Item 1. Financial Statements.
Turtle Beach Corporation
Condensed Consolidated Balance Sheets
(unaudited)
|
|
|
|
|
|
|
|
|
|
September 30,
2017
|
|
December 31, 2016
|
ASSETS
|
(in thousands, except par value and share amounts)
|
Current Assets:
|
|
|
|
|
|
Cash and cash equivalents
|
$
|
473
|
|
|
$
|
6,183
|
|
Accounts receivable, net
|
24,588
|
|
|
54,633
|
|
Inventories
|
45,869
|
|
|
21,698
|
|
Prepaid expenses and other current assets
|
4,956
|
|
|
4,121
|
|
Total Current Assets
|
75,886
|
|
|
86,635
|
|
Property and equipment, net
|
4,427
|
|
|
4,311
|
|
Intangible assets, net
|
1,484
|
|
|
1,618
|
|
Deferred income taxes
|
126
|
|
|
543
|
|
Other assets
|
1,146
|
|
|
1,693
|
|
Total Assets
|
$
|
83,069
|
|
|
$
|
94,800
|
|
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
|
|
|
|
|
Current Liabilities:
|
|
|
|
|
Revolving credit facilities
|
$
|
24,793
|
|
|
$
|
35,905
|
|
Term loan
|
4,814
|
|
|
2,647
|
|
Accounts payable
|
29,996
|
|
|
11,927
|
|
Other current liabilities
|
12,110
|
|
|
16,414
|
|
Total Current Liabilities
|
71,713
|
|
|
66,893
|
|
Term loan, long-term portion
|
7,238
|
|
|
10,442
|
|
Series B redeemable preferred stock
|
18,547
|
|
|
17,480
|
|
Subordinated notes - related party
|
20,051
|
|
|
17,881
|
|
Other liabilities
|
2,239
|
|
|
2,800
|
|
Total Liabilities
|
119,788
|
|
|
115,496
|
|
Commitments and Contingencies
|
|
|
|
Stockholders' Equity (Deficit)
|
|
|
|
|
|
Common stock, $0.001 par value - 100,000,000 shares authorized; 49,386,006 and 49,251,336 shares issued and outstanding as of September 30, 2017 and December 31, 2016, respectively
|
49
|
|
|
49
|
|
Additional paid-in capital
|
147,802
|
|
|
146,615
|
|
Accumulated deficit
|
(184,279
|
)
|
|
(166,800
|
)
|
Accumulated other comprehensive loss
|
(291
|
)
|
|
(560
|
)
|
Total Stockholders' Equity (Deficit)
|
(36,719
|
)
|
|
(20,696
|
)
|
Total Liabilities and Stockholders' Equity (Deficit)
|
$
|
83,069
|
|
|
$
|
94,800
|
|
See accompanying Notes to the Condensed Consolidated Financial Statements (unaudited)
Turtle Beach Corporation
Condensed Consolidated Statements of Operations
(unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
September 30,
2017
|
|
September 30,
2016
|
|
September 30,
2017
|
|
September 30,
2016
|
|
(in thousands, except per-share data)
|
Net Revenue
|
$
|
35,975
|
|
|
$
|
38,384
|
|
|
$
|
69,439
|
|
|
$
|
91,774
|
|
Cost of Revenue
|
23,437
|
|
|
34,457
|
|
|
48,384
|
|
|
79,372
|
|
Gross Profit
|
12,538
|
|
|
3,927
|
|
|
21,055
|
|
|
12,402
|
|
Operating expenses:
|
|
|
|
|
|
|
|
Selling and marketing
|
5,586
|
|
|
7,016
|
|
|
15,564
|
|
|
19,737
|
|
Research and development
|
1,336
|
|
|
2,637
|
|
|
4,423
|
|
|
6,701
|
|
General and administrative
|
3,499
|
|
|
4,591
|
|
|
11,740
|
|
|
15,161
|
|
Goodwill and intangible asset impairment
|
—
|
|
|
32,084
|
|
|
—
|
|
|
63,236
|
|
Restructuring charges
|
241
|
|
|
339
|
|
|
509
|
|
|
564
|
|
Total operating expenses
|
10,662
|
|
|
46,667
|
|
|
32,236
|
|
|
105,399
|
|
Operating income (loss)
|
1,876
|
|
|
(42,740
|
)
|
|
(11,181
|
)
|
|
(92,997
|
)
|
Interest expense
|
2,042
|
|
|
1,866
|
|
|
5,717
|
|
|
5,331
|
|
Other non-operating expense (income), net
|
(252
|
)
|
|
326
|
|
|
(517
|
)
|
|
1,395
|
|
Earnings (loss) before income tax
|
86
|
|
|
(44,932
|
)
|
|
(16,381
|
)
|
|
(99,723
|
)
|
Income tax expense (benefit)
|
578
|
|
|
(133
|
)
|
|
1,098
|
|
|
(340
|
)
|
Net loss
|
$
|
(492
|
)
|
|
$
|
(44,799
|
)
|
|
$
|
(17,479
|
)
|
|
$
|
(99,383
|
)
|
|
|
|
|
|
|
|
|
Net loss per share:
|
|
|
|
|
|
|
|
Basic
|
$
|
(0.01
|
)
|
|
$
|
(0.91
|
)
|
|
$
|
(0.35
|
)
|
|
$
|
(2.05
|
)
|
Diluted
|
$
|
(0.01
|
)
|
|
$
|
(0.91
|
)
|
|
$
|
(0.35
|
)
|
|
$
|
(2.05
|
)
|
Weighted average number of shares:
|
|
|
|
|
|
|
|
Basic
|
49,386
|
|
|
49,230
|
|
|
49,328
|
|
|
48,371
|
|
Diluted
|
49,386
|
|
|
49,230
|
|
|
49,328
|
|
|
48,371
|
|
See accompanying Notes to the Condensed Consolidated Financial Statements (unaudited)
Turtle Beach Corporation
Condensed Consolidated Statements of Comprehensive Income (Loss)
(unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
September 30, 2017
|
|
September 30, 2016
|
|
September 30, 2017
|
|
September 30, 2016
|
|
(in thousands)
|
Net loss
|
$
|
(492
|
)
|
|
$
|
(44,799
|
)
|
|
$
|
(17,479
|
)
|
|
$
|
(99,383
|
)
|
|
|
|
|
|
|
|
|
Other comprehensive income (loss):
|
|
|
|
|
|
|
|
Foreign currency translation adjustment
|
111
|
|
|
1
|
|
|
269
|
|
|
(69
|
)
|
Other comprehensive income (loss)
|
111
|
|
|
1
|
|
|
269
|
|
|
(69
|
)
|
Comprehensive loss
|
$
|
(381
|
)
|
|
$
|
(44,798
|
)
|
|
$
|
(17,210
|
)
|
|
$
|
(99,452
|
)
|
See accompanying Notes to the Condensed Consolidated Financial Statements (unaudited)
Turtle Beach Corporation
Condensed Consolidated Statements of Cash Flows
(unaudited)
|
|
|
|
|
|
|
|
|
|
Nine Months Ended
|
|
September 30, 2017
|
|
September 30, 2016
|
|
(in thousands)
|
CASH FLOWS FROM OPERATING ACTIVITIES
|
|
|
|
|
|
Net loss
|
$
|
(17,479
|
)
|
|
$
|
(99,383
|
)
|
Adjustments to reconcile net loss to net cash provided by operating activities:
|
|
|
|
Depreciation and amortization
|
3,000
|
|
|
4,185
|
|
Amortization of intangible assets
|
259
|
|
|
4,028
|
|
Amortization of debt financing costs
|
1,181
|
|
|
957
|
|
Stock-based compensation
|
1,187
|
|
|
3,222
|
|
Accrued interest on Series B redeemable preferred stock
|
1,067
|
|
|
989
|
|
Paid in kind interest
|
1,844
|
|
|
1,585
|
|
Deferred income taxes
|
417
|
|
|
(485
|
)
|
Reversal of sales returns reserve
|
(2,209
|
)
|
|
(4,931
|
)
|
Provision for doubtful accounts
|
49
|
|
|
105
|
|
Provision for obsolete inventory
|
1,914
|
|
|
9,628
|
|
Loss on impairment of assets
|
—
|
|
|
63,236
|
|
Changes in operating assets and liabilities:
|
|
|
|
Accounts receivable
|
32,205
|
|
|
33,564
|
|
Inventories
|
(26,085
|
)
|
|
(28,975
|
)
|
Accounts payable
|
17,537
|
|
|
20,796
|
|
Prepaid expenses and other assets
|
(733
|
)
|
|
(1,465
|
)
|
Income taxes payable
|
669
|
|
|
81
|
|
Other liabilities
|
(5,532
|
)
|
|
(4,020
|
)
|
Net cash provided by operating activities
|
9,291
|
|
|
3,117
|
|
CASH FLOWS FROM INVESTING ACTIVITIES
|
|
|
|
Purchase of property and equipment
|
(2,584
|
)
|
|
(2,260
|
)
|
Net cash used for investing activities
|
(2,584
|
)
|
|
(2,260
|
)
|
CASH FLOWS FROM FINANCING ACTIVITIES
|
|
|
|
Borrowings on revolving credit facilities
|
98,165
|
|
|
131,810
|
|
Repayment of revolving credit facilities
|
(109,277
|
)
|
|
(137,964
|
)
|
Repayment of capital leases
|
(4
|
)
|
|
(31
|
)
|
Repayment of term loan
|
(1,443
|
)
|
|
(3,610
|
)
|
Proceeds from sale of common stock, net of issuance costs
|
—
|
|
|
5,968
|
|
Debt financing costs
|
—
|
|
|
(805
|
)
|
Net cash used for financing activities
|
(12,559
|
)
|
|
(4,632
|
)
|
Effect of exchange rate changes on cash and cash equivalents
|
142
|
|
|
(62
|
)
|
Net decrease in cash and cash equivalents
|
(5,710
|
)
|
|
(3,837
|
)
|
Cash and cash equivalents - beginning of period
|
6,183
|
|
|
7,114
|
|
Cash and cash equivalents - end of period
|
$
|
473
|
|
|
$
|
3,277
|
|
|
|
|
|
SUPPLEMENTAL DISCLOSURE OF INFORMATION
|
|
|
|
Cash paid for interest
|
$
|
1,364
|
|
|
$
|
1,474
|
|
Cash paid for income taxes
|
$
|
—
|
|
|
$
|
—
|
|
See accompanying Notes to the Condensed Consolidated Financial Statements (unaudited)
Turtle Beach Corporation
Condensed Consolidated Statement of Stockholders' Equity (Deficit)
(unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common Stock
|
|
Additional Paid-In Capital
|
|
Accumulated Deficit
|
|
Accumulated Other Comprehensive Income (Loss)
|
|
Total
|
|
Shares
|
Amount
|
|
|
|
|
|
(in thousands)
|
Balance at December 31, 2016
|
49,251
|
|
$
|
49
|
|
|
$
|
146,615
|
|
|
$
|
(166,800
|
)
|
|
$
|
(560
|
)
|
|
$
|
(20,696
|
)
|
Net loss
|
—
|
|
—
|
|
|
—
|
|
|
(17,479
|
)
|
|
—
|
|
|
(17,479
|
)
|
Other comprehensive loss
|
—
|
|
—
|
|
|
—
|
|
|
—
|
|
|
269
|
|
|
269
|
|
Stock-based compensation
|
135
|
|
—
|
|
|
1,187
|
|
|
—
|
|
|
—
|
|
|
1,187
|
|
Balance at September 30, 2017
|
49,386
|
|
$
|
49
|
|
|
$
|
147,802
|
|
|
$
|
(184,279
|
)
|
|
$
|
(291
|
)
|
|
$
|
(36,719
|
)
|
See accompanying Notes to the Condensed Consolidated Financial Statements (unaudited)
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 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 HyperSound® brands. Turtle Beach is a worldwide leading provider of feature-rich headset solutions for use across multiple platforms, including video game and entertainment consoles, handheld consoles, personal computers, tablets and mobile devices. HyperSound technology is an innovative patent-protected sound technology that delivers immersive, directional audio offering unique potential benefits in a variety of commercial settings and consumer devices.
VTB Holdings, Inc. (“VTBH”), the parent holding company of the headset business, was incorporated in the state of Delaware in 2010 with operations principally located in Valhalla, New York. Voyetra Turtle Beach, Inc. (“VTB”) was incorporated in the state of Delaware in 1975.
In October 2012, VTB acquired Lygo International Limited (“Lygo”), a private limited company organized under the laws of England and Wales, which was subsequently renamed Turtle Beach Europe Limited (“TB Europe”).
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, 2016
Condensed Consolidated Balance Sheet has been derived from the Company's most recent audited financial statements included in its Annual Report on Form 10-K.
These financial statements should be read in conjunction with the annual financial statements and the notes thereto included in our Annual Report on Form 10-K filed with the SEC on March 8, 2017 (“Annual Report”) that contains information useful to understanding the Company's businesses and financial statement presentations.
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 our 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.
Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09,
Revenue from Contracts with Customers
, which requires entities to recognize revenue in a way that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. The new guidance also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and
Turtle Beach Corporation
Notes to Condensed Consolidated Financial Statements - (Continued)
(unaudited)
changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. In July 2015, the FASB deferred the effective date of the standard by one year to annual reporting periods beginning after December 15, 2017 and interim periods within those annual periods. Based on our initial assessment, we do not believe the standard will materially impact our recognition of revenue from our headset business. The new standard will require certain price concessions and right of return arrangements to be recorded as part of the transaction price determination. The Company has identified, and is in the process of implementing, appropriate changes to its business processes, systems and controls to support recognition and disclosure under the new standard. The Company will adopt the new standard on January 1, 2018 under the the modified retrospective method of adoption, reflecting the cumulative effect of initially applying the new standard to revenue recognition in the first quarter of 2018.
In February 2016, the FASB issued ASU No. 2016-02,
Leases
, that introduces the recognition of a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term and, a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis for all leases (with the exception of short-term leases). The guidance will be effective for public companies for annual reporting periods beginning after December 15, 2018, and interim periods within those fiscal years with early adoption permitted. The Company has not yet selected a transition method or determined the effect on its consolidated financial statements.
In March 2016, the FASB issued ASU No. 2016-09,
Compensation—Stock Compensation
, which requires excess tax benefits and tax deficiencies, which arise due to differences between the measure of compensation expense and the amount deductible for tax purposes, to be recorded directly through earnings as a component of income tax expense. Previously, these differences were generally recorded in additional paid-in capital and thus had no impact on net income. Additionally, this guidance permits entities to make an accounting policy election for the impact of forfeitures on the recognition of expense for share-based payment awards. Forfeitures can be estimated, as allowed under previous standards, or recognized when they occur. The standard was effective for interim and annual reporting periods beginning after December 15, 2016. The Company adopted this standard on January 1, 2017 and the standard did not have a material impact on its consolidated financial statements.
In August 2016, the FASB issued ASU 2016-15,
Statement of Cash Flows (Topic 230)
,
which attempts to reduce the existing diversity in practice with respect to reporting the following eight specific cash flow issues: debt prepayment or debt extinguishment costs; settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; contingent consideration payments made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of corporate-owned life insurance policies (including bank-owned life insurance policies); distributions received from equity method investees; beneficial interests in securitization transactions; and separately identifiable cash flows and application of the predominance principle. This guidance will be effective for the Company on January 1, 2018. The Company does not believe the guidance will have a material impact on its consolidated financial statements.
In May 2017, the FASB issued ASU 2017-09,
Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting
to provide clarity and reduce diversity in practice and cost and complexity when applying the guidance to a change to the terms or conditions of a share-based payment award. The amendments state that an entity will not have to account for the effects of a modification if: (i) the fair value of the modified award is the same immediately before and after the modification; (ii) the vesting conditions of the modified award are the same immediately before and after the modification; and (iii) the classification of the modified award as either an equity instrument or liability instrument is the same immediately before and after the modification. The amendments in this update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. Early adoption is permitted, including adoption in any interim period. The adoption of this guidance is not expected to have a material impact upon our financial condition or results of operations.
Note
3
. 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.
|
Turtle Beach Corporation
Notes to Condensed Consolidated Financial Statements
(unaudited)
|
|
•
|
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, and debt instruments. As of
September 30, 2017
and
December 31, 2016
, there were no outstanding financial assets and liabilities recorded at fair value on a recurring basis and 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
September 30, 2017
and
December 31, 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2017
|
|
December 31, 2016
|
|
Reported
|
|
Fair Value
|
|
Reported
|
|
Fair Value
|
|
(in thousands)
|
Financial Assets and Liabilities:
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
$
|
473
|
|
|
$
|
473
|
|
|
$
|
6,183
|
|
|
$
|
6,183
|
|
Credit Facility
|
24,793
|
|
|
24,793
|
|
|
35,905
|
|
|
35,905
|
|
Term Loans
|
12,924
|
|
|
12,575
|
|
|
14,367
|
|
|
14,281
|
|
Subordinated Debt
|
21,247
|
|
|
21,403
|
|
|
19,403
|
|
|
18,569
|
|
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 and Term Loan Due 2018 equals fair value as the stated interest rate approximates market rates currently available to the Company, which are considered Level 2 inputs. The fair values of our Term Loan Due 2019 and Subordinated Debt are based upon an estimated market value calculation that factors principal, time to maturity, interest rate and current cost of debt, which is considered a Level 3 input.
Note
4
. 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
|
|
Nine Months Ended
|
|
September 30,
|
|
September 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
|
(in thousands)
|
Balance, beginning of period
|
$
|
2,153
|
|
|
$
|
579
|
|
|
$
|
4,591
|
|
|
$
|
6,268
|
|
Reserve accrual
|
2,146
|
|
|
2,807
|
|
|
4,228
|
|
|
7,341
|
|
Recoveries and deductions, net
|
(1,917
|
)
|
|
(2,049
|
)
|
|
(6,437
|
)
|
|
(12,272
|
)
|
Balance, end of period
|
$
|
2,382
|
|
|
$
|
1,337
|
|
|
$
|
2,382
|
|
|
$
|
1,337
|
|
Turtle Beach Corporation
Notes to Condensed Consolidated Financial Statements - (Continued)
(unaudited)
Note
5
. Composition of Certain Financial Statement Items
Inventories
Inventories consist of the following:
|
|
|
|
|
|
|
|
|
|
September 30, 2017
|
|
December 31, 2016
|
|
(in thousands)
|
Raw materials
|
$
|
1,842
|
|
|
$
|
1,680
|
|
Finished goods
|
44,027
|
|
|
20,018
|
|
Total inventories
|
$
|
45,869
|
|
|
$
|
21,698
|
|
Property and Equipment, net
Property and equipment, net, consists of the following:
|
|
|
|
|
|
|
|
|
|
September 30, 2017
|
|
December 31, 2016
|
|
(in thousands)
|
Machinery and equipment
|
$
|
1,359
|
|
|
$
|
1,321
|
|
Software and software development
|
383
|
|
|
383
|
|
Furniture and fixtures
|
400
|
|
|
288
|
|
Tooling
|
2,043
|
|
|
1,581
|
|
Leasehold improvements
|
1,271
|
|
|
1,247
|
|
Demonstration units and convention booths
|
10,652
|
|
|
8,172
|
|
Total property and equipment, gross
|
16,108
|
|
|
12,992
|
|
Less: accumulated depreciation and amortization
|
(11,681
|
)
|
|
(8,681
|
)
|
Total property and equipment, net
|
$
|
4,427
|
|
|
$
|
4,311
|
|
Other Current Liabilities
Other current liabilities consist of the following:
|
|
|
|
|
|
|
|
|
|
September 30, 2017
|
|
December 31, 2016
|
|
(in thousands)
|
Accrued vendor expenses
|
$
|
1,839
|
|
|
$
|
4,735
|
|
Accrued royalty
|
2,485
|
|
|
3,370
|
|
Accrued employee expenses
|
1,580
|
|
|
2,791
|
|
Accrued expenses
|
6,206
|
|
|
5,518
|
|
Total other current liabilities
|
$
|
12,110
|
|
|
$
|
16,414
|
|
Note
6
. Goodwill and Other Intangible Assets
At acquisition, the Company estimates and records the fair value of purchased intangible assets. The fair values of these intangible assets are estimated based on our assessment. Goodwill is the excess of the purchase price over the fair value of identifiable net assets acquired in business combinations. Goodwill and certain other intangible assets having indefinite lives are not amortized to earnings, but instead are subject to periodic testing for impairment. Intangible assets determined to have definite lives are amortized over their remaining useful lives.
We assess the impairment of long-lived assets, intangibles assets and goodwill whenever events or changes in circumstances indicate that full recoverability of net asset balances through future cash flows is in question. Goodwill and indefinite-lived
Turtle Beach Corporation
Notes to Condensed Consolidated Financial Statements
(unaudited)
intangible assets are assessed at least annually, but also whenever events or changes in circumstances indicate the carrying values may not be recoverable. Factors that could trigger an impairment review include: (a) significant underperformance relative to historical or projected future operating results; (b) significant changes in the manner of use of the acquired assets or the strategy for our overall business; (c) significant negative industry or economic trends; (d) significant decline in our stock price for a sustained period; and (e) a decline in our market capitalization below net book value.
Acquired Intangible Assets
Acquired identifiable intangible assets, and related accumulated amortization, as of
September 30, 2017
and
December 31, 2016
consist of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2017
|
|
Gross Carrying Value
|
|
Accumulated Amortization
|
|
Asset Impairment
|
|
Net Book Value
|
|
(in thousands)
|
Customer relationships
|
$
|
5,796
|
|
|
$
|
4,064
|
|
|
$
|
—
|
|
|
$
|
1,732
|
|
Foreign Currency
|
(933
|
)
|
|
(685
|
)
|
|
—
|
|
|
(248
|
)
|
Total Intangible Assets
|
$
|
4,863
|
|
|
$
|
3,379
|
|
|
$
|
—
|
|
|
$
|
1,484
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2016
|
|
Gross Carrying Value
|
|
Accumulated Amortization
|
|
Asset Impairment
|
|
Net Book Value
|
|
(in thousands)
|
Customer relationships
|
$
|
5,796
|
|
|
$
|
3,737
|
|
|
$
|
—
|
|
|
$
|
2,059
|
|
Non-compete agreements
|
177
|
|
|
177
|
|
|
—
|
|
|
—
|
|
In-process Research and Development
|
27,100
|
|
|
4,074
|
|
|
23,026
|
|
|
—
|
|
Developed technology
|
8,880
|
|
|
802
|
|
|
8,078
|
|
|
—
|
|
Trade names
|
170
|
|
|
92
|
|
|
78
|
|
|
—
|
|
Patent and trademarks
|
967
|
|
|
65
|
|
|
902
|
|
|
—
|
|
Foreign Currency
|
(1,294
|
)
|
|
(853
|
)
|
|
—
|
|
|
(441
|
)
|
Total Intangible Assets
|
$
|
41,796
|
|
|
$
|
8,094
|
|
|
$
|
32,084
|
|
|
$
|
1,618
|
|
In October 2012, VTB acquired Lygo, subsequently renamed TB Europe Ltd. The acquired intangible asset 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 January 2014, the merger between VTBH and Turtle Beach (f/k/a Parametric Sound Corporation) was completed. The acquired intangible assets relating to developed technology, customer relationships and trade name were subject to amortization over their respective useful lives. In September 2016, we recorded an impairment charge related to the total remaining acquired intangible assets value.
Amortization expense related to definite lived intangible assets of
$0.1 million
and
$0.3 million
was recognized for the
three and nine
months ended
September 30, 2017
, respectively, and
$1.4 million
and
$4.0 million
for the
three and nine
months ended
September 30, 2016
, respectively.
Turtle Beach Corporation
Notes to Condensed Consolidated Financial Statements
(unaudited)
As of
September 30, 2017
, estimated annual amortization expense related to definite lived intangible assets in future periods is as follows:
|
|
|
|
|
|
(in thousands)
|
2017
|
$
|
109
|
|
2018
|
366
|
|
2019
|
307
|
|
2020
|
258
|
|
2021
|
217
|
|
Thereafter
|
475
|
|
Total
|
$
|
1,732
|
|
Note
7
. Credit Facilities and Long-Term Debt
|
|
|
|
|
|
|
|
|
|
September 30, 2017
|
|
December 31, 2016
|
|
(in thousands)
|
Revolving credit facility, maturing March 2019
|
$
|
24,793
|
|
|
$
|
35,905
|
|
|
|
|
|
Term Loan Due 2018
|
2,564
|
|
|
3,632
|
|
Term Loan Due 2019
|
10,360
|
|
|
10,735
|
|
Less unamortized deferred financing fees
|
872
|
|
|
1,278
|
|
Total Term Loans
|
12,052
|
|
|
13,089
|
|
|
|
|
|
Subordinated notes - related party
|
21,247
|
|
|
19,403
|
|
Less unamortized debt discount
|
1,196
|
|
|
1,522
|
|
Total Subordinated notes
|
20,051
|
|
|
17,881
|
|
Total outstanding debt
|
56,896
|
|
|
66,875
|
|
Less: current portion of revolving line of credit
|
(24,793
|
)
|
|
(35,905
|
)
|
Less: current portion of term loans
|
(4,814
|
)
|
|
(2,647
|
)
|
Total noncurrent portion of long-term debt
|
$
|
27,289
|
|
|
$
|
28,323
|
|
Total interest expense, inclusive of amortization of deferred financing costs, on long-term debt obligations was
$1.5 million
and
$4.2 million
, respectively, for the
three and nine
months ended
September 30, 2017
and,
$1.3 million
and
$3.9 million
, respectively, for the
three and nine
months ended
September 30, 2016
. This includes related party interest of
$0.6 million
and
$1.8 million
for the
three and nine
months ended
September 30, 2017
, respectively, and
$0.5 million
and
$1.6 million
for the
three and nine
months ended
September 30, 2016
, respectively, in connection with the subordinated notes.
Amortization of deferred financing costs was
$0.4 million
and
$1.2 million
or the
three and nine
months ended
September 30, 2017
, respectively,
$0.3 million
and
$1.0 million
for the
three and nine
months ended
September 30, 2016
, respectively.
Revolving Credit Facility
On March 31, 2014, Turtle Beach and certain of its subsidiaries entered into a new asset-based revolving credit 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 loan and security agreement. The Credit Facility,
which
expires on
March 31, 2019
, provides for a line of credit of up to
$60 million
inclusive of a
sub-facility limit of
$10 million
for
TB Europe, a wholly owned subsidiary of Turtle Beach. The Credit Facility may be used for working capital,
the issuance of bank guarantees,
letters of credit and other corporate purposes.
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.
Turtle Beach Corporation
Notes to Condensed Consolidated Financial Statements
(unaudited)
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
1.00%
to
1.50%
for U.S. base rate loans
and between
2.00%
to
2.50%
for U.S. LIBOR loans and U.K. loans. As of
September 30, 2017
, interest rates for outstanding borrowings were
6.24%
for base rate loans and
3.21%
for LIBOR rate loans. 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.
If certain availability thresholds are not met, meaning that the Company does not have receivables and inventory which are eligible to borrow on under the Credit Facility in excess of amounts borrowed, the Credit Facility requi
res the Company and its restricted subsidiaries to maintain a fixed charge coverage ratio. The fixed charge ratio is defined as the ratio, determined
on a consolidated basis for the most recent four fiscal quarters, of (a) EBITDA minus capital expenditures, excluding those financed through other instruments, and cash taxes paid, and (b) Fixed Charges defined as the sum of cash interest expense plus scheduled principal payments.
The current fixed charge coverage ratio of at least
1.15
to 1.00 on the last day of each month will become effective again after the Company has complied with such ratio for six consecutive months.
The Credit Facility also contains affirmative and negative covenants that, subject to certain exceptions, limit our ability to take certain actions, including our ability to incur debt, pay dividends and repurchase stock, make certain investments and other payments, enter into certain mergers and consolidations, engage in sale leaseback transactions and transactions with affiliates and encumber and dispose of assets. Obligations under the Credit Facility are secured by a security interest and lien upon substantially all of the Company's assets.
On October 31, 2016, in connection with the HyperSound business restructuring, the Company amended certain provisions to provide, among other things, that (i) the existing loan availability blocks be permanently reduced during certain specified periods, (ii) replaced certain financial covenants determined on a segment-by-segment basis by amended EBITDA levels for the Headset business beginning with the month ended October 31, 2016, (iii) the Company maintain revised cash flow levels, in the aggregate and with respect to its HyperSound segment, during each rolling four week period beginning with the period ended October 31, 2016 through December 31, 2018 and September 30, 2017, respectively, and (iv) in the event the Company’s availability is less than certain specified amounts, obtain additional funding from the issuance of a subordinated promissory note provided by SG VTB (the “Promissory Note”).
As of
September 30, 2017
, the Company was in compliance with all financial covenants, as amended, and excess borrowing availability was approximately
$12.5 million
, net of the outstanding Term Loan Due 2018 (as defined below) that is considered to be an additional outstanding amount under the Credit Facility.
Term Loans
Term Loan Due 2018
On December 29, 2014, the Company amended the Credit Facility with Bank of America to enter in to an additional loan (the “Term Loan Due 2018”) for the repayment of
$7.7 million
of then existing subordinated debt and accrued interest. The Term Loan Due 2018 resulted in modified financial covenants while it is outstanding, will bear interest at a rate of LIBOR for the applicable interest period plus
5%
and will be repaid in equal monthly installments beginning on April 1, 2015 and ending on October 1, 2018, reflecting a six month waiver. Amounts so repaid are recognized by lowering the balance of the term loan tranche and increasing the lower interest rate base revolver amount, with no net impact on borrowing availability.
Term Loan Due 2019
On July 22, 2015, the Company and its subsidiaries, entered into a term loan, guaranty and security agreement (the “Term Loan Due 2019”) with Crystal Financial LLC, as agent, sole lead arranger and sole bookrunner, Crystal Financial SPV LLC and the other persons party thereto (“Crystal”), which provides for an aggregate term loan commitment of
$15 million
that bears interest at a rate per annum equal to the 90-day LIBOR rate plus
10.25%
. Under the terms of the Term Loan Due 2019, the Company is required to make payments of interest in arrears on the first day of each month beginning August 1, 2015 and will repay the principal in monthly payments beginning January 1, 2016, inclusive of a nine month waiver, with a final payment on
June 28, 2019
, the maturity date.
Turtle Beach Corporation
Notes to Condensed Consolidated Financial Statements
(unaudited)
The Term Loan Due 2019 is secured by a security interest in substantially all of the Company and each of its subsidiaries' working capital assets and is subject to the first-priority lien of Bank of America, as agent, under the Credit Facility, other than with respect to equipment, fixtures, real property interests, intellectual property, intercompany property, intercompany indebtedness, equity interest in their subsidiaries, and certain other assets specified in an inter-creditor agreement between Bank of America and Crystal.
The Company and its subsidiaries are required to comply with various customary covenants including, (i) maintaining minimum EBITDA (as defined in the Term Loan Due 2019) in each trailing twelve month period beginning August 31, 2015, (ii) maintaining a Consolidated Leverage Ratio (as defined in the Term Loan Due 2019) to be measured on the last day of each month while the term loans are outstanding of no more than
5.75
:1 beginning December 31, 2015 with periodic step-downs to
3.00
:1 on January 31, 2018, (iii) not making capital expenditures in excess of
$5 million
in each of the years ending December 31, 2016, 2018 and 2019 and in excess of
$5.5 million
in the year ending December 31, 2017, (iv) restrictions on the Company’s and its subsidiaries ability to prepay its subordinated notes, pay dividends, incur debt, create or suffer liens and engage in certain fundamental transactions and (v) an obligation to provide certain financial and other information. The agreement permits certain equity holders of the Company to contribute funds to the Company to cure certain financial covenant defaults.
The Term Loan Due 2019 contains customary representations, mandatory prepayment events and events of default, including defaults triggered by the failure to make payments when due, breaches of covenants and representations, material impairment in the perfection of Crystal’s security interest in the collateral and events related to bankruptcy and insolvency of the Company and its subsidiaries. Upon an event of default, Crystal may declare all outstanding obligations immediately due and payable (along with a prepayment fee), a default rate of an additional
2.0%
may be applied to amounts outstanding and may take other actions including collecting or taking such other action with respect to the collateral pledged in connection with the term loan.
On October 31, 2016, in connection with the recently announced HyperSound business restructuring, the Company amended certain provisions to provide, among other things, that (i) the existing loan availability blocks be permanently reduced during certain specified periods, (ii) replaced certain financial covenants determined on a segment-by-segment basis by amended EBITDA levels for the Headset business beginning with the month ended October 31, 2016, (iii) the Company maintain revised cash flow levels, in the aggregate and with respect to its HyperSound segment, during each rolling four week period beginning with the period ended October 31, 2016 through December 31, 2018 and September 30, 2017, respectively, and (iv) in the event the Company’s availability is less than certain specified amounts, obtain additional funding from the issuance of a subordinated promissory note provided by SG VTB (the “Promissory Note”).
As of
September 30, 2017
, the Company was in compliance with all the amended financial covenants.
Subordination Agreement
On November 16, 2015, as a condition precedent to the Company's lenders permitting the Company to enter into certain subordinated notes, the Company entered into a subordination agreement with and between Bank of America and Crystal, pursuant to which the parties agreed that the Company's obligations under any such notes would be subordinate in right of payment to the payment in full of all the Company’s obligations under the Credit Facility and Term Loan Due 2019.
Subordinated Notes - Related Party
O
n April 23, 2015, the Company issued a
$5.0 million
subordinated note (the “April Note”) to SG VTB Holdings, LLC, the Company’s largest stockholder (“SG VTB”). The April Note was issued with an interest rate of (i)
10%
per annum for the first year and (ii)
20%
per annum for all periods thereafter, with interest accruing and being added to the principal amount of the note quarterly.
On May 13, 2015, the Company issued subordinated notes (the “May Notes”) with an aggregate principal amount of
$3.8 million
to SG VTB, and a trust affiliated with Ronald Doornink, the Chairman of the Company's board of directors (the “Board”). The May Notes were issued with an interest rate of
10%
per annum until the maturity date of the May Notes (which was
August 13, 2015
but could be extended up to two additional 90 day periods upon the written agreement of the Company and the noteholder), with interest accruing and being added to the principal amount of the May Notes quarterly. Following the maturity date, the interest rate would have increased to
20%
per annum.
Turtle Beach Corporation
Notes to Condensed Consolidated Financial Statements
(unaudited)
On June 17, 2015, the Company issued a subordinated note (the “June Note”) with an aggregate principal amount of
$3.0 million
to SG VTB. The June Note was issued at an interest rate of
10%
per annum until the maturity date of the June Note (which was
September 17, 2015
but could be extended up to two additional 90 day periods upon the written agreement of the Company and the noteholder), with interest accruing and being added to the principal amount of the June Note quarterly. Following the maturity date, the interest rate would have increased to
20%
per annum. In addition, the Company had the option to request that SG VTB make, in SG VTB’s sole discretion, additional advances from time to time up to an aggregate principal amount of
$15.0 million
. Prior to the amendment (see below), following an additional advance of
$6.0 million
on July 8, 2015,
$9.0 million
was outstanding under the June Note.
Concurrently with the completion of the Term Loan Due 2019, the Company amended and restated each of its outstanding subordinated notes (the “Amended Notes”). The obligations of the Company under the Amended Notes are subordinate and junior to the prior payment of amounts due under the Credit Facility and Term Loan Due 2019. In addition, the stated maturity date of the Amended Notes was extended to
September 29, 2019
, subject to acceleration in certain circumstances, such as a change of control in the Company. The Amended Notes bear interest at a rate per annum equal to LIBOR plus
10.5%
and shall be paid-in-kind by adding the amount to the principal amount due. Further, as consideration for the concessions in the Amended Notes, the Company issued warrants to purchase
1.7 million
of the Company’s common stock at an exercise price of
$2.54
per share.
On November 16, 2015, the Company issued a
$2.5 million
subordinated note (the “November Note”) to SG VTB, the proceeds of which, as set forth in the amendment to the Term Loan Due 2019, were applied against the outstanding balance of the Term Loan Due 2019. The November Note will bear interest at a rate of
15%
per annum until its maturity date, which is
September 29, 2019
, and is subordinated to all senior debt of the Company.
In consideration of the credit extended under the November Note, VTB and VTBH entered into a Third Lien Continuing Guaranty, (as amended, the “Third Lien Guaranty”), under which they guarantee and promise to pay to Stripes, any and all obligations of the Company under the November Note. To secure our obligations under the November Note and the Third Lien Guaranty, the Company entered into a Third Lien Security Agreement, dated as of November 16, 2015, pursuant to which Stripes was granted a security interest upon all property of the VTB and VTBH until the payment in full of the Subordinated Note or the release of the guarantee or collateral, as applicable. Concurrent with entering into the November Note and Third Lien Guaranty, the Company also issued to SG VTB a warrant to purchase
1.4 million
shares of the Company’s common stock at an exercise price of
$2.00
per share.
On October 31, 2016, in connection with certain amendments to the Credit Facility and Term Loan Due 2019, the Company and SG VTB entered into the Promissory Note, which states that in the event the Company’s availability under the Credit Facility is less than certain specified amounts, the Company may, upon request, at any time until September 29, 2019 require that SG VTB provide a
$2 million
subordinated loan. Upon issuance, the loan would bear interest at a rate of either (i) LIBOR plus
10.5%
per annum or (ii)
12.0%
, dependent upon the Company’s compliance with certain financial covenants and would be subordinated to all senior debt of the Company.
In addition, under the terms of the Promissory Note, if and when the funding occurs, as additional consideration the Company would issue to SG VTB a warrant, exercisable for a period of ten years beginning on the date of issuance, to purchase an amount of shares of the Company’s common stock equal to 2.4% of the Company’s then fully diluted shares outstanding at an exercise price equal to the closing price on that date. The warrant would not entitle the holder to any voting rights or other rights as a stockholder of the Company prior to exercise.
SG VTB is an affiliate of Stripes Group LLC (“Stripes”), a private equity firm focused on internet, software, healthcare IT and branded consumer products businesses. Kenneth A. Fox, one of our directors, is the managing general partner of Stripes and the sole manager of SG VTB and Ronald Doornink, our Chairman of the Board, is an operating partner of Stripes.
Turtle Beach Corporation
Notes to Condensed Consolidated Financial Statements
(unaudited)
Note
8
. Income Taxes
In order to determine the quarterly provision for income taxes, we use 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, we determine the quarterly 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 quarter during which they occur and can be a source of variability in the effective tax rates from quarter to quarter.
The following table presents our income tax expense (benefit) and effective income tax rate:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
September 30,
|
|
September 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
|
(in thousands)
|
Income tax expense (benefit)
|
$
|
578
|
|
|
$
|
(133
|
)
|
|
$
|
1,098
|
|
|
$
|
(340
|
)
|
Effective income tax rate
|
672.1
|
%
|
|
0.3
|
%
|
|
(6.7
|
)%
|
|
0.3
|
%
|
Income tax expense for the
three and nine
months ended
September 30, 2017
was
$0.6 million
at an effective tax rate of
672.1%
and
$1.1 million
at an effective tax rate of
(6.7)%
, respectively. Income tax benefit for the
three and nine
months ended
September 30, 2016
was
$(0.1) million
at an effective tax rate of
0.3%
and
$(0.3) million
at an effective tax rate of
0.3%
, respectively.
The effective tax rate was primarily impacted by the full valuation allowance on domestic earnings, foreign entity tax benefits and certain state tax expense.
At
December 31, 2016
, the Company had
$49.0 million
of net operating loss carryforwards and
$21.0 million
of state net operating loss carryforwards, which will begin to expire in 2029. An ownership change occurred on January 15, 2014 as a result of the Merger, and
$12.7 million
of federal net operating losses included in the above are pre-change losses subject to Section 382 of the Internal Revenue Code of 1986, as amended. The Company believes, based on the estimated Section 382 limitation and the net operating loss carryforward period, that the pre ownership change net operating losses can be fully utilized in future years if there is sufficient taxable income in such carryforward period.
The Company is subject to income taxes domestically and in various foreign jurisdictions. Significant judgment is required in evaluating uncertain tax positions and determining its 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 statement of operations. As of
September 30, 2017
, 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 2013 through 2015, and the state tax years open under the statute of limitations are 2012 through 2015. The Company was notified by the IRS of an examination covering our fiscal year end 2015 federal income tax return, which is currently in the discovery phase.
Turtle Beach Corporation
Notes to Condensed Consolidated Financial Statements
(unaudited)
Note
9
. 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 comprised as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
September 30,
|
|
September 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
|
(in thousands)
|
Cost of revenue
|
$
|
20
|
|
|
$
|
152
|
|
|
$
|
(66
|
)
|
|
$
|
398
|
|
Selling and marketing
|
18
|
|
|
40
|
|
|
74
|
|
|
50
|
|
Research and development
|
68
|
|
|
138
|
|
|
188
|
|
|
424
|
|
General and administrative
|
264
|
|
|
687
|
|
|
991
|
|
|
2,350
|
|
Total stock-based compensation
|
$
|
370
|
|
|
$
|
1,017
|
|
|
$
|
1,187
|
|
|
$
|
3,222
|
|
The following table presents the stock activity and the total number of shares available for grant as of
September 30, 2017
:
|
|
|
|
|
(in thousands)
|
Balance at December 31, 2016
|
2,261
|
|
Options granted
|
(705
|
)
|
Restricted Stock granted
|
(167
|
)
|
Forfeited/Expired shares added back
|
1,098
|
|
Balance at September 30, 2017
|
2,487
|
|
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, 2016
|
6,381,447
|
|
|
1.90
|
|
7.37
|
|
20,033
|
|
Granted
|
704,865
|
|
|
0.93
|
|
|
|
|
Exercised
|
—
|
|
|
—
|
|
|
|
|
Forfeited
|
(1,053,683
|
)
|
|
2.22
|
|
|
|
|
Outstanding at September 30, 2017
|
6,032,629
|
|
|
1.73
|
|
6.75
|
|
2,543
|
|
Vested and expected to vest at September 30, 2017
|
6,022,628
|
|
|
1.74
|
|
6.75
|
|
2,543
|
|
Exercisable at September 30, 2017
|
3,886,414
|
|
|
1.76
|
|
6.68
|
|
2,100
|
|
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 2013 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).
Turtle Beach Corporation
Notes to Condensed Consolidated Financial Statements
(unaudited)
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. There were
no
option exercises during the
nine
months ended
September 30, 2017
.
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 assumptions for the
nine months ended
September 30, 2017
.
|
|
|
Expected term (in years)
|
6.1
|
Risk-free interest rate
|
1.9% - 2.1%
|
Expected volatility
|
40.1% - 41.1%
|
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
nine months ended
September 30, 2017
was
$0.39
. The total estimated fair value of employee options vested during the
nine months ended
September 30, 2017
was
$1.2 million
. As of
September 30, 2017
, total unrecognized compensation cost related to non-vested stock options granted to employees was
$1.3 million
, which is expected to be recognized over a remaining weighted average vesting period of
2.6 years
.
Restricted Stock Activity
|
|
|
|
|
|
|
|
Shares
|
|
Weighted Average Grant Date Fair Value Per Share
|
Nonvested restricted stock at December 31, 2016
|
135,705
|
|
|
1.84
|
|
Granted
|
166,665
|
|
|
0.90
|
|
Vested
|
(91,002
|
)
|
|
2.06
|
|
Forfeited
|
(43,903
|
)
|
|
1.16
|
|
Nonvested restricted stock at September 30, 2017
|
167,465
|
|
|
0.96
|
|
As of
September 30, 2017
, total unrecognized compensation cost related to the nonvested restricted stock awards granted to be recognized over a remaining weighted average vesting period of
0.5 years
was minimal.
Stock Warrants
In connection with and as consideration for the concessions in the Amended Notes, the Company issued to SG VTB and a trust affiliated with Ronald Doornink warrants to purchase
1.7 million
shares of the Company’s common stock at an exercise price of
$2.54
per share. The warrants are exercisable for a period of
five
years beginning on the date of issuance, July 22, 2015. The exercise price and the number of shares of Common Stock purchasable are subject to adjustment and do not carry any voting rights or other rights as a stockholder of the Company prior to exercise. The shares issuable upon exercise are also subject to the “demand” and “piggyback” registration rights set forth in the in the Company’s Stockholder Agreement, dated August 5, 2013, as amended July 10, 2014.
In connection with the November Note, the Company issued a warrant to purchase
1.4 million
shares of the Company’s common stock at an exercise price of
$2.00
per share to SG VTB. The exercise price and the number of shares are subject to standard anti-dilution adjustments and do not carry any voting rights as a stockholder of the Company prior to exercise. The warrant is exercisable for a period of
ten
years beginning on the date of issuance and does not entitle the holder to any voting rights or other rights as a stockholder of the Company prior to exercise.
The warrants entitle the holder to purchase a stated amount of shares of common stock at a fixed exercise price that are not puttable (either the warrant or the shares) to the Company or redeemable for cash, and as such are classified within equity.
Turtle Beach Corporation
Notes to Condensed Consolidated Financial Statements
(unaudited)
Series B Redeemable Preferred Stock
In September 2010, VTBH issued
1,000,000
shares of its Series B Redeemable Preferred Stock with a fair value of
$12.4 million
. The Series B Redeemable Preferred Stock is required to be redeemed on the earlier of September 28, 2030, or the occurrence of a liquidation event at its original issue price of
$12.425371
per share plus any accrued but unpaid dividends. The redemption value was
$18.5 million
and
$17.5 million
as of
September 30, 2017
and December 31, 2014, respectively.
On February 18, 2015, the holder of the Series B Redeemable Preferred Stock, filed a complaint in Delaware Chancery Court alleging breach of contract against VTBH. According to the complaint, the Merger purportedly triggered a contractual obligation for VTBH to redeem the stock. Refer to Note
12
,
“Commitments and Contingencies”
for further information.
Phantom Equity Activity
In November 2011, VTBH adopted a 2011 Phantom Equity Appreciation Plan (the “Appreciation Plan”) that covers certain employees, consultants, and directors of VTBH (“Participants”) who are entitled to phantom units, as applicable, pursuant to the provisions of their respective award agreements. The Appreciation Plan is shareholder-approved, which permits the granting of phantom units to VTBH’s Participants of up to
1,500,000
units. These units are not exercisable or convertible into shares of common stock but give the holder a right to receive a cash bonus equal to the appreciation in value between the exercise price and value of common stock at the time of a change in control event as defined in the plan.
As of
September 30, 2017
and
December 31, 2016
,
714,347
phantom units at a weighted-average exercise price of
$0.93
had been granted and were outstanding. Because these phantom units are not exercisable or convertible into common shares, said amounts and exercise prices were not subject to the exchange ratio provided by the Merger agreement. As of
September 30, 2017
, compensation expense related to the Appreciation Plan units remained unrecognized because as of those dates a change in control, as defined in the plan, had not occurred and is not probable to occur. In July 2015, the Appreciation Plan was terminated as to new grants, but vested and unvested phantom units will continue.
Note
10
. Net Loss Per Share
The following table sets forth the computation of basic and diluted net loss per share of common stock attributable to common stockholders:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
September 30,
|
|
September 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
|
(in thousands, except per-share data)
|
Net Loss
|
$
|
(492
|
)
|
|
$
|
(44,799
|
)
|
|
$
|
(17,479
|
)
|
|
$
|
(99,383
|
)
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding — Basic
|
49,386
|
|
|
49,230
|
|
|
49,328
|
|
|
48,371
|
|
Plus incremental shares from assumed conversions:
|
|
|
|
|
|
|
|
Dilutive effect of stock options
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Weighted average common shares outstanding — Diluted
|
49,386
|
|
|
49,230
|
|
|
49,328
|
|
|
48,371
|
|
Net loss per share:
|
|
|
|
|
|
|
|
Basic
|
$
|
(0.01
|
)
|
|
$
|
(0.91
|
)
|
|
$
|
(0.35
|
)
|
|
$
|
(2.05
|
)
|
Diluted
|
$
|
(0.01
|
)
|
|
$
|
(0.91
|
)
|
|
$
|
(0.35
|
)
|
|
$
|
(2.05
|
)
|
Incremental shares from stock options and restricted stock awards are computed by 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, unrecognized compensation expense for outstanding awards and the estimated tax benefit of the assumed exercises.
Turtle Beach Corporation
Notes to Condensed Consolidated Financial Statements
(unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
September 30,
|
|
September 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
|
(in thousands)
|
Stock options
|
6,133
|
|
|
6,758
|
|
|
6,287
|
|
|
6,321
|
|
Warrants
|
3,059
|
|
|
3,068
|
|
|
3,061
|
|
|
3,072
|
|
Unvested restricted stock awards
|
167
|
|
|
136
|
|
|
137
|
|
|
115
|
|
Total
|
9,359
|
|
|
9,962
|
|
|
9,485
|
|
|
9,508
|
|
Note
11
. Segment and Geographic Information
The following tables show our net revenues, operating income and total assets by our reporting segments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
September 30,
|
|
September 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Net Revenues
|
(in thousands)
|
Headset
|
$
|
35,947
|
|
|
$
|
38,283
|
|
|
$
|
69,291
|
|
|
$
|
91,172
|
|
HyperSound
|
28
|
|
|
101
|
|
|
148
|
|
|
602
|
|
Total
|
$
|
35,975
|
|
|
$
|
38,384
|
|
|
$
|
69,439
|
|
|
$
|
91,774
|
|
|
|
|
|
|
|
|
|
Operating Income (Loss)
|
|
|
|
|
|
|
|
Headset
|
$
|
1,819
|
|
|
$
|
1,710
|
|
|
$
|
(9,779
|
)
|
|
$
|
(7,971
|
)
|
HyperSound
|
57
|
|
|
(44,450
|
)
|
|
(1,402
|
)
|
|
(85,026
|
)
|
Total
|
$
|
1,876
|
|
|
$
|
(42,740
|
)
|
|
$
|
(11,181
|
)
|
|
$
|
(92,997
|
)
|
Interest Expense
|
$
|
2,042
|
|
|
$
|
1,866
|
|
|
$
|
5,717
|
|
|
$
|
5,331
|
|
Other non-operating expense (income), net
|
$
|
(252
|
)
|
|
$
|
326
|
|
|
(517
|
)
|
|
1,395
|
|
Earnings (loss) before income tax
|
$
|
86
|
|
|
$
|
(44,932
|
)
|
|
$
|
(16,381
|
)
|
|
$
|
(99,723
|
)
|
|
|
|
|
|
|
|
|
|
|
September 30,
2017
|
|
December 31,
2016
|
Total Assets
|
(in thousands)
|
Headset
|
$
|
83,029
|
|
|
$
|
94,081
|
|
HyperSound
(1)
|
27,918
|
|
|
31,233
|
|
Eliminations
|
(27,878
|
)
|
|
(30,514
|
)
|
Total
|
$
|
83,069
|
|
|
$
|
94,800
|
|
(1) At September 30, 2017, HyperSound assets excluding eliminations, totaled less than $0.1 million.
Turtle Beach Corporation
Notes to Condensed Consolidated Financial Statements
(unaudited)
The following table represents total net revenues based on where customers are physically located:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
September 30,
|
|
September 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
|
(in thousands)
|
North America
|
$
|
23,320
|
|
|
$
|
28,063
|
|
|
$
|
47,371
|
|
|
$
|
69,679
|
|
United Kingdom
|
5,204
|
|
|
3,142
|
|
|
9,182
|
|
|
9,073
|
|
Europe
|
5,947
|
|
|
5,477
|
|
|
9,884
|
|
|
9,326
|
|
International
|
1,504
|
|
|
1,702
|
|
|
3,002
|
|
|
3,696
|
|
Total net revenues
|
$
|
35,975
|
|
|
$
|
38,384
|
|
|
$
|
69,439
|
|
|
$
|
91,774
|
|
Note
12
. 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) 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 cases 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. That denial is currently under review by the Nevada Supreme Court, which held a hearing on the Company's petition for review on September 1, 2015. After the hearing, the Nevada Supreme Court requested supplemental briefing, which the parties completed on October 13, 2015. The Nevada Supreme Court also invited the Business Law Section of the Nevada State Bar to submit an amicus brief by December 3, 2015 and briefing was completed on that date. 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 did provide a limited basis upon which plaintiffs could seek to amend their complaint. The schedule for such amendment, if any, has not been set.
Dr. John Bonanno Complaint:
On February 18, 2015, Dr. John Bonanno, a minority shareholder of VTBH, filed a complaint in Delaware Chancery Court alleging breach of contract against VTBH. According to the complaint, the Merger purportedly triggered a contractual obligation for VTBH to redeem Dr. Bonanno's stock. Dr. Bonanno requests a declaratory judgment stating that he is entitled to damages including a redemption of his stock for the redemption value of
$15.1 million
(equal to the original issue price of his stock plus accrued dividends) as well as other costs and expenses. On February 8, 2016, the Delaware Chancery Court granted VTBH's motion to dismiss for improper venue, and Dr. Bonnano's complaint was dismissed without prejudice. In January of 2017, Dr. Bonanno filed a complaint in New York state court alleging breach of contract against VTBH and seeking a declaratory judgment that he is entitled to damages and specific performance, including redemption of his stock. The Company answered the complaint on March 7, 2017. At the order of the Court, the parties filed cross-motions for summary judgment on March 31, 2017, on the sole question of whether the Merger was a defined event in the
Turtle Beach Corporation
Notes to Condensed Consolidated Financial Statements
(unaudited)
purported contract entitling Dr. Bonnano to redemption of his shares. The cross-motions for summary judgment were fully briefed and heard on July 6, 2017. On September 1, 2017, the Court denied Defendant’s motion for summary judgment and granted Plaintiff’s motion for partial summary judgment. On October 5, 2017, a status conference was held that set a pre-trial schedule such that all merits and expert discovery will conclude on May 3, 2018 and a trial readiness conference will be held on May 4, 2018. On October 11, 2017, Defendant filed a motion to reargue plaintiff’s motion for summary judgment in the trial court, specifically seeking clarification that Defendant’s affirmative defenses to liability remain available. On the same day, Defendant filed a notice of appeal of the Court’s decision on summary judgment in its entirety. The plaintiff’s ability to recover any damages is subject to certain limitations, including, but not limited to, legally available funds. VTBH maintains that the Merger did not trigger any obligation to redeem Mr. Bonanno's preferred stock.
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 damages amounting to
€5.0 million
plus accrued interests 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. VTB maintains that its termination of the agreement was valid and that BigBen’s claims against it are without merit. VTB's statement of defense was submitted to the plaintiff and the court has granted the option to submit a further written statement in reply to the statement of defense.
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
September 30, 2017
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
We warrant our 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 warranties, which are included in accrued liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
September 30,
|
|
September 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
|
(in thousands)
|
Warranty, beginning of period
|
$
|
529
|
|
|
$
|
717
|
|
|
$
|
639
|
|
|
$
|
580
|
|
Warranty costs accrued
|
59
|
|
|
195
|
|
|
173
|
|
|
672
|
|
Settlements of warranty claims
|
(109
|
)
|
|
(162
|
)
|
|
(333
|
)
|
|
(502
|
)
|
Warranty, end of period
|
$
|
479
|
|
|
$
|
750
|
|
|
$
|
479
|
|
|
$
|
750
|
|
XO FOUR Stealth Product Recall:
I
n August 2015, the Company received a limited number of reports from consumers and retailers that certain EAR FORCE
®
XO FOUR Stealth headsets appeared to have a white substance or spots on the ear pads. Upon receiving the reports, the Company promptly stopped shipping any units of the XO FOUR Stealth headsets and notified our retail customers to stop sales pending the results of the Company’s investigation. An outside laboratory engaged by the Company identified the substance as mold. In cooperation with the U.S. Consumer Product Safety Commission (“CPSC”), the Company is voluntarily recalling certain units of the headsets. As of
September 30, 2017
and the date of this report, the Company has not received notice of any law suits against the Company in connection with the recall and is working with the contract manufacturer to collect reimbursement for certain related costs.
On February 3, 2016, the Company notified CPSC promptly upon discovery that a vendor had mistakenly shipped certain recalled headsets to fill online orders. The Company has attempted to notify directly each of the affected purchasers to instruct them to participate in the recall. By letter dated August 23, 2017, CPSC staff notified the Company that the staff does not
Turtle Beach Corporation
Notes to Condensed Consolidated Financial Statements
(unaudited)
intend to seek penalties against the Company at this time for the post-recall sale, offer for sale or distribution in commerce of recalled headsets.
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 Exchange Commission on March 8, 2017 (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. 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, 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 (herein referred to as the “Company,” “we,” “us,” or “our”), headquartered in San Diego, California and incorporated in the state of Nevada in 2010, is a premier audio technology company with expertise and experience in developing, commercializing and marketing innovative products across a range of large addressable markets operating under two reportable segments, Turtle Beach® (“Headset“) and HyperSound®.
|
|
•
|
Turtle Beach is a worldwide leading provider of feature-rich headset solutions for use across multiple platforms, including video game and entertainment consoles, handheld consoles, personal computers, tablets and mobile devices.
|
|
|
•
|
HyperSound technology is an innovative patent-protected sound technology that delivers immersive, directional audio with applications in digital signage and kiosks, consumer electronics and hearing healthcare.
|
The Company's stock is traded on NASDAQ Global Market under the symbol HEAR.
Business Trends
Gaming Headset Market
Sales in the gaming accessories market, which includes headsets and other peripherals such as gamepads, specialty controllers, adapters, batteries, memory and interactive gaming toys are heavily dependent on the global video game industry. In 2013, the gaming industry experienced a cyclical event as Microsoft and Sony each announced new consoles for the first time in eight years, and the consumer response to the Xbox One and PlayStation®4 (the “new generation” or “new-gen” consoles) has been overwhelmingly positive, creating a new installed base of gamers and a market for new-gen headsets.
When new console platforms are introduced into the market, changes to their platforms impact how headset connect with or work with the new consoles and, such as with the most recent consoles, required a transition of console gaming headsets and consumers reduced their purchases of game console peripherals and accessories, including headsets, for old generation console platforms in anticipation of the new platforms becoming available.
In September 2016, Sony discontinued the original PlayStation®4 console and released a new, slimmer, and lower-priced PlayStation®4 Slim, which no longer includes an optical audio connector. Despite dropping the optical connector, we were largely able to accommodate this audio connectivity change via software updates to a small selection of our products affected by Sony's hardware change.
We believe this is a good indication that any potential future console changes are not expected to be nearly as disruptive as this past change as the new generation of platform uses fairly standard audio connectivity, which we believe is unlikely to change
and many headsets now have the capability to be updated via software upgrades. Over the long term, we expect to benefit from the extension of the new-gen cycle, driven by the recent introductions of Xbox One S, and PlayStation®VR, and the anticipated releases of PlayStation®4 Pro and Xbox One X, which is believed to result in stronger gaming engagement for the next several years.
While sales of the new-gen consoles have outperformed previous platforms, the overall console gaming market uncharacteristically slowed in the 2016 holiday season, leading to higher-than-normal channel inventory entering 2017, as consumer deferred purchases ahead of mid-cycle console refreshes and a limited line up of multi-player games. By mid-year channel inventory normalized, however, retailer business model initiatives to reduce channels inventory levels have shifted the anticipated timing of revenue. We believe these actions are not an indication of an overall industry decline, but will require the Company to maintain higher inventory levels to meet customer demands with shorter lead times.
The upcoming 2017 holiday outlook, according to recent data, is forecasted to outperform the previous year with multiple game releases expected to exceed $100 million in packaged consumer sales. Additionally, both the PlayStation®4 Pro and Xbox One X have backwards compatibility marking the first time that the console video game business has seen the introduction of two new console systems with complete backward and forward compatibility. And it is the first time that both Sony and Microsoft will have a two-tier product offering which may allow them to offer more competitive pricing on their lower tier models and attract new gamers into the market. We believe the anticipated increased consumer purchase activity, as compared to the prior year, will benefit the gaming console headset market recovery.
Cumulative New Generation Console Sales (in millions)
Source: DFC Intelligence Forecasts: Worldwide Console Forecast, February 2017.
Seasonality
Our gaming headset business is seasonal with a significant portion of sales and profits typically occurring around the holiday period. Historically, more than 50% of headset business revenues are generated during the period from September through December as new headsets are introduced and consumers engage in holiday shopping.
HyperSound
HyperSound technology is a pioneering audio solution that provides an effective means of projecting sound in a highly directional manner, without use of large speaker arrays, to a specific location creating a precise audio zone. HyperSound directs a beam of audio to targeted listeners in a specific spot, delivering an immersive, 3D-like audio experience. Further, in June 2016, we unveiled HyperSound Glass, transparent directional speakers, and have started exploration of potential commercial licensing opportunities.
In the first half of 2017, we substantially completed the process of restructuring the HyperSound business in an effort to reduce costs and align spending with revenues, while continuing to pursue certain licensing opportunities for this technology. In October, the Company agreed to its initial license deal within the commercial audio field of use.
Key Performance Indicators and Non-GAAP Measures
Management routinely reviews key performance indicators including revenue, operating income and margins, 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) it is one of the measures used by our board of directors and management team to evaluate our operating performance; (ii) it is one of the 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) it is used by securities analysts, investors and other interested parties as a common operating performance measure to compare results across companies in our industry by backing out 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 measure, which may not be comparable to similarly titled measures reported by other companies, to be key performance indicators:
|
|
•
|
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 Margins
is defined as gross margin excluding depreciation and amortization, and stock-based compensation.
|
Adjusted EBITDA (and a reconciliation to
Net loss
, the nearest GAAP financial measure) for the
three and nine
months ended
September 30, 2017
and
2016
are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
September 30,
|
|
September 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
|
(in thousands)
|
Net loss
|
$
|
(492
|
)
|
|
$
|
(44,799
|
)
|
|
$
|
(17,479
|
)
|
|
$
|
(99,383
|
)
|
Interest expense
|
2,042
|
|
|
1,866
|
|
|
5,717
|
|
|
5,331
|
|
Depreciation and amortization
|
876
|
|
|
3,047
|
|
|
3,259
|
|
|
8,213
|
|
Stock-based compensation
|
370
|
|
|
1,017
|
|
|
1,187
|
|
|
3,222
|
|
Income tax expense (benefit)
|
578
|
|
|
(133
|
)
|
|
1,098
|
|
|
(340
|
)
|
Restructuring charges
|
241
|
|
|
339
|
|
|
509
|
|
|
564
|
|
Business model transition charge
|
(312
|
)
|
|
7,079
|
|
|
41
|
|
|
7,079
|
|
Impairment charges
|
—
|
|
|
32,084
|
|
|
—
|
|
|
63,236
|
|
Adjusted EBITDA
|
$
|
3,303
|
|
|
$
|
500
|
|
|
$
|
(5,668
|
)
|
|
$
|
(12,078
|
)
|
Comparison of the Three Months Ended
September 30, 2017
to the Three Months Ended
September 30, 2016
Net loss for the three months ended
September 30, 2017
was
$0.5 million
compared to a net loss of
$44.8 million
in the prior year period, including
$0.5 million
and
$0.3 million
of net loss attributable to the Headset segment, respectively.
For the three months ended
September 30, 2017
, Adjusted EBITDA on a consolidated basis was
$3.3 million
, including investments of
$0.2 million
in the HyperSound business compared to
$0.5 million
, including investments of
$2.9 million
in the HyperSound business during the three months ended
September 30, 2016
.
Adjusted EBITDA improved for the three months ended
September 30, 2017
as compared to the prior year period primarily due to lower HyperSound business investment. Headset adjusted EBITDA totaled approximately
$3.5 million
in the three months ended
September 30, 2017
compared to
$3.4 million
in the prior year period which excluded $1.0 million of allocated costs. The increase was primarily due to improved margins driven by product and logistical costs savings, certain initiatives to reduce overhead costs and a foreign exchange benefit.
Comparison of the Nine Months Ended
September 30, 2017
to the Nine Months Ended
September 30, 2016
Net loss for the
nine months ended
September 30, 2017
was
$17.5 million
compared to a net loss of
$99.4 million
in the prior year period, including
$16.1 million
and
$14.4 million
of net loss attributable to the Headset segment, respectively.
For the
nine months ended
September 30, 2017
, Adjusted EBITDA on a consolidated basis was
$(5.7) million
, including investments of
$1.1 million
in the HyperSound business compared to
$(12.1) million
, including investments of
$9.3 million
in the HyperSound business during the
nine months ended
September 30, 2016
. Headset adjusted EBITDA totaled approximately
$(4.6) million
in the
nine months ended
September 30, 2017
compared to
$(2.8) million
in the prior year period that excluded $2.9 million of allocated costs.
Adjusted EBITDA improved for the
nine months ended
September 30, 2017
as compared to the prior year period, despite a challenging gaming consumer market, primarily due to lower HyperSound business investment requirements as a result of the transition to a license model, certain initiatives to reduce overhead costs and improved margins due to product and logistical costs savings.
Results of Operations
The following table sets forth the Company’s statement of operations for the periods presented:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
September 30,
|
|
September 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
|
(in thousands)
|
Net Revenue
|
$
|
35,975
|
|
|
$
|
38,384
|
|
|
$
|
69,439
|
|
|
$
|
91,774
|
|
Cost of Revenue
|
23,437
|
|
|
34,457
|
|
|
48,384
|
|
|
79,372
|
|
Gross Profit
|
12,538
|
|
|
3,927
|
|
|
21,055
|
|
|
12,402
|
|
Operating expenses
|
10,662
|
|
|
46,667
|
|
|
32,236
|
|
|
105,399
|
|
Operating loss
|
1,876
|
|
|
(42,740
|
)
|
|
(11,181
|
)
|
|
(92,997
|
)
|
Interest expense
|
2,042
|
|
|
1,866
|
|
|
5,717
|
|
|
5,331
|
|
Other non-operating expense (income), net
|
(252
|
)
|
|
326
|
|
|
(517
|
)
|
|
1,395
|
|
Earnings (loss) before income tax
|
86
|
|
|
(44,932
|
)
|
|
(16,381
|
)
|
|
(99,723
|
)
|
Income tax expense (benefit)
|
578
|
|
|
(133
|
)
|
|
1,098
|
|
|
(340
|
)
|
Net loss
|
$
|
(492
|
)
|
|
$
|
(44,799
|
)
|
|
$
|
(17,479
|
)
|
|
$
|
(99,383
|
)
|
Net Revenue and Gross Profit
Headset Segment
The following table summarizes net revenue and gross profit for the periods presented:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
September 30,
|
|
September 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
|
(in thousands)
|
Net Revenue
|
$
|
35,947
|
|
|
$
|
38,283
|
|
|
$
|
69,291
|
|
|
$
|
91,172
|
|
Gross Profit
|
12,328
|
|
|
12,766
|
|
|
21,465
|
|
|
24,643
|
|
Gross Margin
|
34.3
|
%
|
|
33.3
|
%
|
|
31.0
|
%
|
|
27.0
|
%
|
Cash Margin
(1)
|
34.8
|
%
|
|
34.0
|
%
|
|
31.6
|
%
|
|
27.9
|
%
|
(1) Excludes non-cash charges of
$0.2 million
and
$0.2 million
, respectively, for the three months ended
September 30, 2017
and
2016
, and
$0.4 million
and
$0.8 million
, respectively, for the
nine months ended
September 30, 2017
and
2016
.
Comparison of the Three Months Ended
September 30, 2017
to the Three Months Ended
September 30, 2016
Net revenues for the three months ended
September 30, 2017
were
$35.9 million
, a
$2.3 million
decrease as compared to three months ended
September 30, 2016
. The slight decrease, due to a holiday order timing shift from certain North American retailers that pushed revenue to October, reflects recent industry data that we believe indicates a start of the gaming console headset market recovery ahead of a solid lineup of expected new game launches and the holiday season that will include the release of the Xbox One X console. Additionally, our international business increased
22.6%
driven by market share growth in the United Kingdom and Europe.
For the three months ended
September 30, 2017
, gross profit as a percentage of net revenue increased to
34.3%
from
33.3%
in the prior year. Headset margins were positively impacted by product cost savings driven by our supply chain and logistics teams and product mix, partially offset by the loss of fixed cost leverage.
Comparison of the Nine Months Ended
September 30, 2017
to the Nine Months Ended
September 30, 2016
Net revenues for the
nine months ended
September 30, 2017
decreased
$21.9 million
or
24.0%
, as compared to
nine months ended
September 30, 2016
, due to the negative impact of 2016 holiday channel overhang, a result of lower industry-wide demand as limited sales of marquee games disrupted holiday purchasing behavior, and retailer business model initiatives to reduce on-hand inventory levels.
For the
nine months ended
September 30, 2017
, gross profit as a percentage of net revenue increased to
31.0%
from
27.0%
in the prior year. Headset margins were positively impacted by favorable product mix and lower obsolescence reserves as we reserved much of the remaining old-gen inventory, partially offset by negative fixed costs leveraging on lower sales volumes.
Operating Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
September 30,
|
|
September 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
|
(in thousands)
|
Selling and marketing
|
$
|
5,586
|
|
|
$
|
7,016
|
|
|
$
|
15,564
|
|
|
$
|
19,737
|
|
Research and development
|
1,336
|
|
|
2,637
|
|
|
4,423
|
|
|
6,701
|
|
General and administrative
|
3,499
|
|
|
4,591
|
|
|
11,740
|
|
|
15,161
|
|
Asset impairment
|
—
|
|
|
32,084
|
|
|
—
|
|
|
63,236
|
|
Restructuring charges
|
241
|
|
|
339
|
|
|
509
|
|
|
564
|
|
Total operating expenses
|
$
|
10,662
|
|
|
$
|
46,667
|
|
|
$
|
32,236
|
|
|
$
|
105,399
|
|
|
|
|
|
|
|
|
|
By Segment:
|
|
|
|
|
|
|
|
Headset
|
$
|
10,509
|
|
|
$
|
11,056
|
|
|
$
|
31,244
|
|
|
$
|
32,613
|
|
HyperSound
|
$
|
153
|
|
|
$
|
35,611
|
|
|
$
|
992
|
|
|
$
|
72,786
|
|
Selling and Marketing
Selling and marketing expenses for the three months ended
September 30, 2017
totaled
$5.6 million
, or
15.5%
as a percentage of net revenues, compared to
$7.0 million
, or
18.3%
as a percentage of net revenues, for the three months ended
September 30, 2016
. The decrease was attributable to the reduction of HyperSound business related sales force and marketing campaigns and, certain promotional activity that has been deferred to align with upcoming game releases.
Selling and marketing expenses for the
nine months ended
September 30, 2017
totaled
$15.6 million
, or
22.4%
as a percentage of net revenues, compared to
$19.7 million
, or
21.5%
as a percentage of net revenues, for the
nine months ended
September 30, 2016
. This decrease was attributable to sales force and marketing spend reductions related to the HyperSound business transition and higher media spend in the prior year period related to certain product launch campaigns. Further, depreciation
expense has decreased year-over-year as certain of our major retail customers have shifted away from independent in-store displays.
Research and Development
As a result of our product development realignment in connection with the HyperSound business transition, research and development expenses decreased for the three and
nine months ended
September 30, 2017
versus the comparable prior year period.
General and Administrative
General and administrative expenses for the three months ended
September 30, 2017
totaled
$3.5 million
, or
9.7%
as a percentage of net revenues, compared to
$4.6 million
, or
12.0%
as a percentage of net revenues, for the three months ended
September 30, 2016
. The decrease was primarily due to lower non-cash charges, legal and professional service fees and headcount reductions.
General and administrative expenses for the
nine months ended
September 30, 2017
totaled
$11.7 million
, or
16.9%
as a percentage of net revenues, compared to
$15.2 million
, or
16.5%
as a percentage of net revenues, for the
nine months ended
September 30, 2016
. The decrease was primarily due to lower non-cash charges and employee expenses.
Restructuring Charges
Restructuring charges for the three and
nine months ended
September 30, 2017
and
September 30, 2016
related to our continued efforts to improve our operating efficiency in our Headset business, such as closing excess facilities and reducing redundancies, and reducing HyperSound business operating expenses.
Interest Expense
For the three and
nine months ended
September 30, 2017
, interest expense increased as compared to
September 30, 2016
due to higher borrowing costs, primarily related to the subordinated notes, additional amortization related to certain amendments to our Credit Facility and the Term Loan Due 2019.
Income Taxes
Income tax expense for the
three and nine
months ended
September 30, 2017
was
$0.6 million
at an effective tax rate of
672.1%
and
$1.1 million
at an effective tax rate of
(6.7)%
, respectively. Income tax benefit for the
three and nine
months ended
September 30, 2016
was
$(0.1) million
at an effective tax rate of
0.3%
and
$(0.3) million
at an effective tax rate of
0.3%
, respectively. The effective tax rate was primarily impacted by the full valuation allowance on domestic earnings, foreign entity tax benefits and certain state tax expense.
Liquidity and Capital Resources
Our primary sources of working capital are cash flow from operations and availability of capital under our revolving credit facility. We have funded operations and acquisitions in recent periods with operating cash flows, and proceeds from debt and equity financings.
The following table summarizes our sources and uses of cash:
|
|
|
|
|
|
|
|
|
|
Nine Months Ended
|
|
September 30,
|
|
2017
|
|
2016
|
|
(in thousands)
|
Cash and cash equivalents at beginning of period
|
$
|
6,183
|
|
|
$
|
7,114
|
|
Net cash provided by operating activities
|
9,291
|
|
|
3,117
|
|
Net cash used for investing activities
|
(2,584
|
)
|
|
(2,260
|
)
|
Net cash used for financing activities
|
(12,559
|
)
|
|
(4,632
|
)
|
Effect of foreign exchange on cash
|
142
|
|
|
(62
|
)
|
Cash and cash equivalents at end of period
|
$
|
473
|
|
|
$
|
3,277
|
|
Operating activities
Cash provided by operating activities for the
nine months ended
September 30, 2017
was
$9.3 million
, an increase of
$6.2 million
as compared to
$3.1 million
for the
nine months ended
September 30, 2016
. The increase is primarily the result of lower HyperSound business net cash burn and certain initiatives to better align cash expenditures with the seasonality of the gaming market, partially offset by lower gross receipts due to reduced sales volumes.
Investing activities
Cash used for investing activities was
$2.6 million
during the
nine months ended
September 30, 2017
compared to
$2.3 million
in the prior period due to an investment to refresh advertising displays at certain major customers and equipment purchases related to our recent headset launches.
Financing activities
Net cash used for financing activities was
$12.6 million
during the
nine months ended
September 30, 2017
compared to
$4.6 million
during the
nine months ended
September 30, 2016
. Financing activities during the
nine months ended
September 30, 2017
included net payments on our revolving credit facility of
$11.1 million
and term loan repayments of
$1.4 million
. Financing activities during the
nine months ended
September 30, 2016
included net payments on our revolving credit facility of
$6.2 million
and term loan repayments of
$3.6 million
with cash from operations and the issuance of common stock.
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 12 months. Significant assumptions underlie this belief, including, among other things, that there will be no material adverse developments in our business, liquidity or capital requirements.
We believe the combination of our revolving credit facility, long-term debt and cash flow generated by our gaming headset business and reduced costs related to the HyperSound business will provide the necessary liquidity to fund our annual working capital needs.
Foreign cash balances at
September 30, 2017
and
December 31, 2016
were
$0.1 million
and
$0.2 million
, respectively.
Revolving Credit Facility
On March 31, 2014, Turtle Beach and certain of its subsidiaries entered into a new asset-based revolving credit 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 loan and security agreement. The Credit Facility,
which
expires on
March 31, 2019
, provides for a line of credit of up to
$60 million
inclusive of a
sub-facility limit of
$10 million
for
TB Europe, a wholly owned subsidiary of Turtle Beach. The Credit Facility may be used for working capital,
the issuance of bank guarantees,
letters of credit and other corporate purposes.
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.
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
1.00%
to
1.50%
for U.S. base rate loans
and between
2.00%
to
2.50%
for U.S. LIBOR loans and U.K. loans. As of
September 30, 2017
, interest rates for outstanding borrowings were
6.24%
for base rate loans and approximately
3.21%
for LIBOR rate loans. 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.
If certain availability thresholds are not met, meaning that the Company does not have receivables and inventory which are eligible to borrow on under the Credit Facility in excess of amounts borrowed, the Credit Facility requi
res the Company and its restricted subsidiaries to maintain a fixed charge coverage ratio. The fixed charge ratio is defined as the ratio, determined
on a consolidated basis for the most recent four fiscal quarters, of (a) EBITDA minus capital expenditures, excluding those financed through other instruments, and cash taxes paid, and (b) Fixed Charges defined as the sum of cash interest expense plus scheduled principal payments.
The current fixed charge coverage ratio of at least
1.15
to 1.00 on the last day of each month will become effective again after the Company has complied with such ratio for six consecutive months.
The Credit Facility also contains affirmative and negative covenants that, subject to certain exceptions, limit our ability to take certain actions, including our ability to incur debt, pay dividends and repurchase stock, make certain investments and other payments, enter into certain mergers and consolidations, engage in sale leaseback transactions and transactions with affiliates and encumber and dispose of assets. Obligations under the Credit Facility are secured by a security interest and lien upon substantially all of the Company's assets.
On October 31, 2016, the Company amended certain provisions to provide, among other things, that (i) the existing loan availability blocks be temporarily reduced during certain specified periods, (ii) replaced certain financial covenants determined on a segment-by-segment basis by amended EBITDA levels for the Headset business beginning with the month ended October 31, 2016, (iii) the Company maintain revised cash flow levels, in the aggregate and with respect to its HyperSound division, during each rolling four week period beginning with the period ended October 31, 2016 through December 31, 2018 and September 30, 2017, respectively, and (iv) in the event the Company’s availability is less than certain specified amounts, obtain additional funding from the issuance of a subordinated promissory note provided by SG VTB (the “Promissory Note”).
As of
September 30, 2017
, the Company was in compliance with all financial covenants, as amended, and excess borrowing availability was approximately
$12.5 million
, net of the outstanding Term Loan Due 2018 (as defined below) that is considered to be an additional outstanding amount under the Credit Facility.
Term Loan Due 2018
On December 29, 2014, the Company amended the Credit Facility (the “December Amendment”) to permit the repayment of
$7.7 million
of then existing subordinated debt and accrued interest with the proceeds of an additional loan (the “Term Loan Due 2018”). The Term Loan Due 2018 resulted in modified financial covenants while it is outstanding, will bear interest at a rate of LIBOR for the applicable interest period plus
5%
will be repaid in equal monthly installments beginning on April 1, 2015 and ending on October 1, 2018, reflecting a six month waiver. Amounts so repaid are recognized by lowering the balance of the term loan tranche and increasing the lower interest rate base revolver amount, with no net impact on borrowing availability.
Term Loan Due 2019
On July 22, 2015, the Company and its subsidiaries, entered into a term loan, guaranty and security agreement (the “Term Loan Due 2019”) with Crystal Financial LLC, as agent, sole lead arranger and sole bookrunner, Crystal Financial SPV LLC and the other persons party thereto (“Crystal”), which provides for an aggregate term loan commitment of
$15 million
that bears interest at a rate per annum equal to the 90-day LIBOR rate plus
10.25%
. Under the terms of the Term Loan Due 2019, the Company is required to make payments of interest in arrears on the first day of each month beginning August 1, 2015 and will repay the principal in monthly payments beginning January 1, 2016, inclusive of a nine month waiver, with a final payment on
June 28, 2019
, the maturity date.
The Term Loan Due 2019 is secured by a security interest in substantially all of the Company and each of its subsidiaries' working capital assets and is subject to the first-priority lien of Bank of America, as agent, under the Credit Facility, other than with respect to equipment, fixtures, real property interests, intellectual property, intercompany property, intercompany indebtedness, equity interest in their subsidiaries, and certain other assets specified in an inter-creditor agreement between Bank of America and Crystal.
The Company and its subsidiaries are required to comply with various customary covenants including, (i) maintaining minimum EBITDA (as defined in the Term Loan Due 2019) in each trailing twelve month period beginning August 31, 2015, (ii) maintaining a Consolidated Leverage Ratio (as defined in the Term Loan Due 2019) to be measured on the last day of each month while the term loans are outstanding of no more than
5.75
:1 beginning December 31, 2015 with periodic step-downs to
3.00
:1 on January 31, 2018, (iii) not making capital expenditures in excess of
$5 million
in each of the years ending December 31, 2016, 2018 and 2019 and in excess of
$5.5 million
in the year ending December 31, 2017, (iv) restrictions on the Company’s and its subsidiaries ability to prepay its subordinated notes, pay dividends, incur debt, create or suffer liens and engage in certain fundamental transactions and (v) an obligation to provide certain financial and other information. The agreement permits certain equity holders of the Company to contribute funds to the Company to cure certain financial covenant defaults.
The Term Loan Due 2019 contains customary representations, mandatory prepayment events and events of default, including defaults triggered by the failure to make payments when due, breaches of covenants and representations, material impairment in the perfection of Crystal’s security interest in the collateral and events related to bankruptcy and insolvency of the Company and its subsidiaries. Upon an event of default, Crystal may declare all outstanding obligations immediately due and payable (along with a prepayment fee), a default rate of an additional
2.0%
may be applied to amounts outstanding and may take other actions including collecting or taking such other action with respect to the collateral pledged in connection with the term loan.
On October 31, 2016, in connection with the recently announced HyperSound business restructuring, the Company amended certain provisions to provide, among other things, that (i) the existing loan availability blocks be permanently reduced during certain specified periods, (ii) replaced certain financial covenants determined on a segment-by-segment basis by amended EBITDA levels for the Headset business beginning with the month ended October 31, 2016, (iii) the Company maintain revised cash flow levels, in the aggregate and with respect to its HyperSound segment, during each rolling four week period beginning with the period ended October 31, 2016 through December 31, 2018 and September 30, 2017, respectively, and (iv) in the event the Company’s availability is less than certain specified amounts, obtain additional funding from the issuance of a subordinated promissory note provided by SG VTB (the “Promissory Note”).
As of
September 30, 2017
, the Company was in compliance with all the amended financial covenants.
Subordinated Notes - Related Party
O
n April 23, 2015, the Company issued a
$5.0 million
subordinated note (the “April Note”) to SG VTB Holdings, LLC, the Company’s largest stockholder (“SG VTB”). The April Note was issued with an interest rate of (i)
10%
per annum for the first year and (ii)
20%
per annum for all periods thereafter, with interest accruing and being added to the principal amount of the note quarterly.
On May 13, 2015, the Company issued subordinated notes (the “May Notes”) with an aggregate principal amount of
$3.8 million
to SG VTB, and a trust affiliated with Ronald Doornink, the Chairman of the Company's board of directors (the “Board”). The May Notes were issued with an interest rate of
10%
per annum until the maturity date of the May Notes (which was
August 13, 2015
but could be extended up to two additional 90 day periods upon the written agreement of the Company and the noteholder), with interest accruing and being added to the principal amount of the May Notes quarterly. Following the maturity date, the interest rate would have increased to
20%
per annum.
On June 17, 2015, the Company issued a subordinated note (the “June Note”) with an aggregate principal amount of
$3.0 million
to SG VTB. The June Note was issued at an interest rate of
10%
per annum until the maturity date of the June Note (which was
September 17, 2015
but could be extended up to two additional 90 day periods upon the written agreement of the Company and the noteholder), with interest accruing and being added to the principal amount of the June Note quarterly. Following the maturity date, the interest rate would have increased to
20%
per annum. In addition, the Company had the option to request that SG VTB make, in SG VTB’s sole discretion, additional advances from time to time up to an aggregate principal amount of
$15.0 million
. Prior to the amendment (see below), following an additional advance of
$6.0 million
on July 8, 2015,
$9.0 million
was outstanding under the June Note.
Concurrently with the completion of the Term Loan Due 2019, the Company amended and restated each of its outstanding subordinated notes (the “Amended Notes”). The obligations of the Company under the Amended Notes are subordinate and junior to the prior payment of amounts due under the Credit Facility and Term Loan Due 2019. In addition, the stated maturity date of the Amended Notes was extended to
September 29, 2019
, subject to acceleration in certain circumstances, such as a change of control of the Company. The Amended Notes bear interest at a rate per annum equal to LIBOR plus
10.5%
and shall be paid-in-kind by adding the amount to the principal amount due.
On November 16, 2015, the Company issued a
$2.5 million
subordinated note (the “November Note”) to SG VTB, the proceeds of which, as set forth in the amendment to the Term Loan Due 2019, were applied against the outstanding balance of the Term Loan Due 2019. The November Note will bear interest at a rate of
15%
per annum until its maturity date, which is
September 29, 2019
, and is subordinated to all senior debt of the Company.
On October 31, 2016, in connection with certain amendments to the Credit Facility and Term Loan Due 2019, the Company and SG VTB entered into the Promissory Note, which states that in the event the Company’s availability under the Credit Facility is less than certain specified amounts, the Company may, upon request, at any time until September 29, 2019 require that SG VTB provide a $2 million subordinated loan. Upon issuance, the loan would bear interest at a rate of either (i) LIBOR plus 10.5% per annum or (ii) 12.0%, dependent upon the Company’s compliance with certain financial covenants and would be subordinated to all senior debt of the Company.
SG VTB is an affiliate of Stripes Group LLC (“Stripes”), a private equity firm focused on internet, software, healthcare IT and branded consumer products businesses. Kenneth A. Fox, one of our directors, is the managing general partner of Stripes and the sole manager of SG VTB and Ronald Doornink, our Chairman of the Board, is an operating partner of Stripes.
Series B Redeemable Preferred Stock
In September 2010, VTBH issued 1,000,000 shares of its Series B Redeemable Preferred Stock with a fair value of $12.4 million. We are required to redeem the Series B Redeemable Preferred Stock on the earlier to occur of September 28, 2030 or the occurrence of a liquidation event at its original issue price of $12.425371 per share plus any accrued but unpaid dividends. The redemption value was
$18.5 million
and
$17.5 million
as of
September 30, 2017
and
December 31, 2016
, respectively.
Stock Warrants
In connection with and as consideration for the concessions in the Amended Notes, the Company issued to SG VTB and a trust affiliated with Ronald Doornink warrants to purchase
1.7 million
shares of the Company’s common stock at an exercise price of
$2.54
per share. The warrants are exercisable for a period of
five
years beginning on the date of issuance, July 22, 2015. The exercise price and the number of shares of Common Stock purchasable are subject to adjustment and do not carry any voting rights or other rights as a stockholder of the Company prior to exercise. The shares issuable upon exercise are also subject to the “demand” and “piggyback” registration rights set forth in the in the Company’s Stockholder Agreement, dated August 5, 2013, as amended July 10, 2014.
In connection with the November Note, the Company issued a warrant to purchase
1.4 million
shares of the Company’s common stock at an exercise price of
$2.00
per share to SG VTB. The exercise price and the number of shares are subject to standard anti-dilution adjustments and do not carry any voting rights as a stockholder of the Company prior to exercise. The warrant is exercisable for a period of
ten
years beginning on the date of issuance and does not entitle the holder to any voting rights or other rights as a stockholder of the Company prior to exercise.
In addition, under the terms of the Promissory Note, if and when the funding occurs, as additional consideration the Company would issue to SG VTB a warrant, exercisable for a period of ten years beginning on the date of issuance, to purchase an amount of shares of the Company’s common stock equal to 2.4% of the Company’s then fully diluted shares outstanding at an exercise price equal to the closing price on that date. The warrant would not entitle the holder to any voting rights or other rights as a stockholder of the Company prior to exercise.
Critical Accounting Estimates
Our discussion and analysis of our results of operations and capital resources are based on our condensed consolidated financial statements, which have been prepared in conformity with GAAP. The preparation of these condensed 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.
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.
See Note
2
,
“Summary of Significant Accounting Policies,”
in the Notes to the condensed consolidated financial statements for a complete discussion of recent accounting pronouncements. We are currently evaluating the impact of certain recently issued guidance on our financial condition and results of operations in future periods.