Juergen Stark - CEO John Hanson - CFO

Mark Argento - Lake Street Capital Thomas Forte - Davidson Nehal Chokshi - Maxim Group Alex Silverman - AWM Investment

Good afternoon, everyone, and thank you for joining us. I'd actually like to start my prepared remarks with something I usually do towards the end, which is to thank all the members of the Turtle Beach team for outstanding results in the first half of this year.

Through persistent and excellent execution of our strategy, and an eye toward building long-term value, we have produced results that have outperformed the market and are getting noticed by investors. Every area of the Company deserves recognition for a job well done.

It's all coming together beautifully, and I couldn't be more proud of the team. Thank you to all of our team members.

We had another great quarter. On our last earnings call, we reviewed the balance sheet, transformation the Company had undergone over the first four months of the year including renegotiating our loans and retiring the Series B liability.

And we recorded strong growth for the first quarter, issued guidance for a strong second quarter, and raised our guidance for the year. Over the three months since then, investor interest has continued to rise and we welcome the new investors and analysts who have recognized the Turtle Beach's leadership position in the growing video game headset market, combined with the great brand, products gamers love and strong operations can be leveraged to produce attractive financial results.

That's exactly what we did in Q2. Turtle Beach had another quarter of outstanding financial performance with net revenue, gross margin, net income and adjusted EBITDA at the highest levels since the Company became public in 2014.

We significantly beat even our own expectations in the quarter. Sell-through of our headsets in the market continued to be strong and saw acceleration in the quarter, and even some incremental share gain in June.

We also did better than we expected at keeping our products in stock and reducing lost sales due to low inventory. And we maintained strong margins despite incurring increased air freight costs.

Our cash and revolver balance position is already more than $13 million ahead of Q2 last year and as a result, last Friday, we paid down $5 million of sub debt. We are operating in an industry is experiencing rapid growth.

Of the $1.8 trillion in consumer spending NPD track in 2017, video games were the fastest growing category. Why the strong growth we often get asked.

Simply put, we believe gaming has evolved into an all-around entertainment phenomena. If you add up all the playing hours plus the viewing hours that console platforms like Xbox, PlayStation, Switch make available, gaming is arguably the world's favorite pastime.

So, it's an exciting time to be in our industry. Our sales growth in the second quarter was fueled by this continued strong industry growth, particularly in the console gaming market and by our continued market share gains over last year.

The growth experienced in the headset market as well as our own revenue growth were higher in the second quarter than in the first. The U.S.

and Canadian market was up 97% in Q2 versus 78% in Q1 and Turtle Beach was up 114% in Q2 versus a 111% in Q1. U.S and Canadian revenue share for Turtle Beach is at 45.5% year-to-date, up from 39.8% in 2017.

And again, we grew more revenue in Q2 year-over-year than the next closest competitor’s entire console gaming headset business in the second quarter. Our share gains and outperformance versus the rest of the market span our major European markets as well.

In the UK for example, based on GFK data, console gaming headset market revenue is up 79% year-over-year while Turtle Beach is up 109% with a 54% market share. One of the accomplishments we’re most pleased with over the last year or so is the way we grew our share in the entry-level price categories.

Last year, we introduced our Recon Chat Headsets, good quality, well-designed products for entry-level gamers using May year-to-date NPD numbers, approximately 40% of the industry sales are at the $50 and below retail price point. Within a few months of launch, our chat headsets became the top-selling chat headsets on both Xbox and PlayStation and have helped us grow our share to roughly 50% of the below $50 price tier.

And we did this while also growing share in the $50 to $99 price tier. So, this was not a cannibalization of our mid-tier headsets.

And with the Battle Royale craze introducing many entry-level gamers, our timing with these new entry-level products was very good to say the least. A few highlights on our product sales in the first half of the year according to NPD retail revenues in the U.S.

and Canada. Turtle Beach had 7 of the top 10 selling console headsets.

All five top-selling console headsets were Turtle Beach. We had the number one selling console headset on both Xbox One and PlayStation 4, the number one and number two top-selling Xbox One wireless headsets, the number one selling PS -- PlayStation 4 wireless headset, and the number one chat headsets on both Xbox One and PlayStation 4, and the top four Xbox One sellers are all Turtle Beach.

It’s a great testament to a line of winning headsets at price points for every level of gamer. I will walk through other business developments and our full-year outlook after John addresses our second quarter financials in greater detail.

John?

Thanks, Juergen, and good afternoon, everyone. Net revenue in the second quarter of 2018 increased 218% to a Company record $60.8 million compared to $19.1 million in the second quarter of 2017.

The significant year-over-year increase was driven by the continued, strong consumer demand for console gaming headsets and our share gain versus last year. The revenue was also higher than our outlook, driven by better than anticipated ability to manage supply and retail allocations to reduce out-of-stock revenue impacts and market and share strength in June month.

Gross margin in the second quarter increased 30 basis points to 33.3% compared to 33% in the second quarter of 2017. This is the highest second quarter gross margin in Turtle Beach's history as a public company.

The increase was primarily due to higher volumes, driving fixed cost leverage. This was partially offset by approximately $4 million in expedited air freight costs, given robust consumer demand, which was about $2.8 million incremental to normal freight.

Operating expenses in the second quarter of 2018 increased to $12 million compared to $11.3 million in the same period of 2017 due primarily to variable sales based commissions and compensation, higher volume-based web costs, and an increase in revenue-related sales expenses and an increase in marketing spend relative to last year. As a percent of net revenue, operating expenses fell sharply to 20% compared to 59% a year-ago, reflecting favorable operating leverage.

Net income in the second quarter increased significantly to a record $6.3 million or $0.40 per diluted share, compared to a net loss of $7.1 million or $0.57 per diluted share in the year ago quarter. The improvement was driven principally by our revenue growth and expense leverage.

Adjusted EBITDA in the second quarter of 2018 increased $12.6 million to our second quarter record of $9.8 million compared to a negative $2.8 million in the year-ago quarter. Now, turning to the balance sheet.

We ended the quarter with cash and cash equivalents of $9.1 million, with no amount outstanding under our $60 million revolving credit facility compared to $1.2 million in cash and cash equivalents and $5.2 million outstanding under the revolving credit facility one year ago. This is a $13.1 million increase in our net cash position versus last year.

Inventories at June 30, 2018 were $28 million compared to $20.9 million at June 30, 2017, and $15.9 million at March 31, 2018, reflecting the higher level of expected sales going into the second half. We are recovering our inventory levels based on excellent execution by our factories and operations teams and increasing our supply.

Total outstanding debt principal at June 30, 2018 decreased to $32.4 million compared to $39.7 million at June 30, 2017. The debt at June 30, 2018 consisted of $19.1 million in the subordinated debt and $12.5 million in term loans.

Recall also that the Series B preferred stock obligation was about $19 million at the time of the transaction in April, whereby it was retired for a combination of cash, stock and warrants at more than a 50% discount. Our senior debt leverage ratio which we define as a total term loans, and average trailing 12-month revolving debt divided by consolidated trailing 12-month adjusted EBITDA, improved significantly to 0.7 times at June 30, 2018 compared to 2.1 times at the end of 2017 and 6.8 times, just one year ago.

As you may have seen today, we filed a customary $100 million universal shelf registration statement. While we have no current plans to raise capital, our Board determined it is in the best interest of the Company and our shareholders to have a shelf in place as is the norm for many public companies.

In fact, subsequent to the quarter, as Juergen mentioned, we paid down our subordinated debt by $5 million, bringing the subordinated balance to $15.1 million and total outstanding debt principal to $27.6 million. This is supportive of our commitment to further reduce debt and maximize value for our equity holders.

Before I turn it back over to Juergen, let me say a few words about taxes. We are currently assuming an effective tax rate of 5% for 2018 for purposes of our internal forecast.

Going forward, the use of our NOLs could be impacted by certain IRS regulations that would require the recognition of NOLs to be spread over time, thereby increasing our effective tax rate. Would still be able to utilize the NOLs but the amount available in any given year could be somewhat reduced.

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

Thanks, John. Now, I'd like to discuss some of the dynamics driving the strong industry market and introduce our third quarter and increase full-year outlook.

I mentioned last time that we would provide some more color on our view of the market and Battle Royale dynamics. We have done two rounds of primary consumer research, as well as industry modeling to help inform our forecast and supply planning.

We will discuss some of these dynamics but for competitive reasons, in a limited way. The dual phenomena of Fortnite and PUBG continues to draw new gamers into the market, and have pushed the attach rate for headsets to much higher than historical levels.

These games contribute to market growth in several important ways. First, Battle Royale games are inherently highly social, making headsets particularly useful.

We estimate from our research that 80% or more of gamers playing Battle Royale format games are using headsets, a usage rate similar to other games that drive headset usage such as Call of Duty. Second, in addition to adding to the social element of the game, we believe headsets provide a significant competitive advantage because full headset users are generally better able to hear where threats are coming from.

Our shows that even the players don't use a headset when they first start playing these games, they often realize they need a headset to be competitive. Third, many existing Xbox and PlayStation gamers who were not playing first-person shooter games are now playing Battle Royale games and their headset usage is going, based on our estimates, from the mid 20% range to around 80%, causing substantial new headset demand from existing console gamers.

Our research indicates that almost 50% of existing console gamers are now playing Battle Royale games. Fourth, the Battle Royale format and Fortnite in particular is driving millions of new gamers into gaming.

In many cases, these new gamers may be from the same household that already has a console, in which case, they would not show directly up as incremental console sales. We estimate there could now be nearly two or more gamers per console.

Fifth, Fortnite launched on Switch in June and Epic incorporated chat capabilities directly into the game. And while there is a large overlap in switch owners that also have an Xbox or PlayStation, this may bring some incremental gamers and headset users to the switch platform.

We also have survey data that is showing gamers on mobile devices are starting to use gaming headsets, both Switch and mobile are, quote, new platforms, which didn't historically drive gaming headset use. So let’s step back and fold the above points into our overall view of gaming and gaming headsets.

Gaming and gaming on consoles in particular has been an increasingly popular form of entertainment. Use of gaming headsets is also increased over the years as games have become more multiplayer.

Every year, obviously some new gamers into the market and some existing gamers adopt gaming headset usage. But, we believe that historically, the vast majority of the gaming headset market year-after-year has been driven by the installed base of gaming headset users, replacing or upgrading their headsets.

We believe that Battle Royale games like Fortnite have kicked all the elements above in the high gear. More consoles, more gamers and significantly higher portion of gamers using headsets.

Beyond any specific titles like Fortnite or PUBG, we believe that this big jump in highly social, collaborative and competitive gaming is here to stay. We believe games won't be competitive if they don’t bring the same level of fun and social interaction, as well as a comparable level of immersive sound, both of which drive the desire to game with a headset.

Indeed, as an example, Call of Duty has announced a Battle Royale mode for their holiday release. We don't believe this will be a fad, because it's a better experience, independent of any specific game.

And given that the vast majority of the gaming headset market is driven by replacement and upgrading, this large influx of new gaming headset users could drive a step function increase in the size of the gaming headset market going forward. That would only change if these gamers stop gaming or stop gaming with headsets which we believe to be unlikely.

So, what these drivers over our momentum in mind, I'd like to turn to our increased outlook for 2018. But first, let me walk through our third quarter expectations.

We expect net revenue to increase 81% to approximately $65 million compared to $36 million in the third quarter of 2017. Our in-stock positions continue to improve but there could be some variability in actual sales, depending on how well our supplies can meet demand.

Net income is expected to improve to approximately $0.44 per share compared to a net loss of $0.04 per share in the third quarter of 2017. This improvement is expected to result from gross margin improvement, as well as favorable leverage of operating expenses.

Adjusted EBITDA is expected to improve to approximately $11 million, more than triple the $3.3 million in the third quarter of 2017. Note that the holiday channel fill often starts in late September.

And as we have mentioned in the past, significant orders can easily move between September and October and impact the split of Q3 and Q4 revenues without impacting the year. This year, we are expecting somewhat higher September load-in because of several major game launches in October and have reflected that in our current estimates of the revenue splits between Q3 and Q4.

Now moving on to our increased full-year outlook. In 2018, we now expect net revenue to increase 71% to approximately $255 million compared to $149.1 million in 2017 and up from $205 million in our May outlook.

This puts second half revenues at roughly 32% higher than last year and reflects a continuation of the roughly $20 million of incremental sales per quarter from new gamers, driven by Battle Royale style games for the balance of 2018. I spoke before about the dynamic driving the market.

Number one, installed base upgrade replacements which is traditionally the majority driver; two, increase in gaming headset usage rate; and three, influx of new gaming headset users. We know that the over 100% sell through increase we've all been seeing will slow down at some point.

We know that the wave of new users, driven by Battle Royale games will, quote, crest, but, and this is the key point, after a crest, we believe it will leave a meaningfully higher water level. Trying to predict the timing of the crest is difficult.

You can see from our raised guidance that we are planning for some slowing in the influx of new gamers, driven by Fortnite and PUBG. That’s the working estimate our guidance is based on.

But, note that we have not seen any meaningful slowdown in sell through so far. And again, it's difficult to predict the timing of the crest.

Importantly, the crest timing is a separate dynamic from headset usage rates going up and/or the installed base of gaming headset users upgrading or replacing their headsets. Indeed, there are many compelling reasons for gamers to upgrade, which would impact Q4 and future quarters, independent of the crest.

Based on this, we are planning our supply be able to deliver product for upside scenarios. Gross margin in 2018 is now expected to be approximately 35%, including the impact of additional costs we’re occurring expedite our products, offset by operating leverage from higher revenues.

Operating expenses are expected to increase several million dollars in the second half versus second half of 2017 due to higher variable sales and marketing expenses, as well as select additional investments to drive growth. As a result, adjusted EBITDA in 2018 is now expected to increase significantly to approximately $45 million, up from $26 million in our May outlook and compared to $11.6 million in 2017.

Net income in 2018 is now expected to improve to approximately $1.95 per share, up significantly from the $0.95 per share in our May outlook. Per share estimates are based upon 15.5 million estimated diluted shares outstanding.

This is compared to a net loss total of $0.26 per share in 2017. This net income forecast assumes an effective tax rate of 5%, per John's earlier comments.

Our full-year outlook anticipates positive free cash flow of approximately $38 million this year, which we believe will enable us to further reduce debt over time. Given this outlook, I'd like to address our strategic priorities for the remainder of 2018, which remain unchanged.

First, continue to lead the console -- core console headset market. We have more great products coming this year and we will continue to focus on our brand, distribution, merchandising and all of the operational capabilities that we believe make us the leader in our segment.

We plan to continue to make some investments to nurture and broaden our brand as well. Second, drive our presence in the burgeoning e-sports market.

According to 2018 global e-sports market research issued by Newzoo, in the coming year, the global e-sports economy will grow to over $900 million in 2018, a year-on-year growth of 38%. Over 75% of this will be generated directly, having sponsorships and advertisements, and indirectly, media rights and content licenses through investments made by endemic and non-endemic brands that will spend almost $700 million, a 48% increase since last year.

As a leading brand of gaming headsets in our core markets including measuring console and PC gaming headsets together, we are one of the top brands providing headsets and other gear to professional e-sports teams, players and their fans. And as mentioned earlier, we've gone out of our way to create dynamic, comprehensive and integrated partnerships with some of the world's premier proteins, including OpTic Gaming, Astrolists and the Houston Outlaws, plus high-profile influencers such as Dr.

DisRespect, Steve and Ali A among others, and have additionally aligned with some of the most iconic traditional sports franchises as a foundational part of their e-sports initiative such as this year's partnership with Manchester City and Knicks Gaming. Third priority.

We will continue to invest to drive future growth. As I've mentioned on prior calls, we believe we have opportunities in PC gaming headsets and new geographies like China over time, as well as non-headset gaming accessories in the future.

The PC gaming headset market is similar in size to the console gaming headset market. And based on recent research we commissioned, we believe that our brand is known and relevant with PC gamers in our core markets.

That's currently our first growth priority and we’ll be announcing several great new PC products soon with a launch plan that focuses on our core North American and European markets. China is the biggest gaming market in the world and virtually untapped by us.

We’re making some modest investments this year in China, but currently intend to increase our focus in the future as a second priority. We also plan to evaluate other gaming product areas in which we can leverage our strong brand and great distribution for future growth.

Our year-to-date performance has provided us with more flexibility to pursue efforts to drive future growth, and we are increasing our focus and resources there accordingly. Being in a leadership position with the best-selling console gaming headsets across multiple price points, and what I would argue is the most exciting consumer category on the planet is clearly a good place to be.

Personally, after five years of hard work resolving what sometimes seemed like nearly insurmountable balance sheet issues, I'm proud that we've put ourselves in a position to take advantage of the great market we’re in and have our employees, partners and shareholders benefit. Operator, we’re are now ready to take questions.

Hey, guys. Congratulations on a spectacular quarter.

It’s exciting to see the continued momentum. So, a couple of quick questions.

When you are thinking about the holidays here, really doesn’t seem like there is a whole lot else out there in terms of kind of go to holiday, electronics gifts this year, sounds like you guys are probably at or headsets are at. How do you -- conversation you have with retail, how are you guys thinking about planning for the holiday season ,making sure that hopefully you are not in out of stock type of situation, just given that the potential demand.

And then, secondly, do you have the capacity with your manufacturers to be able to deliver if the holiday is as big as we think it could be?

Thanks Mark and thanks for the congratulations. So, yes, the holiday planning, we made a couple of comments in the remarks.

We’ve got kind of bunch of modeling, we monitor retail sell through weekly that's all been factored in and is factored into our guidance, including trying to forecast some of the stuff which is difficult to forecast that I went through, like this influx of new gamers and when that’s going quote, crest, to stick to the analogy I used in the prepared remarks. So, I also mentioned though, and this is a really important part of our planning that we are planning supply and inventory to be able to accommodate some upside scenarios from what we've guided to.

So, that means that we’re ensuring that our factories have capacity, lot of that work is done and our factories have done a fantastic job along with our operations team of ramping their supply and helping us recover inventories and all that as you can see from the Q2 numbers. So, that work is going to continue.

And then, the other key element on longer -- on planning for holiday and having supply is making sure we have components. That one is far more complicated.

They’re components that have long lead times and the second analogy I used before, we don’t have steering wheels, you’re not shipping cars. So, we have been working already at this point for I’d say four months on long lead component planning trying to make sure we have inventory to meet upside cases, trying to build buffer inventory, all of that.

That is not an easy thing and is not -- won’t be a done deal until we’re in holiday and can execute through it. But, it’s something that we’re paying a lot of attention to with multiple scenarios and optimizing everything from how we could use air freighting, if we hit an upside to keeping buffer inventories to making sure we have the right relationships with long-term component suppliers, all of that.

Not easy, but the team’s done a very good job year-to-date. The whole set of items there as you can see from the higher Q2 results which were partially driven by the fact that a lot of our operational execution was just better than we had expected.

So, I’m hoping that that will continue and that’s kind how we’re thinking about the holiday.

And John, one for your quick. When you think about the effective tax rate of 5%, what kind of NOI are you carrying right now?

And obviously hopefully you get to choose some of that up, but what are you looking at right now in terms of the ability to protect earnings?

Yes. So, right now, our guidance, which assumed a 5% effective tax rate did assume that we would have strong utilization on the federal and state side of the existing NOLs or federal’s over $50 million heading into this year.

And we have about $30 million NOLs in the states. And so, the assumption has been that we will not have any limits on what we can utilize from an NOL basis for 2018.

Thanks for taking my question. So, two questions I wanted to ask.

One, given the incredible turnaround, Juergen, that you orchestrated here, what’s your thought on long-term reports remaining independent? And then, two particularly hot topic in the consumer tech spec right now is tariff.

Is there anything in the tariff front that could potentially be concerning for Turtle Beach?

Yes. Thanks, Tom.

And welcome by the way. It’s great to have you in the group with us among the analysts.

So, the first question, I appreciate the comments about the turnaround that that's hard work by a lot of people well beyond me as I've acknowledged in the prepared remarks. You asked about being independent.

Honestly, I don’t give that much thought. We’re focused on being able to continue to deliver good products, maintain our supply, do the right level of forecasting, all of that.

And obviously there's advantages and disadvantages to being an independent public company. So, I think as long as we can continue to do the things that give us our leading market share and great products and all that, it's not something that we are putting a lot of thought into.

So, that's number one. And then, you asked about tariffs.

Yes. I'm glad you asked actually.

It's something that we are very closely monitoring. It is a risk item that’s factored into our guidance for the holiday because we don’t know exactly what's going to happen there.

Every day you read different news about could happen and all that. So, we’re monitoring it.

And I would say, it's too early to tell what's going to happen, both in terms of tariffs and then obviously there could also be freight, important implications and all that. So, the team is well on top of it, monitoring.

And we've kind of factored it in, but I wouldn’t be able to say more about that because I think the whole tariff environment is very uncertain for everybody right now.

Thanks for sharing the survey to help explain what’s going on of increased attach rates with existing console users. I guess, first thing is that you probably have discussed this in the past but do you have a sense is to what is the actual refresh rate for your Turtle Beach users?

Yes. We do and we have discussed it.

So, historically, there is like a 20 to 24 months refresh cycle. Now, it's really important to note that that's got a wide distribution band, like imagine on kind of normal bell curve.

So, the average is 20 to 24 months based on consumer survey data. But that's got a wide range.

So, some people will buy a headset and never replace or upgrade it and some people will buy headsets and they work them, they’ll break them or they will just want an upgrade in a matter of months. So, our working assumption here in our historical basis is around two years.

So, half or little bit more than half of the installed base of gaming headset users would be up for replacement. I'll tell you though that we've got, and this is why I mentioned, it is one of the factors that independent of this kind of influx of new gamers from Fortnite and PUBG and all these games that if that rate moves around, for example, if there are more compelling reasons for people to upgrade, then that would obviously impact the water line to use my analogy, the water line would come up because you would have a higher proportion of the installed base, upgrading headsets each year.

But right now, our working hypothesis is that will stay around that 20 to 24 months cycle.

Got it. And then, in your updated guidance for CY18 of 255 million what percent of that do you think is going to be refreshed as opposed to an incremental user?

That's a good question. But, I would not be able to break that out because it’s going to be very different across the quarters.

Tom, I would say, our working -- in the first two quarters, a lot of the sales have been this new influx of gamers. And then underneath that’s the normal market replacing and upgrading.

So, for Q4, I think that, we think that the majority of the revenues will be from the normal replace upgrade, which by the way would include then some of the new gamers that have coming earlier in the year. And we are, as I mentioned, basing our guidance on a reducing level of influx of new gamers, somewhat lower in Q3 and then again somewhat lower in Q4.

So, we’re modeling and guiding based upon this crest, kind of hitting in Q3 and then again independent of that you’ve got the underlying market of replacing, upgrading and increasing than tax rates.

And then, finally, as we’ve had this influx of users, presumably your ASP has gone down, but I guess as to the influx average finishes off or possibly off, then you’re going to start to see that ASP tick back up?

We don't give ASPs by the way and we did discuss it because I get asked all the time units and ASPs, but it’s very sensitive competitive data. So, we are not going to be disclosing specific ASPs.

For those investors by the way who’ve asked me, we’re going kind of stick to the broad market metrics. But that said, ASPs have not gone down in any kind of meaningful way.

There is some of these new gamers have bought one of the entry-level models and certainly our high market share in those segments, as I mentioned in my remarks was well-timed to say the least. But we -- every price tier is up significantly.

In fact, the highest revenue product in the market is our Stealth 600X wireless for $99. That’s the top-selling by revenue product year-to-date.

So, I don't know that we could assume that ASPs are going to go down significantly in the top backup in Q4 because all of the price tiers seem to be benefiting from this underlying growth.

Can you help us with a couple things. How do you think about your free cash of $38 million, how you use it in the year ahead?

Sure. So, well, the primary use of cash flow will be pay down debt over time, and then, use it to continue to improve the balance sheet.

And obviously, as we mentioned Alex, we’re also funding which we started already, some growth initiatives. So, that’s got more of our focus now and we’ve got a couple PC gaming headsets that are going to be announcing soon as part of that and will be upping our level of investment, including in Q4 to market in the PC and all that.

That's not huge numbers by the way but that's going to get the kind of support you would expect if you are entering a new market. And otherwise a free cash flow will be used to pay down debt and improve the balance sheet.

And then, where is the -- you had guided at one point you'd refill the shelves first, refill the channel second and then sort of refill your in-house warehouses, third. Where are you in terms of catching-up?

Yes. Good question.

And let me just caveat it by saying it varies widely by product model and by retailer, by geography, all of that. But in general, we -- the low point for us in terms of inventory levels, in-stocks and all of that was in May.

June was now significantly recovering, and where our inventory level now is 28 million versus I think 15 or 16 at the end of Q1. That’s a good example of how we’re now -- we've recovered our inventory.

Shelf and stocks are now very good. Not perfect across the board but largely recovered.

Channel inventories are now recovering rapidly and mostly recovered, I would say. And we’re to the point where we are able to start kind of refilling our own warehouse levels of inventory.

So, we’re -- in fact I'm really pleased with our ability to manage through kind of that trough in Q2 with a less disruption to our revenues than we had originally predicted and built into our initial guidance for Q2.

Does that suggest that you didn't have to fly much inventory in July or August?

No, we did. We spent a $4 million roughly, not July or August.

Sorry, yes, in Q2, we kind of did what we expected but the air freight, it will be significantly lower now in Q3. By the way, you always have some of it, especially in late Q3 or early Q4 because we uses it if you have to and some new product launches and things like that.

So, I want to be clear that it's not supposed to be zero, but we had a much higher than normal level at $4 million in Q2 and that is certainly now coming back into kind of the more normal level.

I was just wondering, given the higher installed base that we now have and some of your other comments that you've got from the survey and the data, the upgrade cycle. Juergen, can you just talk a little bit more about 2019?

I mean, I know, you don't want to give numbers, but just your high-level thoughts on what you expect for demand next year, after this strong year? It would seem like it would still be pretty healthy, but any color that you could prove there would be great.

Yes. Thanks, Will.

We are not commenting on 2019, other than what we put into the prepared remarks. We never do by the way, because you need to see holiday sell through, you need to see market shares, all of that.

So, I won't be making further comments to 2019 at this point.

And then, the separate question, and I understand that certainly on that. Just OpEx, remarkably given the growth containing those pretty tight in terms of OpEx spending.

Do we expect a little bit more spending on some of your growth initiatives going forward or just any thoughts there?

Yes. No problem.

We do expect somewhat higher level of OpEx in the back half, single-digit millions. Part of that’s driven by increased selling costs or selling driven sales and marketing costs and then a few million of incremental investment in PC.

We do run a tight shift, and we have not increased staffing levels in any kind of meaningful way. That's led to high flow-throughs you can see from EBITDA.

We are making selective increases to make sure that our teams are not burning out given the high volumes and all that. It takes a lot of work in a number of functions to be able to keep up with the level of demand.

But, we’re being very careful to not overdo it on OpEx while also balancing the needs of our employees to be able to maintain healthy work-life balance.

Okay. And then in terms of just a follow-up on Alex’s question on capital, deploying of the free cash flow.

You paid off $5 million of the subordinated net, are you going to be paying off more o that in these coming quarters here, I mean should that be gone by the end of the year or early part of ‘19?

I would say that our goal is to have the sub debt be paid off by the end of Q1 2019. And the reason why we wouldn't do more in the meantime here is because we need the working capital for holiday.

And so, we’re balancing all the various interest costs. There is a prepayment penalty, a small one on the sub debt.

So, all that stuff gets factored in. But, we want to use the extra cash right now for working capital in holiday, finish the holiday.

And then, in Q1, we get to kind of John calls it, the tsunami of cash, holiday sales that comes in and we use that then to pay down the rest of the sub debt. That’s the default plan.

It could change by the way as we go along. But, that's kind of our operating model and game plan at the moment.

Okay. And just then, lastly, there was -- you filed a mixed shelf after the close of the year, is that just replacing something that expired or any comments?

I’m sure there’ll be questions about that.

Yes. So, we had a shelf a while ago and it expired.

And obviously public companies have shelves as just part of normal operating procedure. And so, we had -- we would have put one in sooner, but there were some constraints because of the Series B transaction.

They just listed a few days ago. And so, we timed it intentionally to do it today, just so that we’d have the ability to make some comments as we did in the prepared remarks.

Okay. Thank you very much.

Again, I appreciate all the good questions and the interest in the Company. Thanks again to all of our employees for the hard work in the first half of the year, keep up the good work.

And we look forward to speaking with our investors and analysts, when we report our third quarter results in November. Thank you very much.