100 million more units are yet to be sold 2016 through 2019.

So we are still in the early years of what is expected to be a thriving, growing console gaming market for the coming years.

The strong sellthrough in 2016 is a great start to the year.

We have additional growth opportunities from a recovery in Europe, and China remains largely untapped.

In addition, we have opportunities to grow our PC gaming headset business there and in other parts of the world over time.

As I mentioned, longer term we see opportunities in mobile gaming and VR.

We believe our strong brand, great retail presence, and strong product capabilities will provide opportunities to expand into these adjacent markets.

On HyperSound, our focus going forward will be to successfully ramp the healthcare product and get that business to cash-flow breakeven.

The products currently purchased by our target market today, the hearing-loss population, are worth $5 billion in sales annually, and hearing aid penetration is typically below 25%.

While we are going to execute a careful controlled ramp of this business and work within our resources and capital constraints, we believe it is a significant market opportunity.

As I've discussed, HyperSound's entrance into the healthcare market is only the first type of application.

That is a key point in our long-term view and why we continue to invest in the HyperSound technology.

For the remainder of 2016, with the product portfolio transition largely behind us as well as the final drop in lower margin old-gen headset sales, growing new-gen headset sales, and HyperSound Clear 500P now launched, we believe we are well positioned to drive top-line growth and increasing profitability.

Before we turn it over to questions and comments I'd like to think the fantastic team of people at Turtle Beach.

Your hard work and continued dedication is what got us here and what will carry us forward.

Thank you very much.

Operator, we are now ready to take questions.

(Operator Instructions) Mark Argento, Lake Street Capital Markets.

Good afternoon, guys.

Congrats on a solid end of the year.

Got a couple housekeeping questions to start and then some more business-centric questions.

Just so I'm understanding the guidance, I think it's pretty straightforward for Q1 and for the full year on the revenue side.

But I just wanted to make sure I understand the EBITDA or adjusted EBITDA guidance.

So $9 million for the headset business, and then the investment in HyperSound, a net investment of $14 million or less.

So should we think about adjusted EBITDA -- consolidated adjusted EBITDA target of a loss of about $5 million for the full year on a consolidated basis?

Is that the right way to think about it?

Yes, I think based on where we are today, Mark, I think that is the right way to think about it.

Obviously that number, because of what we talked about in terms of our desire to get the HyperSound business to cash-flow breakeven as quickly as possible, obviously that's going to play here in terms of our full-year expectation.

But based on what we see today, I think you're thinking about it in the right way.

Got you.

Then the ability to toggle that investment up or down -- obviously I'm assuming most of the spend or a good chunk of the spend, in terms of the HyperSound spend, is on marketing and sales.

Is that correct in terms of your commitment and costs on that side of the house?

Probably about half and half.

Engineering and G&A have a sizable amount of expense there as well.

Great.

Then again more of a housekeeping question, but the share count post-deal, post-transaction; I think you guys issued about 6.7 million shares.

So on a fully-baked basis, the 49.2 million, is that a good share count number to use?

Obviously I know you did the transaction mid-quarter so there's going to be half of it in for the quarter.

But when you look at a fully-baked, fully-diluted number is that the right number?

Yes, so the number that we put in our scripts here really, Mark, is thinking about the share count at the end of the first quarter.

So that would be comparable to what we would show in the P&L for our fully diluted shares.

So obviously as the year goes on, obviously that number would rise.

Yes.

I guess a simpler way to think about it, you issued what?

Was it 6.7 million shares.

Right.

You add that to the 42 million, so I just want to -- you should be in that 49 million and change.

I just heard 46 million, and I was a little confused.

That's because it's average.

So it starts -- so the average for the year will be that 46 million because your -- or average at this point for the year, because it's only reflected in the first 90 days.

Actually, the average I think for the full year should be higher than that, because --

Yes, it will.

The average for the (multiple speakers).

The average for the quarter.

So I just wanted -- I kind of had the answer, but I just wanted to make sure you guys made that clear because there was a -- it could be a little bit confusing.

All right.

Shifting gears, looking at the fundamentals of the business, so when we think about the takeaway or the sellthrough at retail, obviously it looks like sellthrough has been pacing ahead of sell-in.

So obviously we saw your inventories come down, and you had mentioned in the prepared remarks that it's a high-end problem to have when you actually have to figure out how to get product on the shelves.

Yes, indeed.

Can you talk a little bit about your capabilities now that you've -- I think you've switched your manufacturer.

And their ability, does that give you now -- I think you guys are working with Foxconn now -- but the ability to get product on the shelves more quickly?

How does that partnership work there?

And are you guys in a good position there to be able to continue to hopefully be able to fill the channel?

Yes, a couple of things back.

Retail sellthrough is really strong and, as I mentioned, far outpacing sales.

So we're chasing supply, and our inventory levels both for us and at retail are low as a result.

World-class problem like you said.

What I'll tell you is, first of all, we have three large manufacturing partners, not just Foxconn.

So we're working with all three.

We have, I think, one of the best supply chain teams in the business.

We have an excellent capability both to understand ahead of time what we need on a product level basis, on a retail basis, and very good mechanisms in place with an outstanding team to go accommodate that.

Now, there are limits.

You can't speed up leadtimes on components and all that.

We try to pull some things in.

One lever we have is airfreight, and we use that.

So if we have to airfreight some product in to make sure that pegs aren't empty, we will do that.

That has some effect on margins but -- and we do the analysis very carefully to make sure it's worthwhile -- but that's an example of one of three to four levers that the team is very good at economically analyzing and operationally executing.

Great.

Then in terms of -- I know and I think I ask the question every quarter, so I'm just going to throw it out there again for you.

But the adapter, on the Xbox adapters, do you expect those to trend out or be phased out throughout this year?

Or what's your thought process on cutting over to an almost mandatory upgrade on the headset side of the house?

Right.

I think we should have a dartboard here with the adapter right in the middle of it and have people throwing darts at it.

There were high sales last year -- over 400,000 units of adapters sold last year; and 80,000 year to date this year.

So frankly we've stopped trying to guess when it's going to go away.

We've just baked it into our plans.

Eventually we think it will go away.

It's kind of a kludgy solution, and we know that it's not Microsoft's core business to be selling those adapters.

But we've fully baked it into our business plans for the year; so if it does wind down, that would be some upside.

Got it.

Then last question for me, shifting over to the HyperSound side of the house.

You had mentioned it's a new product, and it's one of these products that you can't get your head around into actually try it or listen to it.

But have you guys thought about -- obviously going into the channel, through the hearing health channel makes a ton of sense -- but in terms of driving more awareness, the opportunity to do a direct sale model, either with a partner or some other mechanism in which to get the word out, no pun intended, in terms of what the product is and how it works?

I'm thinking about or wanted to get your thoughts on alternative channels of distribution above and beyond the hearing health market.

Because I think the product is pretty neat, but like you said the model or at least a lot of the audiologists that we spoke to are very -- they sell hearing aids and that's what they know.

They have this whole new -- it's hard for them to switch gears on the fly and dedicate the time to it.

Maybe some thoughts, if you have any, around how you could see this rolling out.

Obviously you've spent a lot of money and are focused on this channel, and it makes sense; but maybe a tangential channel or another channel to help drive some penetration and awareness.

Yes, very good insightful question, and one that we have extensive conversations here about.

Frankly, similar to the supply chain team, we've got some of the best people in the industry in our HyperSound business.

Not just Rodney who runs it, but the staff of people he's got underneath it.

These guys understand the market really well.

One factor in right now sticking with the hearing channel is that we have good confidence that that is the right place to start, and we don't want to do anything to mess it up along the way, including potentially threatening that channel with direct sales.

That's factor number one.

Factor number two which is, as I mentioned in my remarks, we have a limited amount of resources.

We don't have millions of dollars to spend on marketing.

So we are leveraging the fact that people with hearing loss are going into these practices; and those practices, once they get trained, they have a lot of motivation once they figure this out here to actually convert those customers, because a lot of times they would lose them.

So it's an area of extensive discussion, debate, and analysis, frankly.

We keep looking at: Okay, if we go a different channel, do we have the resources to make that channel successful, including marketing funds and all the other things you need to cover a channel?

What does it do to our core channel that we started?

It continues to be on our radar.

So we are both preparing to and continuing to analyze for that.

But right now we feel like our focus needs to be in the channel we're in.

One other comment.

Europe just by nature is more retail oriented.

There are more storefronts, and so that for us is a little bit of an opportunity to see how does a direct retail model work and learn before we try anything in the US market.

Great.

Appreciate it and, again, congrats on a solid wrap-up to 2015.

And best of luck here as you're moving into 2016.

(Operator Instructions) James Medvedeff, Cowen and Company.

Good afternoon.

The first question is whether, if you can tell us what the level of HyperSound sales was in Q4?

Yes, it was right in line with our guidance; just over $0.5 million.

Okay.

How is that looking in Q1?

Yes, we're are not guiding separated revenues.

We're just guiding the total revenues at this point.

We can discuss that on our Q1 earnings call, though.

Okay, great.

Then most of my questions have been answered; but the other question, I'm just trying to work through the guidance here for Q1 just at a high level.

If revenue is up 10%, gross margin is somewhat higher, expenses are lower, how is it that we end up with a wider loss?

The loss is lower.

The loss is --

The earnings-per-share loss, yes.

Yes, the EBITDA is improved from $9.7 million to $9 million loss.

I guess I was thinking about net income and EPS.

Yes.

In Q1 of 2015 the Company was able to realize a $3.4 million tax benefit.

In Q3 of 2015, as I pointed out in my remarks, in the earlier remarks, the Company essentially recorded a full valuation allowance.

So from Q3 forward from a federal tax perspective we don't -- we have to fully reserve, if you will, any tax benefit or any tax expense going forward.

So the Company is not able to realize any tax benefit from the loss in Q1 of 2016, and as a result it drives a higher negative EPS in 2016.

It's all driven by the tax.

So there's enough delta in the taxes to make up for 10% revenue growth, better gross margin, and lower expense?

Yes.

Yes.

Okay.

Then we should carry that tax rate at a zero level for the foreseeable future, it sounds like.

Yes, exactly.

There's $44 million in federal and $20 million in state NOLs that are carried forward.

I made mention that they don't expire until 2029.

So as the business generates pretax income obviously there will be no tax expense until we work off the NOLs.

My final question is, how is the interest to that, $5.3 million of interest expense, how is that distributed throughout the year?

I assume it's bigger in Q4.

Yes, it's going to be a function as to how the ABL ramps throughout the year.

As we've discussed obviously the interest associated with the term loan and the subordinated debt will be very consistent quarter on quarter.

Where the cash interest will move on a quarterly basis is around the revolver portion of the ABL.

That's a function of it'll be lower in the first two quarters and then it will be higher in Q3 and Q4 as inventory ramps.

It's in the couple hundred thousand difference range though, not huge.

Yes.

Because based upon the interest that --

Yes, only $1.9 million of the $5.3 million is cash interest, and that's the part that's affected by the ABL interest difference.

So it would be a couple hundred thousand dollars difference between the quarters.

Yes.

Okay, great.

Thank you very much.

Thank you.

At this time this does conclude our Q&A session for today.

I would now like to turn the call back over to Mr. Stark for any closing remarks.

Thank you very much, and thanks to everyone again for joining the call.

We look forward to speaking with our investors and analysts when we report our first-quarter results in early May.

Have a great day.

Ladies and gentlemen, this does conclude today's teleconference.

You may now disconnect your lines at this time.

Thank you for your participation.