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Turtle Beach Corp - Quarter Report: 2020 March (Form 10-Q)

 

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark one)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2020

or

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to           

 

Commission File Number: 001-35465

 

TURTLE BEACH CORPORATION

(Exact name of registrant as specified in its charter)

 

Nevada

27-2767540

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification Number)

 

 

11011 Via Frontera, Suite A/B

San Diego, California

92127

(Address of principal executive offices)

(Zip Code)

 

(888) 496-8001

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

Trading Symbols

Name of each exchange on which registered

Common Stock, par value $0.001

HEAR

Nasdaq

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes   No

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).   Yes   No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

 

Accelerated filer

Non-accelerated filer

 

Smaller reporting company

Emerging growth company

 

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes   No

The number of shares of the registrant’s Common Stock, par value $0.001 per share, outstanding on April 30, 2020 was 14,572,756.

 

 

 

 


 

INDEX

 

 

 

Page

 

 

 

PART I. FINANCIAL INFORMATION

3

 

 

 

Item 1.

Financial Statements (unaudited)

3

 

 

 

 

  Condensed Consolidated Balance Sheets as of March 31, 2020 and December 31, 2019

3

 

 

 

 

Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2020 and 2019

4

 

 

 

 

Consolidated Condensed Statements of Comprehensive Income (Loss) for the Three Months Ended March 31, 2020 and 2019

5

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2020 and 2019

6

 

 

 

 

Condensed Consolidated Statement of Stockholder's Equity (Deficit) for the Three Months Ended March 31, 2020 and 2019

7

 

 

 

 

Notes to Condensed Consolidated Financial Statements

8

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

20

 

 

 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

25

 

 

 

Item 4.

Controls and Procedures

26

 

 

 

PART II. OTHER INFORMATION

27

 

 

 

Item 1.

Legal Proceedings

27

 

 

 

Item 1A.

Risk Factors

27

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

37

 

 

 

Item 5.

Other Information

37

 

 

 

Item 6.

Exhibits

38

 

 

SIGNATURES

39

 

 

2


 

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

Turtle Beach Corporation

Condensed Consolidated Balance Sheets

 

 

 

March 31,

 

 

December 31,

 

 

 

2020

 

 

2019

 

 

 

(unaudited)

 

 

 

 

 

ASSETS

 

(in thousands, except par value and share amounts)

 

Current Assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

8,733

 

 

$

8,249

 

Accounts receivable, net

 

 

12,402

 

 

 

44,530

 

Inventories

 

 

39,291

 

 

 

45,711

 

Prepaid expenses and other current assets

 

 

5,172

 

 

 

4,057

 

Total Current Assets

 

 

65,598

 

 

 

102,547

 

Property and equipment, net

 

 

4,002

 

 

 

3,962

 

Deferred income taxes

 

 

9,316

 

 

 

7,439

 

Goodwill

 

 

8,515

 

 

 

8,515

 

Intangible assets, net

 

 

5,740

 

 

 

6,011

 

Other assets

 

 

2,563

 

 

 

2,877

 

Total Assets

 

$

95,734

 

 

$

131,351

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

Current Liabilities:

 

 

 

 

 

 

 

 

Revolving credit facility

 

$

301

 

 

$

15,655

 

Accounts payable

 

 

11,503

 

 

 

22,511

 

Other current liabilities

 

 

20,786

 

 

 

26,422

 

Total Current Liabilities

 

 

32,590

 

 

 

64,588

 

Deferred income taxes

 

 

140

 

 

 

153

 

Other liabilities

 

 

3,021

 

 

 

3,223

 

Total Liabilities

 

 

35,751

 

 

 

67,964

 

Commitments and Contingencies

 

 

 

 

 

 

 

 

Stockholders’ Equity

 

 

 

 

 

 

 

 

Common stock, $0.001 par value - 25,000,000 shares authorized; 14,506,140 and 14,488,152 shares issued and outstanding as of March 31, 2020 and December 31, 2019, respectively

 

 

15

 

 

 

14

 

Additional paid-in capital

 

 

177,745

 

 

 

176,776

 

Accumulated deficit

 

 

(117,074

)

 

 

(113,519

)

Accumulated other comprehensive income (loss)

 

 

(703

)

 

 

116

 

Total Stockholders’ Equity

 

 

59,983

 

 

 

63,387

 

Total Liabilities and Stockholders’ Equity

 

$

95,734

 

 

$

131,351

 

 

See accompanying Notes to the Condensed Consolidated Financial Statements (unaudited)

3


 

Turtle Beach Corporation

Condensed Consolidated Statements of Operations

(unaudited)

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

March 31,

 

 

 

2020

 

 

2019

 

 

 

(in thousands, except per-share data)

 

Net revenue

 

$

35,007

 

 

$

44,846

 

Cost of revenue

 

 

24,222

 

 

 

30,059

 

Gross profit

 

 

10,785

 

 

 

14,787

 

Operating expenses:

 

 

 

 

 

 

 

 

Selling and marketing

 

 

7,648

 

 

 

6,881

 

Research and development

 

 

2,427

 

 

 

1,456

 

General and administrative

 

 

5,723

 

 

 

4,649

 

Total operating expenses

 

 

15,798

 

 

 

12,986

 

Operating income (loss)

 

 

(5,013

)

 

 

1,801

 

Interest expense

 

 

169

 

 

 

244

 

Other non-operating expense (income), net

 

 

197

 

 

 

(1,662

)

Income (loss) before income tax

 

 

(5,379

)

 

 

3,219

 

Income tax expense (benefit)

 

 

(1,824

)

 

 

164

 

Net income (loss)

 

$

(3,555

)

 

$

3,055

 

 

 

 

 

 

 

 

 

 

Net income (loss) per share

 

 

 

 

 

 

 

 

Basic

 

$

(0.25

)

 

$

0.21

 

Diluted

 

$

(0.25

)

 

$

0.09

 

Weighted average number of shares:

 

 

 

 

 

 

 

 

Basic

 

 

14,495

 

 

 

14,336

 

Diluted

 

 

14,495

 

 

 

16,260

 

 

See accompanying Notes to the Condensed Consolidated Financial Statements (unaudited)

4


 

Turtle Beach Corporation

Condensed Consolidated Statements of Comprehensive Income (Loss)

(unaudited)

 

 

 

Three Months Ended

 

 

 

March 31,

2020

 

 

March 31,

2019

 

 

(in thousands)

 

Net income (loss)

 

$

(3,555

)

 

$

3,055

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

Foreign currency translation adjustment

 

 

(819

)

 

 

165

 

Other comprehensive income (loss)

 

 

(819

)

 

 

165

 

Comprehensive income (loss)

 

$

(4,374

)

 

$

3,220

 

 

See accompanying Notes to the Condensed Consolidated Financial Statements (unaudited)

5


 

Turtle Beach Corporation

Condensed Consolidated Statements of Cash Flows

(unaudited)

 

 

 

Three Months Ended

 

 

 

March 31, 2020

 

 

March 31, 2019

 

 

 

(in thousands)

 

CASH FLOWS FROM OPERATING ACTIVITIES

 

 

 

 

 

 

 

 

Net income (loss)

 

$

(3,555

)

 

$

3,055

 

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

1,033

 

 

 

1,040

 

Amortization of intangible assets

 

 

222

 

 

 

62

 

Amortization of debt financing costs

 

 

47

 

 

 

47

 

Stock-based compensation

 

 

999

 

 

 

522

 

Deferred income taxes

 

 

(1,891

)

 

 

 

Provision for (reversal of) sales returns reserve

 

 

(2,553

)

 

 

(2,532

)

Provision for obsolete inventory

 

 

439

 

 

 

783

 

Unrealized loss (gain) on financial instrument obligation

 

 

 

 

 

(1,601

)

Increase in fair value of contingent consideration

 

 

21

 

 

 

 

Changes in operating assets and liabilities, net of acquisitions:

 

 

 

 

 

 

 

 

Accounts receivable

 

 

34,681

 

 

 

42,868

 

Inventories

 

 

5,981

 

 

 

4,210

 

Accounts payable

 

 

(11,192

)

 

 

(4,493

)

Prepaid expenses and other assets

 

 

(1,091

)

 

 

(317

)

Income taxes payable

 

 

(132

)

 

 

132

 

Other liabilities

 

 

(5,483

)

 

 

(2,814

)

Net cash provided by operating activities

 

 

17,526

 

 

 

40,962

 

CASH FLOWS FROM INVESTING ACTIVITIES

 

 

 

 

 

 

 

 

Purchases of property and equipment

 

 

(890

)

 

 

(557

)

Net cash used for investing activities

 

 

(890

)

 

 

(557

)

CASH FLOWS FROM FINANCING ACTIVITIES

 

 

 

 

 

 

 

 

Borrowings on revolving credit facilities

 

 

48,426

 

 

 

48,119

 

Repayment of revolving credit facilities

 

 

(63,780

)

 

 

(85,504

)

Proceeds from exercise of stock options and warrants

 

 

18

 

 

 

23

 

Repurchase of common stock to satisfy employee tax withholding obligations

 

 

(48

)

 

 

(101

)

Net cash used for financing activities

 

 

(15,384

)

 

 

(37,463

)

Effect of exchange rate changes on cash and cash equivalents

 

 

(768

)

 

 

136

 

Net increase in cash and cash equivalents

 

 

484

 

 

 

3,078

 

Cash and cash equivalents - beginning of period

 

 

8,249

 

 

 

7,078

 

Cash and cash equivalents - end of period

 

$

8,733

 

 

$

10,156

 

 

 

 

 

 

 

 

 

 

SUPPLEMENTAL DISCLOSURE OF INFORMATION

 

 

 

 

 

 

 

 

Cash paid for interest

 

$

161

 

 

$

268

 

Cash paid for income taxes

 

$

175

 

 

$

 

Reclassification of financial instrument obligation

 

$

 

 

$

6,248

 

 

 

 

 

 

 

 

 

 

 

See accompanying Notes to the Condensed Consolidated Financial Statements (unaudited)

6


 

Turtle Beach Corporation

Condensed Consolidated Statement of StockholdersEquity (Deficit)

(unaudited)

 

 

 

Common Stock

 

 

Additional

Paid-In

 

 

Accumulated

 

 

Accumulated

Other

Comprehensive

 

 

 

 

 

 

 

Shares

 

 

Amount

 

 

Capital

 

 

Deficit

 

 

Income (Loss)

 

 

Total

 

 

 

(in thousands)

 

Balance at December 31, 2019

 

 

14,488

 

 

$

14

 

 

$

176,776

 

 

$

(113,519

)

 

$

116

 

 

$

63,387

 

Net loss

 

 

 

 

 

 

 

 

 

 

 

(3,555

)

 

 

 

 

 

(3,555

)

Other comprehensive loss, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(819

)

 

 

(819

)

Issuance of restricted stock

 

 

19

 

 

 

1

 

 

 

 

 

 

 

 

 

 

 

 

1

 

Repurchase of common stock and retirement of related treasury shares

 

 

(7

)

 

 

 

 

 

(48

)

 

 

 

 

 

 

 

 

(48

)

Stock options exercised

 

 

6

 

 

 

 

 

 

18

 

 

 

 

 

 

 

 

 

18

 

Stock-based compensation

 

 

 

 

 

 

 

 

999

 

 

 

 

 

 

 

 

 

999

 

Balance at March 31, 2020

 

 

14,506

 

 

$

15

 

 

$

177,745

 

 

$

(117,074

)

 

$

(703

)

 

$

59,983

 

 

 

 

 

Common Stock

 

 

Additional

Paid-In

 

 

Accumulated

 

 

Accumulated

Other

Comprehensive

 

 

 

 

 

 

 

Shares

 

 

Amount

 

 

Capital

 

 

Deficit

 

 

Income (Loss)

 

 

Total

 

 

 

(in thousands)

 

Balance at December 31, 2018

 

 

14,268

 

 

$

14

 

 

$

169,421

 

 

$

(131,463

)

 

$

(476

)

 

$

37,496

 

Net income

 

 

 

 

 

 

 

 

 

 

 

3,055

 

 

 

 

 

 

3,055

 

Other comprehensive income, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

165

 

 

 

165

 

Reclassification of financial instrument obligation

 

 

 

 

 

 

 

 

6,248

 

 

 

 

 

 

 

 

 

6,248

 

Issuance of restricted stock

 

 

12

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Repurchase of common stock and retirement of related treasury shares

 

 

(6

)

 

 

 

 

 

(101

)

 

 

 

 

 

 

 

 

(101

)

Issuance of common stock upon exercise of warrants

 

 

295

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock options exercised

 

 

6

 

 

 

 

 

 

23

 

 

 

 

 

 

 

 

 

23

 

Stock-based compensation

 

 

 

 

 

 

 

 

522

 

 

 

 

 

 

 

 

 

522

 

Balance at March 31, 2019

 

 

14,575

 

 

$

14

 

 

$

176,113

 

 

$

(128,408

)

 

$

(311

)

 

$

47,408

 

 

 

See accompanying Notes to the Condensed Consolidated Financial Statements (unaudited)

7


 

Turtle Beach Corporation

Notes to Condensed Consolidated Financial Statements

(unaudited)

 

Note 1. Background and Basis of Presentation

Organization

 

Turtle Beach Corporation (“Turtle Beach” or the “Company”), headquartered in San Diego, California and incorporated in the state of Nevada in 2010, is a premier audio and gaming technology company with expertise and experience in developing, commercializing and marketing innovative products across a range of large addressable markets under the Turtle Beach® and ROCCAT® brands. Turtle Beach is a worldwide leader of feature-rich headset solutions for use across multiple platforms, including video game and entertainment consoles, handheld consoles, personal computers (“PC”), tablets and mobile devices. ROCCAT is a gaming keyboards, mice and other accessories brand focused in the PC peripherals market.

 

VTB Holdings, Inc. (“VTBH”), a wholly-owned subsidiary of Turtle Beach and the owner of Voyetra Turtle Beach, Inc. (“VTB”), was incorporated in the state of Delaware in 2010. VTB, the owner of Turtle Beach Europe Limited (“TB Europe”), was incorporated in the state of Delaware in 1975 with operations principally located in Valhalla, New York.

Basis of Presentation

The accompanying interim condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and, in the opinion of management, reflect all adjustments (which include normal recurring adjustments) considered necessary for a fair presentation of the financial position, results of operations, and cash flows for the periods presented. All intercompany accounts and transactions have been eliminated in consolidation. Certain information and footnote disclosures, normally included in annual financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”), have been condensed or omitted pursuant to those rules and regulations. The Company believes that the disclosures made are adequate to make the information presented not misleading. The results of operations for the interim periods are not necessarily indicative of the results of operations for the entire fiscal year.

The December 31, 2019 Condensed Consolidated Balance Sheet has been derived from the Company’s audited financial statements included in its Annual Report on Form 10-K filed with the SEC on March 13, 2020 (“Annual Report”).

These financial statements should be read in conjunction with the annual financial statements and the notes thereto included in the Annual Report that contains information useful to understanding the Company's businesses and financial statement presentations.

Use of estimates: The preparation of accompanying unaudited consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions about future events. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the unaudited consolidated financial statements and reported amounts of revenues and expenses during the reporting period. These estimates may change, as new events occur and additional information is obtained, and will be recognized in the consolidated financial statements in the period in which such changes occur. Future actual results could differ materially from these estimates. The novel coronavirus (“COVID-19”) pandemic has disrupted worldwide economic markets and the extent to which COVID-19 impacts the Company’s business, results of operations and financial condition will depend on future developments, which are highly uncertain and difficult to predict. As of March 31, 2020, our liquidity and operations have not been significantly impacted. However, the Company will continue to monitor and assess the impact of the pandemic.

 

Note 2. Summary of Significant Accounting Policies

The preparation of consolidated annual and quarterly financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the Company’s consolidated financial statements, and the reported amounts of revenue and expenses during the reporting periods. The Company can give no assurance that actual results will not differ from those estimates.

There have been no material changes to the critical accounting policies and estimates from the information provided in Note 1 of the notes to our consolidated financial statements in our Annual Report.

 

8


 

Recent Accounting Pronouncements

 In January 2017, the FASB issued ASU No. 2017-04, Intangibles-Goodwill and Other: Simplifying the Test for Goodwill Impairment, which simplifies how an entity is required to test goodwill for impairment. A goodwill impairment will be measured by the amount by which a reporting unit’s carrying value exceeds its fair value, with the amount of impairment not to exceed the carrying amount of goodwill. ASU 2017-04 is effective for goodwill impairment tests in fiscal years beginning after December 15, 2019, and for interim periods within those fiscal years, and must be adopted on a prospective basis. The Company adopted the ASU prospectively on January 1, 2020, which did not have a material impact on the consolidated financial statements.

In December 2019, the FASB issued ASU No. 2019-12, Simplifying the Accounting for Income Taxes, which amends ASC Topic 740 by removing certain exceptions related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period and the recognition of deferred tax liabilities for outside basis differences. It also simplifies aspects of the accounting for franchise taxes and enacted changes in tax laws or rates and clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill. The pronouncement is effective for fiscal years beginning after December 15, 2020, or for any interim periods within those fiscal years, with early adoption permitted. The Company adopted ASU 2019-12 on January 1, 2020 and does not expect the adoption of this guidance to have a material impact on its financial statements.

 

 

Note 3. Acquisitions

 

ROCCAT

 

On May 31, 2019, the Company completed its acquisition of the business and assets of ROCCAT, a provider of gaming keyboards, mice and other accessories for a purchase price of approximately $12.7 million at the closing and up to $3.4 million in potential earn-outs based on revenues for the years ending December 31, 2019 and 2020, as provided in the asset purchase agreement. The purchase price was paid in cash at closing and was funded by the Company’s cash reserves and additional borrowings under its credit facility. In addition, business transaction costs incurred in connection with the acquisition totaled $3.9 million, of which $0.3 million was recorded as a component of “General and administrative” expenses in the Condensed Consolidated Statements of Operations for the three months ended March 31, 2020.

 

The preliminary ROCCAT purchase price allocation as of May 31, 2019, is shown in the following table:

 

(In thousands)

 

Amount

 

Receivables

 

$

1,257

 

Inventories

 

 

6,986

 

Property and equipment

 

 

1,110

 

Intangible assets

 

 

5,589

 

Other long-term assets

 

 

461

 

Accounts payable

 

 

(5,510

)

Accrued and other current liabilities

 

 

(3,821

)

Contingent consideration

 

 

(1,592

)

Other non-current liabilities

 

 

(328

)

Total identifiable net assets

 

 

4,152

 

Goodwill

 

 

8,515

 

Total consideration

 

$

12,667

 

 

The fair values of ROCCAT’s assets and liabilities are provisional and were determined based on preliminary estimates and assumptions that management believes are reasonable. The preliminary purchase price allocation is subject to further refinement and may require significant adjustments to arrive at the final purchase price allocation. These adjustments will primarily relate to certain short-term assets, intangible assets, and certain liabilities including contingent consideration. The final determination of the fair value of certain assets and liabilities will be completed as soon as the necessary information is available, including the completion of a valuation of the tangible and intangible assets and the contingent consideration, but no later than one year from the acquisition date.

 

The goodwill from the acquisition of ROCCAT, which is fully deductible for tax purposes, consists largely of synergies and economies of scale expected from combining the operations of ROCCAT and the Company’s existing business.

 

9


 

The estimate of fair value of ROCCAT’s identifiable intangible assets was determined primarily using the “income approach,” which requires a forecast of all of the expected future cash flows either through the use of the multi-period excess earnings method or the relief-from-royalty method. Some of the more significant assumptions inherent in the development of intangible asset values include: the amount and timing of projected future cash flows, the discount rate selected to measure the risks inherent in the future cash flows, the assessment of the intangible asset’s life cycle, as well as other factors. The following table summarizes key information underlying intangible assets related to the ROCCAT acquisition:

 

(In thousands)

 

Life

 

Amount

 

Customer relationships

 

7 Years

 

$

2,119

 

Tradenames

 

10 Years

 

 

2,686

 

Developed technology

 

7 Years

 

 

784

 

Total

 

 

 

$

5,589

 

 

For the three months ended March 31, 2020, revenue related to ROCCAT products was $4.3 million. The Company is unable to provide the results of operations attributable to ROCCAT as those operations were substantially integrated into our legacy business.

 

The Company has not presented combined pro forma financial information of the Company and the pre-acquisition ROCCAT business because the results of operations of the acquired business are considered immaterial.

 

In connection with the $1.6 million fair value of the potential $3.4 million earn-outs, for the year ended December 31, 2019, the fair value of the contingent consideration decreased $0.5 million primarily as a result of the revenues not achieving the stated threshold in the asset purchase agreement.

 

Note 4. Fair Value Measurement

The Company follows a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. This hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows:

 

 

Level 1 — Quoted prices in active markets for identical assets or liabilities.

 

Level 2 — Observable inputs other than quoted prices included in Level 1, such as quoted prices for markets that are not active, or other inputs that are observable or can be corroborated by observable market data.

 

Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.

Financial instruments consist of cash and cash equivalents, accounts receivable, accounts payable, debt instruments and certain warrants. As of March 31, 2020 and December 31, 2019, the Company had not elected the fair value option for any financial assets and liabilities for which such an election would have been permitted. The following is a summary of the carrying amounts and estimated fair values of our financial instruments at March 31, 2020 and December 31, 2019

 

 

March 31, 2020

 

 

December 31, 2019

 

 

 

Reported

 

 

Fair Value

 

 

Reported

 

 

Fair Value

 

 

 

(in thousands)

 

Financial Assets and Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

8,733

 

 

$

8,733

 

 

$

8,249

 

 

$

8,249

 

Revolving credit facility

 

$

301

 

 

$

301

 

 

$

15,655

 

 

$

15,655

 

Contingent consideration liabilities

 

$

1,142

 

 

$

1,142

 

 

$

1,121

 

 

$

1,121

 

 

Cash equivalents are stated at amortized cost, which approximates fair value as of the consolidated balance sheet dates, due to the short period of time to maturity; and accounts receivable and accounts payable are stated at their carrying value, which approximates fair value due to the short time to the expected receipt or payment. The carrying value of the Credit Facility equals fair value as the stated interest rate approximates market rates currently available to the Company, which is considered a Level 2 input. The Company values contingent consideration related to business combinations using a weighted probability calculation of potential payment scenarios discounted at rates reflective of the risks associated with the expected future cash flows.

 

10


 

Note 5. Allowance for Sales Returns

The following table provides the changes in our sales return reserve, which is classified as a reduction of accounts receivable:

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2020

 

 

2019

 

 

 

(in thousands)

 

Balance, beginning of period

 

$

8,815

 

 

$

9,212

 

Reserve accrual

 

 

2,651

 

 

 

2,621

 

Recoveries and deductions, net

 

 

(5,204

)

 

 

(5,153

)

Balance, end of period

 

$

6,262

 

 

$

6,680

 

 

Note 6. Composition of Certain Financial Statement Items

Inventories

Inventories consist of the following:

 

 

March 31,

2020

 

 

December 31,

2019

 

 

 

(in thousands)

 

Raw materials

 

$

1,502

 

 

$

1,288

 

Finished goods

 

 

37,789

 

 

 

44,423

 

Total inventories

 

$

39,291

 

 

$

45,711

 

 

Property and Equipment, net

Property and equipment, net, consists of the following:

 

 

March 31,

2020

 

 

December 31,

2019

 

 

 

(in thousands)

 

Machinery and equipment

 

$

1,835

 

 

$

1,783

 

Software and software development

 

 

446

 

 

 

439

 

Furniture and fixtures

 

 

992

 

 

 

601

 

Tooling

 

 

5,358

 

 

 

5,340

 

Leasehold improvements

 

 

1,324

 

 

 

1,326

 

Demonstration units and convention booths

 

 

12,652

 

 

 

12,051

 

Total property and equipment, gross

 

 

22,607

 

 

 

21,540

 

Less: accumulated depreciation and amortization

 

 

(18,605

)

 

 

(17,578

)

Total property and equipment, net

 

$

4,002

 

 

$

3,962

 

 

Other Current Liabilities

Other current liabilities consist of the following:

 

 

March 31,

2020

 

 

December 31,

2019

 

 

 

(in thousands)

 

Accrued customer fees

 

$

2,787

 

 

$

3,147

 

Accrued royalty

 

 

2,436

 

 

 

3,880

 

Accrued employee expenses

 

 

4,575

 

 

 

3,674

 

Accrued marketing

 

 

2,149

 

 

 

3,695

 

Foreign tax liability

 

 

1,340

 

 

 

2,504

 

Accrued expenses

 

 

7,499

 

 

 

9,522

 

Total other current liabilities

 

$

20,786

 

 

$

26,422

 

 

11


 

Other non-operating expense (income), net

Other non-operating expense (income), net consists of the following:

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2020

 

 

2019

 

 

 

(in thousands)

 

Unrealized gain on financial instrument obligation

 

$

 

 

$

(1,601

)

Other non-operating expense (income)

 

 

176

 

 

 

(61

)

Change in fair value of contingent consideration

 

 

21

 

 

 

 

Total other non-operating expense (income),net

 

$

197

 

 

$

(1,662

)

 

Note 7. Goodwill and Other Intangible Assets

Acquired Intangible Assets

Acquired identifiable intangible assets, and related accumulated amortization, as of March 31, 2020 and December 31, 2019 consist of:

 

 

March 31, 2020

 

 

 

Gross

Carrying

Value

 

 

Accumulated

Amortization

 

 

Net Book

Value

 

 

 

(in thousands)

 

Customer relationships

 

$

7,915

 

 

$

5,163

 

 

$

2,752

 

Tradenames

 

 

2,686

 

 

 

224

 

 

 

2,462

 

Developed technology

 

 

784

 

 

 

93

 

 

 

691

 

Foreign currency

 

 

(1,282

)

 

 

(1,118

)

 

 

(165

)

Total Intangible Assets

 

$

10,103

 

 

$

4,362

 

 

$

5,740

 

 

 

 

December 31, 2019

 

 

 

Gross

Carrying

Value

 

 

Accumulated

Amortization

 

 

Net Book

Value

 

 

 

(in thousands)

 

Customer relationships

 

$

7,915

 

 

$

5,024

 

 

$

2,891

 

Tradenames

 

$

2,686

 

 

$

157

 

 

$

2,529

 

Developed technology

 

$

784

 

 

$

65

 

 

$

719

 

Foreign currency

 

 

(1,004

)

 

 

(876

)

 

 

(128

)

Total Intangible Assets

 

$

10,381

 

 

$

4,370

 

 

$

6,011

 

 

In connection with the October 2012 acquisition of TB Europe, the acquired intangible assets related to customer relationships is being amortized over an estimated useful life of thirteen years with the amortization being included within sales and marketing expense.

 

In May 2019, the Company completed its acquisition of the business and assets of ROCCAT. The acquired intangible assets relating to developed technology, customer relationships and trade name are subject to amortization. Refer to Note 3, “Acquisitions” for additional information related to ROCCAT’s identifiable intangible assets.

Amortization expense related to definite lived intangible assets of $0.2 million was recognized for the three months ended March 31, 2020, and $0.1 million for the three months ended March 31, 2019.

12


 

As of March 31, 2020, estimated annual amortization expense related to definite lived intangible assets in future periods is as follows:

 

 

(in thousands)

 

2020

 

$

708

 

2021

 

 

901

 

2022

 

 

866

 

2023

 

 

837

 

2024

 

 

813

 

Thereafter

 

 

1,780

 

Total

 

$

5,905

 

 

Note 8. Revolving Credit Facility and Long-Term Debt

 

 

March 31,

2020

 

 

December 31,

2019

 

 

 

(in thousands)

 

Revolving credit facility, maturing March 2024

 

$

301

 

 

$

15,655

 

 

Total interest expense, inclusive of amortization of deferred financing costs, on long-term debt obligations was $0.2 million for both the three months ended March 31, 2020 and 2019.

Amortization of deferred financing costs was $47,000 for both the three months ended March 31, 2020 and 2019.

Revolving Credit Facility

On December 17, 2018, Turtle Beach and certain of its subsidiaries entered into an amended and restated loan, guaranty and security agreement (“Credit Facility”) with Bank of America, N.A. (“Bank of America”), as Agent, Sole Lead Arranger and Sole Bookrunner, which replaced the then existing asset-based revolving loan agreement. The Credit Facility, which expires on March 5, 2024, provides for a line of credit of up to $80 million inclusive of a sub-facility limit of $12 million for TB Europe, a wholly-owned subsidiary of Turtle Beach. In addition, the Credit Facility provides for a $40 million accordion feature and the ability to increase the borrowing base with a FILO Loan of up to $6.8 million. 

On May 31, 2019, the Company amended the Credit Facility to provide for, amongst other items, (i) the addition of TBC Holding Company LLC, a wholly-owned subsidiary of VTB, as an obligor and (ii) the ability to make investments in TB Germany GmbH, a wholly-owned subsidiary of TB Europe, of up to $4 million in connection with the acquisition of the business and assets of ROCCAT and up to an additional $4 million annually.

The maximum credit availability for loans and letters of credit under the Credit Facility is governed by a borrowing base determined by the application of specified percentages to certain eligible assets, primarily eligible trade accounts receivable and inventories, and is subject to discretionary reserves and revaluation adjustments. The Credit Facility may be used for working capital, the issuance of bank guarantees, letters of credit and other corporate purposes.

Amounts outstanding under the Credit Facility bear interest at a rate equal to either a rate published by Bank of America or the LIBOR rate, plus in each case, an applicable margin, which is between 0.50% to 1.25% for base rate loans and between 1.25% to 2.00% for U.S. LIBOR loans and U.K. loans, and between 2.00% to 2.75% for the FILO loan. In addition, Turtle Beach is required to pay a commitment fee on the unused revolving loan commitment at a rate ranging from 0.25% to 0.50% and letter of credit fees and agent fees. As of March 31, 2020, interest rates for outstanding borrowings were 3.75% for base rate loans and 3.00% for LIBOR rate loans.

The Company is subject to quarterly financial covenant testing if certain availability thresholds are not met or certain other events occur (as defined in the Credit Facility). At such times, the Credit Facility requires the Company and its restricted subsidiaries to maintain a fixed charge coverage ratio of at least 1.00 to 1.00 as of the last day of each fiscal quarter.

The Credit Facility also contains affirmative and negative covenants that, subject to certain exceptions, limit our ability to take certain actions, including the Company’s ability to incur debt, pay dividends and repurchase stock, make certain investments and other payments, enter into certain mergers and consolidations, engage in sale leaseback transactions and transactions with affiliates, and encumber and dispose of assets. Obligations under the Credit Facility are secured by a security interest and lien upon substantially all of the Company’s assets.

13


 

As of March 31, 2020, the Company was in compliance with all financial covenants under the Credit Facility, as amended, and excess borrowing availability was approximately $21.4 million.

Note 9. Income Taxes

In order to determine the quarterly provision for income taxes, the Company uses an estimated annual effective tax rate (“ETR”), which is based on expected annual income and statutory tax rates in the various jurisdictions. However, to the extent that application of the estimated annual effective tax rate is not representative of the quarterly portion of actual tax expense expected to be recorded for the year, the Company determines the provision for income taxes based on actual year-to-date income (loss). Certain significant or unusual items are separately recognized as discrete items in the period during which they occur and can be a source of variability in the effective tax rates from quarter to quarter.

The following table presents the Company’s income tax expense and effective income tax rate:

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2020

 

 

2019

 

 

(in thousands)

 

Income tax expense (benefit)

 

$

(1,824

)

 

$

164

 

Effective income tax rate

 

 

33.9

%

 

 

5.1

%

 

Income tax benefit for the three months ended March 31, 2020 was $1.8 million at an effective tax rate of 33.9%, compared to income tax expense of $0.2 million at an effective tax rate of 5.1% for the three months ended March 31, 2019. The effective tax rate for the three months ended March 31, 2020 was primarily impacted by permanent items including global intangible low taxed income and executive compensation and, certain state tax expense.

The Company is subject to income taxes domestically and in various foreign jurisdictions. Significant judgment is required in evaluating uncertain tax positions and determining the provision for income taxes.

The Company recognizes only those tax positions that meet the more-likely-than-not recognition threshold and establishes tax reserves for uncertain tax positions that do not meet this threshold. Interest and penalties associated with income tax matters are included in the provision for income taxes in the condensed consolidated statements of operations. As of March 31, 2020, the Company had uncertain tax positions of $2.2 million, inclusive of $0.7 million of interest and penalties.

The Company files U.S., state and foreign income tax returns in jurisdictions with various statutes of limitations. The federal tax years open under the statute of limitations are 2017 through 2018, and the state tax years open under the statute of limitations are 2015 through 2018.

The Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) was enacted in March 2020. The CARES Act includes several U.S. income tax provisions related to, among other things, net operating loss carrybacks, alternative minimum tax credits, modifications to the net interest deduction limitations, and technical amendments regarding the income tax depreciation of qualified improvement property placed in service after December 31, 2017. The CARES Act is not expected to have a material impact on the Company’s financial results.

Note 10. Stock-Based Compensation

Total estimated stock-based compensation expense for employees and non-employees, related to all of the Company’s stock-based awards, was as follows:

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2020

 

 

2019

 

 

 

(in thousands)

 

Cost of revenue

 

$

58

 

 

$

(125

)

Selling and marketing

 

 

199

 

 

 

116

 

Research and development

 

 

125

 

 

 

74

 

General and administrative

 

 

617

 

 

 

457

 

Total stock-based compensation

 

$

999

 

 

$

522

 

 

14


 

The following table presents the stock activity and the total number of shares available for grant as of March 31, 2020:

 

 

(in thousands)

 

Balance at December 31, 2019

 

 

1,777

 

Options granted

 

 

(49

)

Options cancelled

 

 

26

 

Restricted stock granted

 

 

(3

)

Forfeited/Expired shares added back

 

 

4

 

Balance at March 31, 2020

 

 

1,755

 

 

Stock Option Activity

 

 

 

Options Outstanding

 

 

 

Number of

Shares

Underlying

Outstanding

Options

 

 

Weighted-

Average

Exercise

Price

 

 

Weighted-

Average

Remaining

Contractual

Term

 

 

Aggregate

Intrinsic

Value

 

 

 

 

 

 

 

 

 

 

 

(in years)

 

 

 

 

 

Outstanding at December 31, 2019

 

 

2,142,925

 

 

$

7.83

 

 

 

7.13

 

 

$

6,545,982

 

Granted

 

 

49,350

 

 

 

5.55

 

 

 

 

 

 

 

 

 

Exercised

 

 

(5,707

)

 

 

3.19

 

 

 

 

 

 

 

 

 

Forfeited

 

 

(26,190

)

 

 

11.61

 

 

 

 

 

 

 

 

 

Outstanding at March 31, 2020

 

 

2,160,378

 

 

$

7.75

 

 

 

6.92

 

 

$

2,755,627

 

Vested and expected to vest at March 31, 2020

 

 

2,111,618

 

 

$

7.76

 

 

 

6.88

 

 

$

2,708,414

 

Exercisable at March 31, 2020

 

 

1,130,521

 

 

$

6.50

 

 

 

5.36

 

 

$

1,569,200

 

 

Stock options are time-based and the majority are exercisable within 10 years of the date of grant, but only to the extent they have vested. The options generally vest as specified in the option agreements subject to acceleration in certain circumstances. In the event participants in the plan cease to be employed or engaged by the Company, then all of the options would be forfeited if they are not exercised within 90 days. Forfeitures on option grants are estimated at 10% for non-executives and 0% for executives based on evaluation of historical and expected future turnover. Stock-based compensation expense was recorded net of estimated forfeitures, such that expense was recorded only for those stock-based awards expected to vest. The Company reviews this assumption periodically and will adjust it if it is not representative of future forfeiture data and trends within employee types (executive vs. non-executive).

Aggregate intrinsic value represents the difference between the estimated fair value of the underlying common stock and the exercise price of outstanding, in-the-money options. The aggregate intrinsic value of options exercised was $11,000 for the three months ended March 31, 2020.

The Company uses the Black-Scholes option-pricing model to estimate the fair value of options granted as of the grant date. The following are the assumptions for options granted during the three months ended March 31, 2020.

 

Expected term (in years)

 

 

6.1

 

Risk-free interest rate

 

0.7%- 1.4%

 

Expected volatility

 

50.1%- 51.3%

 

Dividend rate

 

0%

 

 

Each of these inputs is subjective and generally requires significant judgment to determine.

The weighted average grant date fair value of options granted during the three months ended March 31, 2020 was $2.69. The total estimated fair value of employee options vested during the three months ended March 31, 2020 was $0.2 million. As of March 31, 2020, total unrecognized compensation cost related to non-vested stock options granted to employees was $3.1 million, which is expected to be recognized over a remaining weighted average vesting period of 2.6 years.

15


 

Restricted Stock Activity

 

 

 

Shares

 

 

Weighted

Average

Grant Date

Fair Value

Per Share

 

Nonvested restricted stock at December 31, 2019

 

 

421,490

 

 

$

15.06

 

Granted

 

 

3,175

 

 

 

 

Vested

 

 

(19,345

)

 

 

23.65

 

Shares forfeited

 

 

(4,282

)

 

 

12.10

 

Nonvested restricted stock at March 31, 2020

 

 

401,038

 

 

$

14.56

 

 

As of March 31, 2020, total unrecognized compensation costs related to the nonvested restricted stock awards was $4.8 million, which will be recognized over a remaining weighted average vesting period of 2.4 years.   

Note 11. Net Income (Loss) Per Share

The following table sets forth the computation of basic and diluted net income (loss) per share of common stock attributable to common stockholders:

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2020

 

 

2019

 

 

 

(in thousands, except per-share data)

 

Net income (loss)

 

$

(3,555

)

 

$

3,055

 

Unrealized gain on financial instrument obligation

 

 

 

 

 

(1,601

)

Net income (loss) - diluted

 

$

(3,555

)

 

$

1,454

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding — Basic

 

 

14,495

 

 

 

14,336

 

Plus incremental shares from assumed conversions:

 

 

 

 

 

 

 

 

Dilutive effect of restricted stock

 

 

 

 

 

55

 

Dilutive effect of stock options

 

 

 

 

 

1,053

 

Dilutive effect of warrants

 

 

 

 

 

816

 

Weighted average common shares outstanding — Diluted

 

 

14,495

 

 

 

16,260

 

Net income (loss) per share:

 

 

 

 

 

 

 

 

Basic

 

$

(0.25

)

 

$

0.21

 

Diluted

 

$

(0.25

)

 

$

0.09

 

 

Incremental shares from stock options and restricted stock awards are computed using the treasury stock method. The weighted average shares listed below were not included in the computation of diluted earnings per share because to do so would have been anti-dilutive for the periods presented or were otherwise excluded under the treasury stock method. The treasury stock method calculates dilution assuming the exercise of all in-the-money options and vesting of restricted stock, reduced by the repurchase of shares with the proceeds from the assumed exercises and unrecognized compensation expense for outstanding awards.

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2020

 

 

2019

 

 

 

(in thousands)

 

Stock options

 

 

2,147

 

 

 

145

 

Warrants

 

 

550

 

 

 

 

Unvested restricted stock awards

 

 

406

 

 

 

201

 

Total

 

 

3,103

 

 

 

346

 

 

16


 

Note 12. Segment Information

The following table represents total net revenues based on where customers are physically located:

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2020

 

 

2019

 

 

 

(in thousands)

 

North America

 

$

27,020

 

 

$

35,107

 

United Kingdom

 

 

1,447

 

 

 

4,312

 

Europe

 

 

4,550

 

 

 

4,192

 

Other

 

 

1,990

 

 

 

1,235

 

Total net revenues

 

$

35,007

 

 

$

44,846

 

 

Note 13. Commitments and Contingencies

Litigation

 

The Company is subject to various legal proceedings and claims that arise in the ordinary course of its business. Although the amount of any

liability that could arise with respect to these actions cannot be determined with certainty, in the Company’s opinion, any such liability will not have a material adverse effect on its consolidated financial position, consolidated results of operations or liquidity.

 

Shareholders Class Action: On August 5, 2013, VTBH and the Company (f/k/a Parametric Sound Corporation) announced that they had entered into the Merger Agreement pursuant to which VTBH would acquire an approximately 80% ownership interest and existing shareholders would maintain an approximately 20% ownership interest in the combined company. Following the announcement, several shareholders filed class action lawsuits in California and Nevada seeking to enjoin the Merger. The plaintiffs in each case alleged that members of the Company’s Board of Directors breached their fiduciary duties to the shareholders by agreeing to a merger that allegedly undervalued the Company. VTBH and the Company were named as defendants in these lawsuits under the theory that they had aided and abetted the Company’s Board of Directors in allegedly violating their fiduciary duties. The plaintiffs in both cases sought a preliminary injunction seeking to enjoin closing of the Merger, which, by agreement, was heard by the Nevada court with the California plaintiffs invited to participate. On December 26, 2013, the court in the Nevada case denied the plaintiffs’ motion for a preliminary injunction. Following the closing of the Merger, the Nevada plaintiffs filed a second amended complaint, which made essentially the same allegations and sought monetary damages as well as an order rescinding the Merger. The California plaintiffs dismissed their action without prejudice, and sought to intervene in the Nevada action, which was granted. Subsequent to the intervention, the plaintiffs filed a third amended complaint, which made essentially the same allegations as prior complaints and sought monetary damages. On June 20, 2014, VTBH and the Company moved to dismiss the action, but that motion was denied on August 28, 2014. On September 14, 2017, a unanimous en banc panel of the Nevada Supreme Court granted defendants’ petition for writ of mandamus and ordered the trial court to dismiss the complaint but provided a limited basis upon which plaintiffs could seek to amend their complaint. Plaintiffs amended their complaint on December 1, 2017 to assert the same claims in a derivative capacity on behalf of the Company, as a well as in a direct capacity, against VTBH, Stripes Group, LLC, SG VTB Holdings, LLC, and the former members of the Company’s Board of Directors. All defendants moved to dismiss this amended complaint on January 2, 2018, and those motions were denied on March 13, 2018. Defendants petitioned the Nevada Supreme Court to reverse this ruling on April 18, 2018. On June 15, 2018, the Nevada Supreme Court denied defendants’ writ petition without prejudice. The district court subsequently entered a pretrial schedule and set trial for November 2019. On January 18, 2019, the district court certified a class of shareholders of the Company as of January 15, 2014. On October 11, 2019, the parties notified the District Court that they had reached a settlement that would resolve the pending action if ultimately approved by the Court. On January 13, 2020, the District Court preliminarily approved the settlement agreement between the plaintiffs and all defendants. A final approval hearing has been scheduled for May 18, 2020. All pending court dates and deadlines, including the trial date, have been stayed while the parties proceed with the settlement process.

 

Commercial Dispute: On July 20, 2016, Bigben Interactive S.A. (“BigBen”) filed a statement of claim before the Regional Court of Berlin, Germany against VTB, which statement of claim was formally serviced upon VTB on June 28, 2017.  The statement of claim alleges that VTB’s termination of a distribution agreement by and between BigBen and VTB breached the terms thereof and was invalid, and that BigBen is entitled to damages amounting to €5.0 million plus accrued interest thereon plus certain additional damages as a result of such invalid termination. VTB filed its statement of defense with the court on September 21, 2017. On January 7, 2019, the Regional Court of Berlin issued its judgment on this dispute, dismissing BigBen’s claim in its entirety. On February 7, 2019, BigBen Interactive S.A. filed an appeal against the judgment of the Regional Court of Berlin on January 7, 2019 (the "Judgment"). On April 15, 2019, Big Ben provided the reasoning for its appeal against the Judgment. On June 21, 2019, VTB replied to the reasoning for the appeal. Upon Big Ben’s application, the Higher Regional Court of Berlin has reviewed the provisions of the Judgment specifically relating to preliminary enforceability of the Judgment in separate proceedings and before the appellate proceedings regarding the main part of the Judgment. On July 9, 2019, the Higher Regional Court of Berlin completely rejected Big Ben’s applications with regard to the suspension of the preliminary enforceability of the Judgment. On November 19, 2019, an oral hearing was

17


 

held at the Higher Regional Court of Berlin on Big Ben’s appeal against the Judgement on January 7, 2019. The next oral hearing at the Higher Regional Court of Berlin is scheduled for June 5, 2020.

 

Employment Litigation: On April 20, 2017, a former employee filed an action in the Superior Court for the County of San Diego, State of

California. The complaint alleges claims including wrongful termination, retaliation and various other provisions of the California Labor Code.

The complaint seeks unspecified economic and non-economic losses, as well as allegedly unpaid wages, unreimbursed business expenses, statutory penalties, interest, punitive damages and attorneys’ fees. The Company filed a cross-complaint against the former employee on May

25, 2017 for certain activities related to his employment with the Company. Discovery is closed and the case was set for trial on April 6, 2020 in San Diego County Superior Court. Due to the COVID-19 outbreak, the April 6, 2020 trial date was vacated, and a new trial date will be set.

The Company will continue to vigorously defend itself in the foregoing matters. However, litigation and investigations are inherently uncertain. Accordingly, the Company cannot predict the outcome of these matters. The Company has not recorded any accrual at March 31, 2020 for contingent losses associated with these matters based on its belief that losses, while possible, are not probable. Further, any possible range of loss cannot be reasonably estimated at this time. The unfavorable resolution of these matters could have a material adverse effect on the Company’s business, results of operations, financial condition, or cash flows. The Company is engaged in other legal actions, not described above, arising in the ordinary course of its business and, while there can be no assurance, believes that the ultimate outcome of these other legal actions will not have a material adverse effect on its business, results of operations, financial condition, or cash flows.

Warranties

The Company warrants its products against certain manufacturing and other defects. These product warranties are provided for specific periods of time depending on the nature of the product. Warranties are generally fulfilled by replacing defective products with new products. The following table provides the changes in our product warranty reserve, which are included in accrued liabilities:

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2020

 

 

2019

 

 

 

(in thousands)

 

Warranty, beginning of period

 

$

743

 

 

$

668

 

Warranty costs accrued

 

 

146

 

 

 

243

 

Settlements of warranty claims

 

 

(177

)

 

 

(207

)

Warranty, end of period

 

$

712

 

 

$

704

 

 

Operating Leases - Right of Use Assets 

The Company adopted ASU 2016-02, Leases, on January 1, 2019. The Company determines whether an arrangement is a lease at inception. The Company leases office spaces that provide for future minimum rental lease payments under non-cancelable operating leases that have remaining lease terms of one year to nine years, and do not contain any material residual value guarantees or material restrictive covenants.

The components of the right-of-use assets and lease liabilities were as follows:

 

 

 

Balance Sheet Classification

 

March 31, 2020

 

 

 

 

 

(in thousands)

 

Right-of-use assets

 

Other assets

 

$

1,577

 

 

 

 

 

 

 

 

Lease liability obligations, current

 

Other current liabilities

 

$

540

 

Lease liability obligations, noncurrent

 

Other liabilities

 

 

1,079

 

Total lease liability obligations

 

 

 

$

1,619

 

Weighted-average remaining lease term (in years)

 

 

 

 

2.9

 

Weighted-average discount rate

 

 

 

 

3.75

%

 

During the three months ended March 31, 2020, the Company recognized approximately $0.3 million of lease costs in operating expenses and approximately $0.2 million of operating cash flows from operating leases.

18


 

Approximate future minimum lease payments for the Company’s right of use assets over the remaining lease periods as of March 31, 2020, are as follows:

 

 

 

(in thousands)

 

2020

 

$

491

 

2021

 

 

575

 

2022

 

 

220

 

2023

 

 

97

 

2024

 

 

97

 

Thereafter

 

 

275

 

Total minimum payments

 

 

1,755

 

Less: Imputed interest

 

 

(136

)

Total

 

$

1,619

 

 

Note 14. Subsequent Events

 

On May 5, 2020, Jöllenbeck GmbH and First Wise Media GmbH, two of our distributors and affiliates of the sellers of the ROCCAT business, submitted a bankruptcy filing in Germany.  We do not believe this will have a material impact on our financial condition as we believe that the Company has a right to recover from the sellers under the ROCCAT asset purchase agreement to the extent such distributors fail to pay accounts receivable due to the Company.  We will continue to monitor the situation and our conclusion on the collectability of any outstanding balances may change in the future.

 

19


 

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our operations should be read together with our unaudited condensed consolidated financial statements and the related notes included in Part I of this Quarterly Report on Form 10-Q and with our audited consolidated financial statements and the related notes included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 13, 2020 (the "Annual Report.")

This Report on Form 10-Q contains forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements in this Report are indicated by words such as “anticipates,” “expects,” “believes,” “intends,” “plans,” “estimates,” “projects,” “strategies” and similar expressions or negatives thereof. Caution should be taken not to place undue reliance on any such forward-looking statements because they involve risks, uncertainties and other factors that could cause actual results to differ materially from those expressed or implied in, or reasonably inferred from, such statements. Forward-looking statements are based on the beliefs, as well as assumptions made by, and information currently available to, the Company's management and are made only as of the date hereof. The Company undertakes no obligation to update or revise the forward-looking statements, whether as a result of new information, future events or otherwise. In addition, forward-looking statements are subject to certain risks and uncertainties, including those described elsewhere in this Quarterly Report on Form 10-Q (including the effects related to the coronavirus (COVID-19) pandemic) that could cause actual results to differ materially from the Company's historical experience and its present expectations or projections.

Business Overview

 

Turtle Beach Corporation (“Turtle Beach” or the “Company”), headquartered in San Diego, California and incorporated in the state of Nevada in 2010, is a premier audio and gaming technology company with expertise and experience in developing, commercializing and marketing innovative products across a range of large addressable markets under the Turtle Beach® and ROCCAT® brands. Turtle Beach is a worldwide leader of feature-rich headset solutions for use across multiple platforms, including video game and entertainment consoles, handheld consoles, personal computers (“PC”), tablets and mobile devices. ROCCAT is a gaming keyboards, mice and other accessories brand focused in the PC peripherals market.

Business Trends

Gaming Headset Market

 

Gaming headsets are part of a growing global software and accessories gaming market sized at approximately $152 billion. The global

gaming audience now exceeds global cinema and music markets with over 2.5 billion active gamers worldwide. Gaming peripherals, such as

headsets, are a $4.1 billion business globally with over 65% of that market in the Americas and Europe where the Company’s business is

focused. Gaming headsets represent more than a $2.7 billion global market, or more than 60% of the total gaming peripherals market.

 

Competitive esports is a global phenomenon where professional gamers train and compete to win prize money, partner with major

brands, and attract/gain dedicated fans – similar to traditional professional sports. There were approximately 443 million esports viewers in

2019, and that is expected to surge to roughly 495 million viewers by 2020 (11.7% YOY), according to a report from Newzoo. Of those 495

million projected viewers, 272 million will identify as “occasional viewers” and 223 million will consider themselves “esports enthusiasts”. We believe a quality gaming headset is a must-have piece of equipment for any competitive gamer.

Many gamers play online where a gaming headset (which typically includes a microphone and allows players to communicate in real-time) provides a more immersive experience in the industry’s most popular games and franchises.

Xbox and PlayStation® consoles are still the dominant gaming platforms in North America and Europe, however, Nintendo’s Switch™

console continues to perform well three years into its lifecycle. In addition to consoles, personal computers are a popular gaming platform where

players utilize a similar style headset. Gaming on mobile/tablet devices represents about a third of the global gaming market, and while

headsets can be used for mobile gaming, console and PC gaming are by far the largest drivers of gaming headset use.

 

Historically, Microsoft and Sony have gone through cycles where their respective console platform is changed significantly or updated to

a new version. When Microsoft and Sony launched Pro versions of their existing console platforms in 2016 and 2017, respectively, that did not

result in the same levels of disruption as previous cycles in the gaming headset business. Turtle Beach believes this is a good indication that

any potential future console transitions will not be as disruptive. In 2019, Microsoft and Sony confirmed plans to release their next generation

consoles, Xbox Series X and PlayStation®5, respectively, in late 2020. Further, industry guidance suggests that with the launch of the new systems, and continued sales of the current consoles, combined console hardware sales will drive market growth in 2021 and 2022.

 


20


 

In 2019, the Nintendo Switch™ completed its second full year in the market with more than 52 million units sold through the end of

December 2019, during which there has been an expanding library of games and an increased number of multiplayer chat-enabled games. In

addition, Nintendo launched a follow-on product, the Nintendo Switch™ Lite, which is the handheld-only version of their popular gaming console.

 

In addition to console sales, we believe the Xbox, PlayStation®, Nintendo, and PC gaming markets are driven by major game launches

and franchises that encourage players to buy equipment and accessories. On Xbox and PlayStation®, flagship games like Call of Duty®,

Destiny, Star Wars: Battlefront, Battlefield, Grand Theft Auto, and battle royale games like Fortnite, Apex Legends and PlayerUnknown’s

Battlegrounds, are examples of major franchises that prominently feature online multiplayer modes which encourage communication and tend

to drive increased gaming headset sales. Many of these established franchises launch new titles annually leading into the holidays and as a

result, the gaming headset business tends to be highly seasonal, often with approximately 36%- 43% of retail sell through occurring primarily in the fourth quarter.

PC Accessories Market

 

PC gaming in the U.S. has seen a resurgence in popularity the past few years while it continues to be a main gaming platform

internationally, driven by big AAA game launches, PC-specific esports leagues, teams and players, content creators and influencers, cross-platform play, and more. While most games are available on multiple platforms, gaming on PC offers advantages including improved graphics, the increased speed and precision of mouse/keyboard controls, and more. Gaming mice and keyboards are engineered to provide gamers with higher-end performance and a superior gaming experience through benefits including faster response times, improved materials and build quality, programmable buttons and keys, software suites to customize and control devices and settings, and more.

 

PC gaming mice come in a variety of different ergonomic shapes and sizes, are available in both wired and wireless models, offer options for different sensors (optical and laser) and responsiveness, and often feature integrated RGB lighting and software to unify with the lighting on other devices for a visually pleasing PC gaming appearance. Similarly, PC gaming keyboards deliver a competitive advantage by registering keystrokes faster than others, offer options for mechanical key switches that feel and sound different, and utilize customizable lighting. The $2.8 billion market for PC gaming headsets, mice and keyboards grew at 6% in 2019 and is forecasted to grow by another 7% in 2020 to almost $3.0 billion.

 

COVID-19 Outlook

 

The effects of the global pandemic and the measures being taken in response are uncertain and difficult to predict. As a result of government mandated stay-at-home orders, the Company’s March and April 2020 revenues have exceeded historical levels as the overall gaming and headset markets have experienced an unprecedented surge in demand. However, the risk of a global economic recession may adversely impact the long-term demand and/or pricing for our products, constrain retail sales of our products, constrain supply of our products, or delay the launch or supply at launch of the next generation Xbox and PlayStation consoles.

 

Key Performance Indicators and Non-GAAP Measures

 

Management routinely reviews key performance indicators including revenue, operating income and margins, and earnings per share, among others. In addition, we believe certain other measures provide useful information to management and investors about us and our financial condition and results of operations for the following reasons: (i) they are measures used by our board of directors and management team to evaluate our operating performance; (ii) they are measures used by our management team to make day-to-day operating decisions; (iii) the adjustments made are often viewed as either non-recurring or not reflective of ongoing financial performance or have no cash impact on operations; and (iv) they are used by securities analysts, investors and other interested parties as a common operating performance measure to compare results across companies in our industry by adjusting for potential differences caused by variations in capital structures (affecting relative interest expense), and the age and book value of facilities and equipment (affecting relative depreciation and amortization expense). These metrics, however, are not measures of financial performance under accounting principles generally accepted in the United States of America (“GAAP”) and, given the limitations of these metrics as analytical tools, should not be considered a substitute for gross profit, gross margins, net income (loss) or other consolidated income statement data as determined in accordance with GAAP. We consider the following non-GAAP measures, which may not be comparable to similarly titled measures reported by other companies, to be key performance indicator

 

 

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

 

 

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

21


 

Adjusted EBITDA (and a reconciliation to Net income, the nearest GAAP financial measure) for the three months ended March 31, 2020 and 2019, are as follows:

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2020

 

 

2019

 

 

 

(in thousands)

 

Net income (loss)

 

$

(3,555

)

 

$

3,055

 

Interest expense

 

 

169

 

 

 

244

 

Depreciation and amortization

 

 

1,255

 

 

 

1,102

 

Stock-based compensation

 

 

999

 

 

 

522

 

Income tax expense (benefit)

 

 

(1,824

)

 

 

164

 

Unrealized loss (gain) on financial instrument obligation

 

 

-

 

 

 

(1,601

)

Change in fair value of contingent consideration

 

 

21

 

 

 

 

Business transaction expense

 

 

281

 

 

 

780

 

Adjusted EBITDA

 

$

(2,654

)

 

$

4,266

 

 

 

 

Comparison of the Three Months Ended March 31, 2020 to the Three Months Ended March 31, 2019

Net loss for the three months ended March 31, 2020 was $3.6 million, compared to net income of $3.1 million in the prior year period, inclusive of a $1.6 million unrealized financial instrument obligation gain.

For the three months ended March 31, 2020, Adjusted EBITDA was ($2.7) million compared to $4.3 million for the three months ended March 31, 2019, on lower revenue as consumer demand declined as a result of new console announcements. This revenue decline was partially offset by an acceleration at quarter-end due to state and local stay-at-home orders.

Results of Operations

The following table sets forth the Company’s statements of operations for the periods presented:

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2020

 

 

2019

 

 

 

(in thousands)

 

Net revenue

 

$

35,007

 

 

$

44,846

 

Cost of revenue

 

 

24,222

 

 

 

30,059

 

Gross profit

 

 

10,785

 

 

 

14,787

 

Operating expenses

 

 

15,798

 

 

 

12,986

 

Operating income (loss)

 

 

(5,013

)

 

 

1,801

 

Interest expense

 

 

169

 

 

 

244

 

Other non-operating expense (income), net

 

 

197

 

 

 

(1,662

)

Income (loss) before income tax

 

 

(5,379

)

 

 

3,219

 

Income tax expense (benefit)

 

 

(1,824

)

 

 

164

 

Net income (loss)

 

$

(3,555

)

 

$

3,055

 

 

22


 

Net Revenue and Gross Profit

The following table summarizes net revenue and gross profit for the periods presented:

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2020

 

 

2019

 

 

 

(in thousands)

 

Net Revenue

 

$

35,007

 

 

$

44,846

 

Gross Profit

 

$

10,785

 

 

$

14,787

 

Gross Margin

 

 

30.8

%

 

 

33.0

%

Cash Margin (1)

 

 

32.7

%

 

 

33.5

%

 

(1) Excludes non-cash charges

Comparison of the Three Months Ended March 31, 2020 to the Three Months Ended March 31, 2019

 

Net revenue for the three months ended March 31, 2020 was $35.0 million, a $9.8 million decrease from $44.8 million in the prior year period when retailers replenished stock on continued consumer battle royale driven demand. The overall market for console gaming accessories was disrupted by the announcements of new Xbox and PlayStation consoles for the first two months of 2020, before the market accelerated due to the pandemic-related stay-at-home orders in our major markets starting in March.

 

For the three months ended March 31, 2020, gross profit as a percentage of net revenue decreased to 30.8% from 33.0% in the comparable prior year period. Margins were negatively impacted primarily by the continued impact of tariffs and a decline in volume-based fixed cost leveraging, partially offset by favorable product mix.

Operating Expenses

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2020

 

 

2019

 

 

 

(in thousands)

 

Selling and marketing

 

$

7,648

 

 

$

6,881

 

Research and development

 

 

2,427

 

 

 

1,456

 

General and administrative

 

 

5,723

 

 

 

4,649

 

Total operating expenses

 

$

15,798

 

 

$

12,986

 

 

Selling and Marketing

Selling and marketing expenses for the three months ended March 31, 2020 totaled $7.6 million compared to $6.9 million for the three months ended March 31, 2019. This increase was primarily due to the inclusion of acquired ROCCAT-related headcount, volume-based direct sales related fees and digital marketing spend, partially offset by decreases in retail marketing initiatives and advertising display depreciation.  

Research and Development

Research and development costs for the three months ended March 31, 2020 and 2019 were $2.4 million and $1.5 million, respectively. Such increases were primarily due to the inclusion of acquired ROCCAT-related product development costs and increased patent-related expenses.

23


 

General and Administrative

General and administrative expenses for the three months ended March 31, 2020 totaled $5.7 million compared to $4.6 million for the three months ended March 31, 2019. Excluding the acquisition integration costs of $0.3 million, the year-over-year increase was primarily due to the inclusion of acquired ROCCAT-related expenses and higher non-cash stock compensation expense.

Other Non-Operating Expense (Income)

Other non-operating loss totaled $0.2 million for the three months ended March 31, 2020 compared to other non-operating income of $1.7 million for the three months ended March 31, 2019, which included a $1.6 million unrealized gain related to the change in fair value of a financial instrument obligation.

Income Taxes

Income tax benefit for the three months ended March 31, 2020 was $1.8 million at an effective tax rate of 33.9%. Income tax expense for the three months ended March 31, 2019 was $0.2 million at an effective tax rate of 5.1%. The effective tax rate for the three months ended March 31, 2020 was primarily impacted by permanent items including global intangible low income taxed income and executive compensation, and certain state tax expense.

Liquidity and Capital Resources

Our primary sources of working capital are cash flows from operations and availability under our revolving credit facility. We have funded operations and acquisitions in recent periods with operating cash flows.

The following table summarizes our sources and uses of cash:

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2020

 

 

2019

 

 

 

(in thousands)

 

Cash and cash equivalents at beginning of period

 

$

8,249

 

 

$

7,078

 

Net cash provided by operating activities

 

 

17,526

 

 

 

40,962

 

Net cash used for investing activities

 

 

(890

)

 

 

(557

)

Net cash used for financing activities

 

 

(15,384

)

 

 

(37,463

)

Effect of foreign exchange on cash

 

 

(768

)

 

 

136

 

Cash and cash equivalents at end of period

 

$

8,733

 

 

$

10,156

 

 

Operating activities

Cash provided by operating activities for the three months ended March 31, 2020 was $17.5 million, a decrease of $23.4 million as compared to $41.0 million for the three months ended March 31, 2019. The decrease is primarily the result of lower gross receipts, increased contract manufacture payments and incremental ROCCAT brand personnel and product development related costs.

Investing activities

Cash used for investing activities was $0.9 million for the three months ended March 31, 2020 compared to $0.6 million for the three months ended March 31, 2019, primarily due to additional advertising display and manufacturing investments.

Financing activities

Net cash used for financing activities was $15.4 million during the three months ended March 31, 2020 compared to $37.5 million during the three months ended March 31, 2019. Financing activities during the three months ended March 31, 2020 consisted of net repayments on our revolving credit facility of $15.4 million compared to net repayments of $37.4 million during the three months ended March 31, 2019.

Management assessment of liquidity

Management believes that our current cash and cash equivalents, the amounts available under our revolving credit facility and cash flows derived from operations will be sufficient to meet anticipated cash needs for working capital and capital expenditures for at least the next twelve months.

24


 

Significant assumptions underlie this belief, including, among other things, that there will be no material adverse developments in our business, liquidity or capital requirements.

Foreign cash balances at March 31, 2020 and December 31, 2019 were $2.2 million and $5.9 million, respectively.

Revolving Credit Facility

On December 17, 2018, Turtle Beach and certain of its subsidiaries entered into an amended and restated loan, guaranty and security agreement (“Credit Facility”) with Bank of America, N.A. (“Bank of America”), as Agent, Sole Lead Arranger and Sole Bookrunner, which replaced the then existing asset-based revolving loan agreement. The Credit Facility, which expires on March 5, 2024, provides for a line of credit of up to $80 million inclusive of a sub-facility limit of $12 million for TB Europe, a wholly-owned subsidiary of Turtle Beach. In addition, the Credit Facility provides for a $40 million accordion feature and the ability to increase the borrowing base with a FILO Loan of up to $6.8 million. 

On May 31, 2019, the Company amended the Credit Facility to provide for, amongst other items, (i) the addition of TBC Holding Company LLC, a wholly-owned subsidiary of VTB, as an obligor and (ii) the ability to make investments in TB Germany GmbH, a wholly-owned subsidiary of TB Europe, of up to $4 million in connection with the acquisition of ROCCAT and up to an additional $4 million annually.

The maximum credit availability for loans and letters of credit under the Credit Facility is governed by a borrowing base determined by the application of specified percentages to certain eligible assets, primarily eligible trade accounts receivable and inventories, and is subject to discretionary reserves and revaluation adjustments. The Credit Facility may be used for working capital, the issuance of bank guarantees, letters of credit and other corporate purposes.

Amounts outstanding under the Credit Facility bear interest at a rate equal to either a rate published by Bank of America or the LIBOR rate, plus in each case, an applicable margin, which is between 0.50% to 1.25% for base rate loans and between 1.25% to 2.00% for U.S. LIBOR loans and U.K. loans, and between 2.00% to 2.75% for the FILO loan. In addition, Turtle Beach is required to pay a commitment fee on the unused revolving loan commitment at a rate ranging from 0.25% to 0.50% and letter of credit fees and agent fees. As of March 31, 2020, interest rates for outstanding borrowings were 3.75% for base rate loans and 3.00% for LIBOR rate loans.

The Company is subject to quarterly financial covenant testing if certain availability thresholds are not met or certain other events occur (as defined in the Credit Facility). At such times, the Credit Facility requires the Company and its restricted subsidiaries to maintain a fixed charge coverage ratio of at least 1.00 to 1.00 as of the last day of each fiscal quarter.

The Credit Facility also contains affirmative and negative covenants that, subject to certain exceptions, limit our ability to take certain actions, including the Company’s ability to incur debt, pay dividends and repurchase stock, make certain investments and other payments, enter into certain mergers and consolidations, engage in sale leaseback transactions and transactions with affiliates, and encumber and dispose of assets. Obligations under the Credit Facility are secured by a security interest and lien upon substantially all of the Company’s assets.

As of March 31, 2020, the Company was in compliance with all financial covenants under the Credit Facility, as amended, and excess borrowing availability was approximately $21.4 million.

Critical Accounting Estimates

Our discussion and analysis of our results of operations and capital resources are based on our consolidated financial statements, which have been prepared in conformity with GAAP. The preparation of these consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses and the disclosure of contingent assets and liabilities. Management bases its estimates, assumptions and judgments on historical experience and on various other factors that it believes to be reasonable under the circumstances.

Different assumptions and judgments would change the estimates used in the preparation of the condensed consolidated financial statements, which, in turn, could change the results from those reported. Management evaluates its estimates, assumptions and judgments on an ongoing basis.

See Note 2, “Summary of Significant Accounting Policies,” to the unaudited condensed consolidated financial statements contained herein for a complete discussion of recent accounting pronouncements. We are currently evaluating the impact of certain recently issued guidance on our financial condition and results of operations in future periods.

Item 3 - Qualitative and Quantitative Disclosures about Market Risk

Market risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and rates. The Company’s market risk exposure is primarily a result of fluctuations in interest rates, foreign currency exchange rates and inflation.

 

25


 

The Company has used derivative financial instruments, specifically foreign currency forward and option contracts, to manage exposure to foreign currency risks, by hedging a portion of its forecasted expenses denominated in British Pounds expected to occur within a year. The

effect of exchange rate changes on foreign currency forward and option contracts is expected to offset the effect of exchange rate changes on the underlying hedged item. The Company does not use derivative financial instruments for speculative or trading purposes. As of March 31, 2020 and December 31, 2019, we did not have any derivative financial instruments.

Foreign Currency Exchange Risk

The Company has exchange rate exposure primarily with respect to the British Pound. As of March 31, 2020 and December 31, 2019, our monetary assets and liabilities that are subject to this exposure are immaterial, therefore the potential immediate loss to us that would result from a hypothetical 10% change in foreign currency exchange rates would not be expected to have a material impact on our earnings or cash flows. This sensitivity analysis assumes an unfavorable 10% fluctuation in the exchange rates affecting the foreign currencies in which monetary assets and liabilities are denominated and does not take into account the offsetting effect of such a change on our foreign currency denominated revenues.

Inflation Risk

The Company is exposed to market risk due to the possibility of inflation, such as increases in the cost of its products. Although the Company does not believe that inflation has had a material impact on its financial position or results of operations to date, a high rate of inflation in the future may have an adverse effect on the Company’s ability to maintain current levels of gross margin and selling, general and administrative expenses as a percentage of net revenue if the selling prices of products do not increase with these increased costs.

Item 4 - Controls and Procedures

Disclosure Controls and Procedures

Disclosure controls and procedures (as defined in Rules 13(a)-15(e) and 15(d)-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), are designed to ensure that (1) information required to be disclosed in reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms; and (2) that such information is accumulated and communicated to management, including the principal executive officer and principal financial officer, to allow timely decisions regarding required disclosures.

At the conclusion of the period covered by this Quarterly Report on Form 10-Q, we carried out an evaluation, under the supervision of our Chief Executive Officer (our principal executive officer, or PEO) and our Chief Financial Officer (our principal financial officer, or PFO), of the effectiveness of the design and operation of our disclosure controls and procedures. Based upon that evaluation, our PEO and PFO concluded that our disclosure controls and procedures, as defined in Rule 13a-15(e) of the Exchange Act, were effective as of March 31, 2020.

Changes in Internal Control over Financial Reporting

There have been no changes in our internal control over financial reporting during the period covered that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Our process for evaluating controls and procedures is continuous and encompasses constant improvement of the design and effectiveness of established controls and procedures and the remediation of any deficiencies, which may be identified during this process.

Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

26


 

PART II. OTHER INFORMATION

Item 1 - Legal Proceedings

Please refer to Note 13, “Commitments and Contingencies” in the notes to the unaudited condensed consolidated financial statements included in Part I, Item 1 of this Report on Form 10-Q, which is incorporated into this item by reference.

Item 1A - Risk Factors

The following discussion of risk factors contains forward-looking statements. These risk factors may be important to understanding any statement in this Form 10-Q or elsewhere. The following information should be read in conjunction with our financial statements and related notes in Part I, Item 1, “Financial Statements” and Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Form 10-Q.

Because of the following factors, as well as other factors affecting the Company’s financial condition and operating results, past financial performance should not be considered to be a reliable indicator of future performance, and investors should not use historical trends to anticipate results or trends in future periods.

Risks Related to COVID-19

The effects of the COVID-19 outbreak could adversely affect our business, results of operations, and financial condition.

 

The effects of a public health crisis caused by the COVID-19 outbreak and the measures being taken in response are uncertain and difficult to predict, but may include:

 

 

A decrease in the long-term demand and/or pricing for our products, and a global economic recession that could further reduce demand and/or pricing for our products, resulting from actions taken by governments, businesses, and/or the general public in an effort to limit exposure to and spreading of such infectious diseases, such as travel restrictions, quarantines, and business shutdowns or slowdowns;

 

 

Negative impacts to our operations, including reductions in efficiency and productivity and increased costs resulting from efforts to mitigate the impact of COVID-19;

 

 

Negative impacts on our results of operations could have an adverse effect on our ability to realize deferred tax assets;

 

 

Deterioration of worldwide credit and financial markets that could limit our ability to obtain financing, result in losses due to failures of financial institutions and other parties, and cause a higher rate of losses on our accounts receivables due to defaults and bankruptcies;

 

 

Deterioration of the financial condition or liquidity, or interruptions to the operations, of our customers, including retailers and distributions, could adversely affect the distribution, availability and sales of our products;

 

 

Disruptions to our supply chain in connection with the sourcing and transportation of materials and services from geographic areas that have been impacted by COVID-19 and by efforts to contain the spread of COVID-19; and

 

 

Disruptions in foot traffic to our retailers in connection with retailer shutdowns or slowdowns could disrupt retail customer awareness and demand for our products.

 

The resumption of normal business operations after such interruptions may be delayed or constrained by lingering effects of COVID-19 on our employees, suppliers, manufactures, distributors, retailers, third-party service providers, and/or customers.

 

These effects, alone or taken together, could have a material adverse effect on our business, results of operations or financial condition. A sustained or prolonged outbreak could exacerbate such adverse impact.

Risks Related to Our Operations

We depend upon the success and availability of third-party gaming platforms and release of certain game titles to drive sales of our headset products.

The performance of our headset business is affected by the continued success of third-party gaming platforms, such as Microsoft's Xbox consoles and Sony's PlayStation® consoles, as well as video games developed by such manufacturers and other third-party publishers. Our

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business could suffer if any of these parties fail to continue to drive the success of these platforms, develop new or enhanced videogame platforms, develop popular game and entertainment titles for current or future generation platforms or produce and timely release sufficient quantities of such consoles. Further, if a platform is withdrawn from the market or fails to sell, we may be forced to liquidate inventories relating to that platform or accept returns resulting in significant losses.

In 2018, the battle royale genre, such as Fortnite, Apex Legends and PlayerUnknown's Battlegrounds, expanded gaming markets and increased demand for our headset products. If console and personal computer game titles that are enhanced by the use of gaming headsets decline in number, popularity, or are delayed, our revenue and profits may decrease substantially and our business may be adversely affected.

Our brands face significant competition from other consumer electronics companies and this competition could have a material adverse effect on our financial condition and results of operations.

We compete with other producers of video game accessories, including the video game console manufacturers. Our competitors may spend more money and time on developing and testing products, undertake more extensive marketing campaigns, adopt more aggressive pricing policies, pay higher fees to licensors for motion picture, television, sports, music and character properties, or develop more commercially successful products for the personal computer or video game platforms than we do. In addition, competitors with large product lines and popular products, in particular the video game console manufacturers, typically have greater leverage with retailers, distributors and other customers, who may be willing to promote products with less consumer appeal in return for access to those competitors’ more popular products.

In the event that a competitor reduces prices, we could be forced to respond by lowering our prices to remain competitive. If we are forced to lower prices, we may be required to “price protect” products that remain unsold in our customers’ inventories at the time of the price reduction. Price protection results in our issuing a credit to our customers in the amount of the price reduction for each unsold unit in that customer’s inventory. Our price protection policies, which are customary in the industry, can have a major impact on our sales and profitability.

In addition, if console manufacturers implement new technologies, through hardware or software, which would cause our headsets to become incompatible with that hardware manufacturer’s console, there could be unanticipated delays in the release of our products as well as increases to projected development, manufacturing, marketing or distribution costs, any of which could harm our business and financial results.

Further, new and emerging technologies and alternate platforms for gaming, such as mobile devices and virtual reality devices, could make the consoles for which our headsets are designed less attractive or, in time, obsolete, which could require us to transition our business model such as develop products for other gaming platforms. 

The industries in which we operate are subject to competition in an environment of rapid technological change, and if we do not adapt to, and appropriately allocate our resources among, emerging technologies, our revenues could be negatively affected.

We must make substantial product development and other investments to align our product portfolio and development efforts in response to market changes in the gaming industry. We must anticipate and adapt our products to emerging technologies in order to keep those products competitive. When we choose to incorporate a new technology into our products or to develop a product for a new platform or operating system, we are often required to make a substantial investment prior to the introduction of the product. If we invest in the development of a new technology or for a new platform that does not achieve significant commercial success, our revenues from those products likely will be lower than anticipated and may not cover our costs.

Further, our competitors may adapt to an emerging technology more quickly or effectively than we do, creating products that are technologically superior to ours, more appealing to consumers, or both. If, on the other hand, we elect not to pursue the development of products incorporating a new technology or for new platforms that achieve significant commercial success, our revenues could also be adversely affected. It may take significant time and resources to shift product development resources to that technology or platform and it may be more difficult to compete against existing products incorporating that technology or for that platform. Any failure to successfully adapt to, and appropriately allocate resources among, emerging technologies could harm our competitive position, reduce our share and significantly increase the time it takes us to bring popular products to market.

There are numerous steps required to develop a product from conception to commercial introduction and to ensure timely shipment to retail customers, including designing, sourcing and testing the electronic components, receiving approval of hardware and other third-party licensors, factory availability and manufacturing and designing the graphics and packaging. Any difficulties or delays in the product development process will likely result in delays in the contemplated product introduction schedule. It is common in new product introductions or product updates to encounter technical and other difficulties affecting manufacturing efficiency and, at times, the ability to manufacture the product at all. Although these difficulties can be corrected or improved over time with continued manufacturing experience and engineering efforts, if one or more aspects necessary for the introduction of products are not completed as scheduled, or if technical difficulties take longer than anticipated to overcome, the product introductions will be delayed, or in some cases may be terminated. No assurances can be given that our products will be introduced in a timely fashion, and if new products are delayed, our sales and revenue growth may be limited or impaired.

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Our business could be adversely affected by actions on trade by domestic and foreign governments.

The U.S. government has altered its approach to international trade policy and in some cases renegotiated, or terminated, certain existing bilateral or multi-lateral trade agreements and treaties with foreign countries, including the North American Free Trade Agreement (“NAFTA”). In addition, the U.S. government has initiated or is considering imposing tariffs on certain foreign goods, including consumer goods. Related to this action, certain foreign governments, including China, have instituted or are considering imposing tariffs on certain U.S. goods. It remains unclear what the U.S. Administration or foreign governments will or will not do with respect to tariffs, NAFTA or other international trade agreements and policies. A trade war or other governmental action related to tariffs or international trade agreements or policies has the potential to adversely impact demand for our products, our costs, customers, suppliers and/or the U.S. economy or certain sectors thereof and, thus, to adversely impact our businesses. The majority of our production occurs in foreign jurisdictions, including China, Taiwan and Vietnam and the majority of our products are currently not subject to tariffs.  While we are exploring a further shift to manufacturing partners in jurisdictions that are not subject to U.S. tariffs, delays related to such transitions or changes in the U.S. tariffs could have a negative impact on our results of operations and competitive position.

 

Our business could be adversely affected by significant movements in foreign currency exchange rates.

We are exposed to fluctuations in foreign currency transaction exchange rates, particularly with respect to the Euro and British Pound. Any significant change in the value of currencies of the countries in which we do business relative to the value of the U.S. dollar could affect our ability to sell products competitively and control our cost structure. Additionally, we are subject to foreign exchange translation risk due to changes in the value of foreign currencies in relation to our reporting currency, the U.S. dollar. The translation risk is primarily concentrated in the exchange rate between the U.S. dollar and the British Pound. As the U.S. dollar fluctuates against other currencies in which we transact business, revenue and income can be impacted.

A significant portion of our revenue is derived from a few large customers, and the loss of any such customer, or a significant reduction in purchases by such customer, could have a material adverse effect on our business, financial condition and results of operations.

During 2019, our three largest individual customers accounted for approximately 42% of our gross sales in the aggregate. The loss of, or financial difficulties experienced by, any of these or any of our other significant customers, including as a result of the bankruptcy of a customer, could have a material adverse effect on our business, results of operations, financial condition and liquidity. We do not have long-term agreements with these or other significant customers and our agreements with these customers do not require them to purchase any specific amount of products. All of our customers generally purchase from us on a purchase order basis. As a result, agreements with respect to pricing, returns, cooperative advertising or special promotions, among other things, are subject to periodic negotiation with each customer. No assurance can be given that these or other customers will continue to do business with us or that they will maintain their historical levels of business. In addition, the uncertainty of product orders can make it difficult to forecast our sales and allocate our resources in a manner consistent with actual sales, and our expense levels are based in part on our expectations of future sales. If our expectations regarding future sales are inaccurate, we may be unable to reduce costs in a timely manner to adjust for sales shortfalls. In addition, financial difficulties experienced by a significant customer could increase our exposure to uncollectible receivables and the risk that losses from uncollected receivables exceed the reserves we have set aside in anticipation of this risk or limit our ability to continue to do business with such customers.

The manufacture, supply and shipment of our products are dependent upon a limited number of third parties, and our success is dependent upon the ability of these parties to manufacture, supply and ship sufficient quantities of their product components to us in a timely fashion, as well as the continued viability and financial stability of these third-parties.

Because we rely on a limited number of manufacturers and suppliers for our products, we may be materially and adversely affected by the failure of any of those manufacturers and suppliers to perform as expected or supply us with sufficient quantities of their product components to ensure consumer availability of our own products. Our manufacturers and suppliers’ ability to supply products to us is also subject to a number of risks, including the availability of raw materials, their financial instability, the destruction of their facilities, epidemics or work stoppages. Any shortage of raw materials or components or an inability to control costs associated with manufacturing could increase our costs or impair our ability to ship orders in a timely and cost-efficient manner. As a result, we could experience cancellations of orders, refusal to accept deliveries or a reduction in our prices and margins, any of which could harm our financial performance and results of operations.

The outbreak of COVID-19 has led to work and travel restrictions globally which in turn has led to factory closures, interruptions in supply chains, increased regulation and workforce shortages. These issues and others, may make it difficult for our suppliers and manufacturers to source raw materials or components, manufacture finished goods and export our products. There may be significant and material disruptions to our supply chain and operations, and delays in the manufacture and shipment of our products, which may then have a material adverse effect on our results of operations.

Moreover, there can be no assurance that such manufacturers and suppliers will not refuse to supply us at prices we deem acceptable, independently market their own competing products in the future, or otherwise discontinue their relationships with us. Our failure to maintain these existing manufacturing and supplier relationships, or to establish new relationships on similar terms in the future, could have a material adverse effect on our business, results of operations, financial condition and liquidity.

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In particular, certain of our products have a number of components and subassemblies produced by outside suppliers. In addition, for certain of these items, we qualify only a single source of supply with long lead times, which can magnify the risk of shortages or result in excess supply and also decreases our ability to negotiate price with our suppliers. Also, if we experience quality problems with suppliers, then our production schedules could be significantly delayed or costs significantly increased, which could have an adverse effect on our business, liquidity, results of operation and financial position.

In addition, the ongoing effectiveness of our supply chain is dependent on the timely performance of services by third parties shipping products and materials to and from our warehouse facilities and other locations. If we encounter problems with these shipments, our ability to meet retailer expectations, manage inventory, complete sales and achieve objectives for operating efficiencies could be materially adversely affected and we may be required to incur material additional costs for expedited shipping, including air freight. We have experienced some of these problems in the past and we cannot assure you that we will not experience similar problems in the future. 

Our net sales and operating income fluctuate on a seasonal basis and decreases in sales or margins during peak seasons could have a disproportionate effect on our overall financial condition and results of operations.

Historically, a majority of our annual revenues have been generated during the holiday season of September to December. If we do not accurately forecast demand for particular products, we could incur additional costs or experience manufacturing delays. Any shortfall in net sales during this period would cause our annual results of operations to suffer significantly.

Demand for our products depends on many factors such as consumer preferences and the introduction or adoption of game platforms and related content and can be difficult to forecast. If we misjudge the demand for our products, we could face the following problems in our operations, each of which could harm our operating results:

 

If our forecasts of demand for products are too high, we may accumulate excess inventories of products, which could lead to markdown allowances or write-offs affecting some or all of such excess inventories. We may also have to adjust the prices of our existing products to reduce such excess inventories;

 

If demand for specific products increases beyond what we forecast, our suppliers and third-party manufacturers may not be able to increase production quickly enough to meet the demand. Our failure to meet market demand may lead to missed opportunities to increase our base of gamers, damage our relationships with retailers or harm our business;

 

The on-going console transition increases the likelihood that we could fail to accurately forecast demand for our new generation console headsets and our existing headsets; and

 

Rapid increases in production levels to meet unanticipated demand could result in increased manufacturing errors, as well as higher component, manufacturing and shipping costs, all of which could reduce our profit margins and harm our relationships with retailers and consumers.

If we are unable to continue to develop innovative and popular products, or if our design and marketing efforts do not effectively raise the recognition and reputation of our brands, we may not be able to successfully implement our gaming accessory growth strategy.

We believe that our ability to extend the recognition and favorable perception of our Turtle Beach brand, and the recently acquired ROCCAT brand, is critical to implement our gaming accessory growth strategy, which includes further establishing our position in existing gaming headsets, developing a strong position in new console headsets, expanding beyond existing console, PC and mobile applications to new technology applications, accelerating our international growth and expanding complementary product categories. To extend the reach of our Turtle Beach brand, we believe we must devote significant time and resources to product design, marketing and promotions. These expenditures, however, may not result in a sufficient increase in net sales to cover such costs.

Transitions in console platforms may adversely affect our headset products.

When new console platforms are announced or introduced into the market, consumers have historically reduced their purchases of game console peripherals and accessories, including headsets, for old generation console platforms in anticipation of new platforms becoming available. During these console transition periods, sales of gaming console headsets related to old generation consoles slow or decline until new platforms are introduced and achieve wide consumer acceptance, which we cannot guarantee. This decrease or decline may not be offset by increased sales of products for the new console platforms. Over time as the old generation platform user base declines, products for the old platforms are typically discontinued which can result in lower margins, excess inventory, excess parts, or similar costs related to end of life of a product model. In addition, as a third party gaming headset company, we are reliant on working with the console manufacturers for our headsets to be compatible with any new console platforms, which if not done on a timely basis may adversely affect sales. Sony and Microsoft may make changes to their platforms that impact how headsets connect with or work with the new consoles which could create a disruption to consumer buying behavior and/or product life-cycles, including if such new consoles are delayed or introduced with limited functionality or compatibility with third party accessories.

As console hardware moves through its life cycle, hardware manufacturers typically enact price reductions, and decreasing prices may put downward pressure on prices for products for such platforms. During platform transitions, we may simultaneously incur costs both in continuing

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to develop and market new products for prior-generation video game platforms, which may not sell at premium prices, and also in developing products for current-generation platforms, which will not generate immediate or near-term revenue. As a result, our operating results during platform transitions are more volatile and difficult to predict than during other times.

Further, technological and other developments may in the future accelerate the frequency of such console transitions resulting in such disruption occurring more frequently. In addition, competing technologies such as tablet-based gaming and virtual reality may result in further disruption to the overall console gaming market.

Any acquisitions we pursue could disrupt our business and harm our financial condition and results of operations.

As part of our business strategy, we review and intend to continue to review acquisition opportunities that we believe would be advantageous or complementary to the development of our business. During the second quarter of 2019, we acquired certain assets of ROCCAT GmbH and its subsidiaries, and we may acquire additional businesses, assets, or technologies in the future. If we make any acquisitions, we could take any or all of the following actions, any one of which could adversely affect our business, financial condition, results of operations or share price:

 

use a significant portion of our available cash;

 

require a significant devotion of management’s time and resources in the pursuit or consummation of any acquisition;

 

incur debt, which may not be available to us on favorable terms and may adversely affect our liquidity;

 

issue equity or equity-based securities that would dilute existing stockholders’ ownership percentage;

 

assume contingent and other liabilities; and

 

take charges in connection with such acquisitions.

Acquisitions also entail numerous other risks, including, without limitation: difficulties in assimilating acquired operations, products, technologies and personnel; unanticipated costs; diversion of management’s attention from existing operations; risks of entering markets in which we have limited or no prior experience; regulatory approvals; unanticipated costs or liabilities; and potential loss of key employees from either our existing business or the acquired organization. Acquisitions may result in accounting charges for restructuring and other expenses, amortization of purchased technology and intangible assets and stock-based compensation expense, any of which could materially and adversely affect our operating results. We may not be able to realize the anticipated synergies, innovation, operational efficiencies, benefits of or successfully integrate with our existing business the businesses, products, technologies or personnel that we acquire, and our failure to do so could harm our business and operating results.

Turtle Beach relies on its partnerships with influencers, athletes and esports teams to expand our market. If we fail to maintain and expand these types of relationships, our business may suffer.

Relationships with new and established influencers, athletes and esports teams have been, and will continue to be critical to our future success. We rely on these partners to assist us in generating increased acceptance and use of our product offerings. We have established a number of these relationships, and our growth depends on establishing new relationships and maintaining existing ones. Certain partners may not view their relationships with us as significant to their own businesses, and they may reassess their commitment to us or decide to compete directly with us in the future. We cannot guarantee that any partner will perform their obligations as agreed or that we would be able to specifically enforce any agreement with them. Our failure to maintain and expand these relationships may adversely impact our future revenue.

The United Kingdom’s exit of the European Union may negatively impact our operations.

The changes to the trading relationship between the United Kingdom (U.K.) and European Union resulting from the U.K.’s exit from the European Union on January 31, 2020 (“Brexit”) will likely result in increased cost of goods imported into and exported from the U.K. and may decrease the profitability of our U.K. and other European operations. Additional currency volatility could result in a weaker British pound, which increases the cost of goods imported into our U.K. operations and may decrease the profitability of our U.K. operations. A weaker British pound versus the Euro and U.S. dollar also causes local currency results of our U.K. operations to be translated into fewer U.S. dollars during a reporting period.  The U.K. is currently in a transition period until December 31, 2020, when agreements regarding tariff , trade, regulatory and other aspects of the U.K.’s future relationship with the European Union and its member status are required to be finalized. Until such agreements are finalized, it is anticipated that there will be both political and economic uncertainty in the United Kingdom as well as the European Union.

Loss of our key management and other personnel could impact our business.

Our future success depends largely upon the continued service of our executive officers and other key management and technical personnel and on our ability to continue to attract, retain and motivate qualified personnel. In addition, competition for skilled and non-skilled employees among companies like ours is intense, and the loss of skilled or non-skilled employees or an inability to attract, retain and motivate additional

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skilled and non-skilled employees required for the operation and expansion of our business could hinder our ability to conduct research activities successfully, develop new products, attract customers and meet customer shipments.

If we are unable to protect our information systems against service interruption, misappropriation of data or breaches of security, our operations could be disrupted, our reputation may be damaged, and we may be financially liable for damages.

We rely heavily on information systems to manage our operations, including a full range of retail, financial, sourcing and merchandising systems. We regularly make investments to upgrade, enhance or replace these systems, as well as leverage new technologies to support our growth strategies. In addition, we have implemented enterprise-wide initiatives that are intended to standardize business processes and optimize performance. Any delays or difficulties in transitioning to new systems or integrating them with current systems or the failure to implement our initiatives in an orderly and timely fashion could result in additional investment of time and resources, which could impair our ability to improve existing operations and support future growth, and ultimately have a material adverse effect on our business.

The reliability and capacity of our information systems are critical. Despite preventative efforts, our systems are vulnerable to damage or interruption from, among other things, natural disasters, technical malfunctions, inadequate systems capacity, human error, power outages, computer viruses and security breaches. Any disruptions affecting our information systems could have a material adverse impact on our business. In addition, any failure to maintain adequate system security controls to protect our computer assets and sensitive data, including associate and client data, from unauthorized access, disclosure or use could damage our reputation with our associates and our clients, exposing us to financial liability, legal proceedings (such as class action lawsuits), and regulatory action. While we have implemented measures to prevent security breaches and cyber incidents, our preventative measures and incident response efforts may not be entirely effective. As a result, we may not be able to immediately detect any security breaches, which may increase the losses that we would suffer. Finally, our ability to continue to operate our business without significant interruption in the event of a disaster or other disruption depends, in part, on the ability of our information systems to operate in accordance with our disaster recovery and business continuity plans.

Our reliance on information systems and other technology also gives rise to cybersecurity risks, including security breach, espionage, system disruption, theft and inadvertent release of information. The occurrence of any of these events could compromise our networks, and the information stored there could be accessed, publicly disclosed, lost or stolen. Any such access, disclosure or other loss of information could result in legal claims or proceedings, liability or regulatory penalties under laws protecting the privacy of personal information, disrupt operations, and damage our reputation, which could adversely affect our business. In addition, as security threats continue to evolve we may need to invest additional resources to protect the security of our systems.

Our results of operations and financial condition may be adversely affected by global business, political, operational, financial and economic conditions.

We face business, political, operational, financial and economic risks inherent in international business, many of which are beyond our control, including:

 

trade restrictions, higher tariffs, currency fluctuations or the imposition of additional regulations relating to import or export of our products, especially in China, where many of our Turtle Beach products are manufactured, which could force us to seek alternate manufacturing sources or increase our costs;

 

difficulties obtaining domestic and foreign export, import and other governmental approvals, permits and licenses, and compliance with foreign laws, which could halt, interrupt or delay our operations if we cannot obtain such approvals, permits and licenses;

 

difficulties encountered by our international distributors or us in staffing and managing foreign operations or international sales, including higher labor costs;

 

transportation delays and difficulties of managing international distribution channels;

 

longer payment cycles for, and greater difficulty collecting, accounts receivable;

 

political and economic instability, including wars, terrorism, political unrest, boycotts, curtailment of trade and other business restrictions, any of which could materially and adversely affect our net sales and results of operations; 

 

public health issues (for example, an outbreak of a contagious disease such as COVID-19); and

 

natural disasters.

Any of these factors could reduce our net sales, decrease our gross margins, increase our expenses or reduce our profitability. Should we establish our own operations in international territories where we currently utilize a distributor, we will become subject to greater risks associated with operating outside of the United States.

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The electronics industry in general has historically been characterized by a high degree of volatility and is subject to substantial and unpredictable variations resulting from changing business cycles. Our operating results will be subject to fluctuations based on general economic conditions, and in particular conditions that impact discretionary consumer spending. Downturns in the worldwide economy could adversely affect our business. For example, the health crisis caused by COVID-19 has caused a downturn in the worldwide economy and resulted in adverse economic conditions across the world. If these conditions continue, we could experience a reduction in demand for our products or a lengthening of consumer replacement schedules for our products. Reduced demand for these products could result in decreases in our average selling prices and product sales. A deterioration of current conditions in worldwide credit markets could limit our ability to obtain financing. A lack of available credit in financial markets may adversely affect the ability of our commercial customers to finance purchases and operations and could result in an absence of orders or spending for our products as well as create supplier disruptions. We are unable to predict the likely duration and severity of any adverse economic conditions and disruptions in financial markets and the effects they will have on our business and its financial condition. Difficult economic conditions may also result in a higher rate of losses on our accounts receivables due to defaults or bankruptcies. As a result, a downturn in the worldwide economy could have a material adverse effect on our business, results of operations, or financial condition.

If we fail to maintain an effective system of internal controls, we may not be able to accurately report financial results or prevent fraud, which could have an adverse effect on our business and financial condition.

Effective internal controls are necessary to provide reliable financial reports and to assist in the effective prevention of fraud. Any inability to provide reliable financial reports or prevent fraud could harm our business. The Sarbanes-Oxley Act requires, among other things, that we evaluate our systems and processes and test our internal controls over financial reporting to allow management and our independent registered public accounting firm, as applicable, to report on the effectiveness of our internal control over financial reporting. We have reported the remediation of a material weakness related to the review of material non-routine transactions or events disclosed in our 2018 Annual Report on Form 10-K.  In the future, if we are not able to remediate any identified material weakness or otherwise comply with the requirements of Section 404 of the Sarbanes-Oxley Act, or if we or our independent registered public accounting firm identifies deficiencies in our internal control over financial reporting that are deemed to be material weaknesses, investors could lose confidence in the accuracy and completeness of our financial reports, the market price of our common stock could decline and we could be subject to sanctions, investigations by the Nasdaq Stock Market, LLC, the SEC or other regulatory authorities, or shareholder litigation.

In addition, failure to maintain effective internal controls could result in financial statements that do not accurately reflect our financial condition or results of operations. There can be no assurance that we will be able to maintain a system of internal controls that fully complies with the requirements of the Sarbanes-Oxley Act of 2002 or that our management and independent registered public accounting firm will continue to conclude that our internal controls are effective.

Risks Related to our Intellectual Property and other Legal and Regulatory Matters

Our competitive position will be adversely damaged if our products are found to infringe on the intellectual property rights of others.

Other companies and our competitors may currently own or obtain patents or other proprietary rights that might prevent, limit or interfere with our ability to make, use or sell our products. Although we do not believe that our products infringe the proprietary rights of any third parties, there can be no assurance that infringement or other legal claims will not be asserted against us or that we will not be found to infringe the intellectual property rights of others. The electronics industry is characterized by vigorous protection and pursuit of intellectual property rights or positions, resulting in significant and often protracted and expensive litigation. In the event of a successful claim of infringement against us and our failure or inability to license the infringed technology, our business and operating results could be adversely affected. Any litigation or claims, whether or not valid, could result in substantial costs or a diversion of our resources. An adverse result from intellectual property litigation could force us to do one or more of the following:

 

cease selling, incorporating or using products or services that incorporate the challenged intellectual property;

 

obtain a license from the holder of the infringed intellectual property right, which license may not be available on reasonable terms, if at all; and/or

 

redesign products or services that incorporate the disputed technology.

If we are forced to take any of the foregoing actions, we could face substantial costs and shipment delays and our business could be seriously harmed. Although we carry general liability insurance, our insurance may not cover potential claims of this type or may be inadequate to insure us for all liability that may be imposed.

In addition, it is possible that our customers or end users may seek indemnity from us in the event that our products are found or alleged to infringe the intellectual property rights of others. Any such claim for indemnity could result in substantial expenses to us that could harm our operating results.

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If we are unable to obtain and maintain intellectual property rights and/or enforce those rights against third parties who are violating those rights, our business could suffer.

We rely on various intellectual property rights, including patents, trademarks, trade secrets and trade dress to protect our Turtle Beach brand name, reputation, product appearance, and technology. Although we have entered into confidentiality and invention assignment agreements with our employees and contractors, and nondisclosure agreements with selected parties with whom we conduct business to limit access to and disclosure of our proprietary information, these contractual arrangements and the other steps we have taken to protect our intellectual property may not prevent misappropriation of that intellectual property or deter independent third-party development of similar technologies. Monitoring the unauthorized use of proprietary technology and trademarks is costly, and any dispute or other litigation, regardless of outcome, may be costly and time consuming and may divert the attention of management and key personnel from our business operations. The steps taken by us may not prevent unauthorized use of proprietary technology or trademarks. Many features of our products are not protected by patents; we may not have the legal right to prevent others from reverse engineering or otherwise copying and using these features in competitive products. If we fail to protect or to enforce our intellectual property rights successfully, our competitive position could suffer, which could adversely affect our financial results.

We are susceptible to counterfeiting of our products, which may harm our reputation for producing high-quality products and force us to incur expenses in enforcing our intellectual property rights. Such claims and lawsuits can be expensive to resolve, require substantial management time and resources, and may not provide a satisfactory or timely result, any of which may harm our results of operations. As some of our products are sold internationally, we are also dependent on the laws of a range of countries to protect and enforce our intellectual property rights. These laws may not protect intellectual property rights to the same extent or in the same manner as the laws of the United States.

Further, we are party to licenses that grant us rights to intellectual property, including trademarks, which are necessary or useful to our Turtle Beach business. One or more of our licensors may allege that we have breached our license agreement with them, and seek to terminate our license. If successful, this could result in our loss of the right to use the licensed intellectual property, which could adversely affect our ability to commercialize our technologies or products, as well as harm our competitive business position and our business prospects.

Our success also depends in part on our ability to obtain and enforce intellectual property protection of our technology, particularly our patents. There is no guarantee any patent be granted on any patent application that we have filed or may file. Claims allowed from existing or pending patents may not be of sufficient scope or strength to protect the economic value of our technologies. Further, any patent that we may obtain will expire, and it is possible that it may be challenged, invalidated or circumvented.

We may initiate claims or litigation against third parties in the future for infringement of our proprietary rights or to determine the scope and validity of our proprietary rights or the proprietary rights of our competitors. These claims could result in costly litigation and divert the efforts of our technical and management personnel. As a result, our operating results could suffer and our financial condition could be harmed.

We are dependent upon third-party intellectual property to manufacture some of our products.

The performance of certain technology used in new generation consoles, such as integrated voice and chat audio from the Xbox One, is improved by a licensed component to ensure compatibility with our products.

While we currently believe that we have the necessary licenses, or can obtain the necessary licenses, in order to produce compatible products, there is no guarantee that our licenses will be renewed or granted in the first instance. Moreover, if these first parties enter into license agreements with companies other than us for their “closed systems” or if we are unable to obtain sufficient quantities of these headset adapters or chips, we would be placed at a competitive disadvantage.

In order for certain of our headsets to connect to the Xbox One's advanced features and controls, a proprietary computer chip or wireless module is required. As a result, with respect to our products designed for the Xbox One, we are currently reliant on Microsoft or their designated supplier to provide us with sufficient quantities. If we are unable to obtain sufficient quantities of these headset adapters or chips, sales of such Xbox One headsets and consequently our revenues would be adversely affected.

We are licensed and approved by Microsoft to develop and sell Xbox One compatible audio products pursuant to a license agreement under which we have the right to manufacture (including through third party manufacturers), market and sell audio products for the Xbox One video game console. Our Xbox One headsets are dependent on this license and headsets for future Xbox consoles may also be dependent on this license. Microsoft has the right to terminate that license under certain circumstances set forth in the agreement. Should that license be terminated, our headset offerings may be limited, thereby significantly reducing our revenues. While Sony does not currently require a license for audio products to be compatible with PlayStation consoles, they could do so in the future.

Accordingly, Microsoft, Sony and other third-party gaming platform manufacturers may control our ability to manufacture headsets compatible with their platforms, and could cause unanticipated delays in the release of our products as well as increases to projected development, manufacturing, licensing, marketing or distribution costs, any of which could negatively impact our business.

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Our products may be subject to warranty claims, product liability and product recalls.

We may be subject to product liability or warranty claims that could result in significant direct or indirect costs, or we could experience greater returns from retailers than expected, which could harm our net sales. The occurrence of any quality problems due to defects in our products could make us liable for damages and warranty claims in excess of any existing reserves. In addition to the risk of direct costs to correct any defects, warranty claims, product recalls or other problems, any negative publicity related to the perceived quality of our products could also affect our brand image, decrease retailer and distributor demand and our operating results and financial condition could be adversely affected.

We could incur unanticipated expenses in connection with warranty or product liability claims relating to a recall of one or more of our products, which could require significant expenditures to defend. Additionally, we may be required to comply with governmental requirements to remedy the defect and/or notify consumers of the problem that could lead to unanticipated expense, and possible product liability litigation against a customer or us.

Changes in laws or regulations or the manner of their interpretation or enforcement could adversely impact our financial performance and restrict our ability to operate our business or execute our strategies.

New laws or regulations, or changes in existing laws or regulations or the manner of their interpretation or enforcement, may create uncertainty for public companies, increase our cost of doing business and restrict our ability to operate our business or execute our strategies. This could include, among other things, compliance costs and enforcement under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”).

We continually evaluate and monitor developments with respect to new and proposed laws, regulations, standards and rules and cannot predict or estimate the amount of the additional costs we may incur or the timing of such costs. Any such new or changed laws, regulations, standards and rules may be subject to varying interpretations and as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. This could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices. We are committed to maintaining high standards of corporate governance and public disclosure. If our efforts to comply with new or changed laws, regulations and standards differ from the activities intended by regulatory or governing bodies due to ambiguities related to practice, regulatory authorities may initiate legal proceedings against us and we may be harmed.

We are subject to various environmental laws and regulations that could impose substantial costs on us and may adversely affect our business, operating results and financial condition.

Our operations and some of our products are regulated under various federal, state, local and international environmental laws. In addition, regulatory bodies in many of the jurisdictions in which we operate propose, enact and amend environmental laws and regulations on a regular basis. If we were to violate or become liable under these environmental laws, we could be required to incur additional costs to comply with such regulations and may incur fines and civil or criminal sanctions, third-party property damage or personal injury claims, or could be required to incur substantial investigation or remediation costs. Liability under environmental laws may be joint and several and without regard to comparative fault. The ultimate costs under environmental laws and the timing of these costs are difficult to predict. Although we cannot predict the ultimate impact of any new environmental laws and regulations, such laws may result in additional costs or decreased revenue, and could require that we redesign or change how we manufacture our products, any of which could have a material adverse effect on our business. Additionally, to the extent that our competitors choose not to abide by these environmental laws and regulations, we may be at a cost disadvantage, thereby hindering our ability to effectively compete in the marketplace.

Failure to comply with the U.S. Foreign Corrupt Practices Act or other applicable anti-corruption legislation could result in fines, criminal penalties and an adverse effect on our business.

Our products are sold in over 40 countries, including countries known to have a reputation for corruption. We are committed to doing business in accordance with applicable anti-corruption laws. We are subject, however, to the risk that our officers, directors, employees, agents and collaborators may take action determined to be in violation of such anti-corruption laws, including the U.S. Foreign Corrupt Practices Act of 1977, the U.K. Bribery Act 2010, the European Union Anti-Corruption Act and other similar laws, or that subjects us to trade sanctions administered by the Office of Foreign Assets Control and the U.S. Department of Commerce. Any such violation could result in substantial fines, sanctions, civil and/or criminal penalties or curtailment of operations in certain jurisdictions, and might adversely affect our results of operations. In addition, actual or alleged violations could damage our reputation and ability to do business.

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We are party to ongoing stockholder litigation, and in the future could be party to additional stockholder litigation, any of which could harm our business, financial condition and operating results.

We have had, and may continue to have, actions brought against us by stockholders in connection with the merger, past transactions, changes in our stock price or other matters. Any such claims, whether or not resolved in our favor, could divert our management and other resources from the operation of our business and otherwise result in unexpected and substantial expenses that would adversely and materially impact our business, financial condition and operating results. For example, and as further described in Note 13, “Commitments and Contingencies,” we are involved in legal proceedings related to the merger of VTBH and Paris Acquisition Corp. involving certain of our stockholders.

Risks Related to Liquidity

We depend upon the availability of capital under our revolving credit facility to finance our operations. Any additional financing that we may need may not be available on favorable terms, or at all.

In addition to cash flow generated from operations, we finance our operations with a credit facility (the “Credit Facility”) provided by Bank of America, as Agent, Sole Lead Arranger and Sole Bookrunner. If we are unable to comply with the financial and other covenants contained in the Credit Facility and are unable to obtain a waiver under the Credit Facility, Bank of America may declare the outstanding borrowings under the Credit Facility immediately due and payable. Such an event would have an immediate and material adverse impact on our business, results of operations, and financial condition. We would be required to obtain additional financing from other sources, and we cannot predict whether or on what terms, if any, additional financing might be available. If we are required to seek additional financing and are unable to obtain it, we may have to change our business and capital expenditure plans, which may have a materially adverse effect on our business, financial condition and results of operations. In addition, the debt under the Credit Facility could make it more difficult to obtain other debt financing in the future, which could put us at a competitive disadvantage to competitors with less debt. The Credit Facility contains financial and other covenants that we are obligated to maintain. The Credit Facility contain certain financial covenants and other restrictions that limit our ability, among other things, to incur certain additional indebtedness; pay dividends and repurchase stock; make certain investments and other payments; enter into certain mergers or consolidations; engage in sale and leaseback transactions and transactions with affiliates; and encumber and dispose of assets.

If we violate any of these covenants, we will be in default under the Credit Facility. If a default occurs and is not timely cured or waived, Bank of America could seek remedies against us, including termination or suspension of obligations to make loans and issue letters of credit, and acceleration of amounts due under the applicable Credit Facility. No assurance can be given that we will be able to maintain compliance with these covenants in the future. The Credit Facility is asset based and can only be drawn down in an amount to which eligible collateral exists and can be negatively impacted by extended collection of accounts receivable, unexpectedly high product returns and slow-moving inventory, among other factors. In addition, we have granted the lender a first-priority lien against substantially all of our assets, including trade accounts receivable and inventories. Failure to comply with the operating restrictions or financial covenants could result in a default which could cause the lender to accelerate the timing of payments and exercise their lien on substantially all of our assets.

If suppliers, customers, landlords, employees or other stakeholders lose confidence in our business, it may be more difficult for us to operate and may materially adversely affect our business, results of operations and financial condition.

If suppliers, customers, landlords, employees or other stakeholders have doubts regarding our ability to continue as a going concern, this could materially adversely affect our ability to operate. Concerns about our financial condition may cause our suppliers and other counterparties to tighten credit terms or cease doing business with us altogether, which would have a material adverse effect on our business and results of operations.

Risks Related to Ownership of our Common Stock

The market price of our common stock may fluctuate significantly.

We cannot predict the prices at which our common stock may trade. The market price of our common stock may fluctuate widely, depending on many factors, some of which may be beyond our control, including but not limited to:

 

actual or anticipated fluctuations in our operating results due to factors related to our business;

 

success or failure of our business strategy;

 

the success of third-party gaming platforms and certain game titles to drive sales;

 

our quarterly or annual earnings, or those of other companies in our industry;

 

changes in earnings estimates by securities analysts or our ability to meet those estimates;

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our ability to execute transformation, restructuring and realignment actions;

 

the operating and stock price performance of other comparable companies;

 

overall market fluctuations and,

 

general economic conditions and other external factors.

Stock markets in general have experienced volatility that has often been unrelated to the operating performance of a particular company. These broad market fluctuations could adversely affect the trading price of our common stock.

Item 2 - Unregistered Sale of Equity Securities and Use of Proceeds

 

On April 9, 2019, the Company’s board of directors authorized a stock repurchase program to acquire up to $15.0 million of its common stock. Any repurchases under the program will be made from time to time on the open market at prevailing market prices. The following table summarizes, by month, the repurchases made during the three months ended March 31, 2020, under the repurchase program and in connection with shares repurchased from employees to satisfy tax withholding obligations in connection with the vesting of restricted stock awards.

 

 

 

 

Issuer Purchases of Equity Securities

 

 

 

Total

Number

of Shares

Purchased

 

 

Average

Price Paid

Per Share

 

 

Total Number

of Shares

Purchased As

Part of Publicly

Announced

Plans or

Programs

 

 

Approximate

Dollar Value

of Shares that

May Yet Be

Purchased Under

the Plans or

Programs

 

Period

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

January 1- 31, 2020

 

 

 

 

$

 

 

 

 

 

 

 

February 1- 29, 2020

 

 

6,651

 

 

$

7.20

 

 

 

 

 

 

 

March 1- 31, 2020

 

 

 

 

$

 

 

 

 

 

 

 

Total

 

 

6,651

 

 

$

7.20

 

 

 

 

 

 

 

 

 

For the first quarter of 2020, we repurchased approximately $0.1 million of common shares related to employee transactions. These amounts represent common shares repurchased from employees in an amount equal to the statutory tax liability associated with the vesting of their equity awards, which is then remitted on behalf of the employee.

Item 5 - Other Information

None.

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Item 6. Exhibits

 

    3.1

Articles of Incorporation of Turtle Beach Corporation, as amended (Incorporated by reference to Exhibit 3.1 to Company’s 10-Q filed August 6, 2018).

 

 

    3.2

Bylaw, as amended, of Turtle Beach Corporation (Incorporated by reference to Exhibit 3.1 to Company’s 8-K filed June 20, 2019).

 

 

  31.1 **

Certification of Juergen Stark, Principal Executive Officer, pursuant to Rule 13a-14(a) or 15d-14(a) of the Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).

 

 

  31.2 **

Certification of John T. Hanson, Principal Financial Officer, pursuant to Rule 13a-14(a) or 15d-14(a) of the Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).

 

 

  32.1 **

Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, executed by Juergen Stark, Principal Executive Officer and John Hanson, Principal Financial Officer (filed herewith).

 

 

 

Extensible Business Reporting Language (XBRL) Exhibits

 

 

101.INS

XBRL Instance Document

 

 

101.SCH

XBRL Taxonomy Extension Schema Document

 

 

101.CAL

XBRL Taxonomy Extension Calculation Linkbase Document

 

 

101.DEF

XBRL Taxonomy Extension Definition Linkbase Document

 

 

101.LAB

XBRL Taxonomy Extension Labels Linkbase Document

 

 

101.PRE

XBRL Taxonomy Extension Presentation Linkbase Document

 

** Filed herewith.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

 

 

 

 

TURTLE BEACH CORPORATION

 

 

 

 

Date:

May 7, 2020

 

By:

/s/ JOHN T. HANSON

 

 

 

 

John T. Hanson

Chief Financial Officer, Treasurer and Secretary

 

 

 

 

(Principal Financial and Accounting Officer)

 

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