News Column

TURTLE BEACH CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

August 11, 2014

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 Prospectus Supplement filed with the Securities Exchange Commission on April 24, 2014. This discussion and analysis contains forward-looking statements that are based on the beliefs, as well as assumptions made by, and information currently available to, its management. Actual results could differ materially from those discussed in or implied by forward-looking statements for various reasons. This Quarterly 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. These statements represent our expectations based on current information and assumptions and are inherently subject to risks and uncertainties. Our actual results could differ materially from those which are anticipated or projected as a result of certain risks and uncertainties, including, but not limited to, changes in business relationships with our major customers and in the timing, size and continuation of our customers' programs; the ability of our customers to achieve their projected sales; competitive product and pricing pressures; increases in production or material costs that cannot be recouped in product pricing; the performance of the aftermarket and original equipment service markets; changes in the product mix and distribution channel mix; economic and market conditions (including access to credit and financial markets); our significant indebtedness; successful integration of acquired businesses; our ability to achieve cost savings from our restructuring initiatives; litigation, product liability and environmental matters; as well as other risks and uncertainties, such as those described under Risk Factors, Quantitative and Qualitative Disclosures About Market Risk and those detailed herein and from time to time in the filings of the Company with the SEC. Forward-looking statements are made only as of the date hereof, and 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, historical information should not be considered as an indicator of future performance. The following discussion should be read in conjunction with the unaudited consolidated financial statements, including the notes thereto, included elsewhere in this Report. Merger with Parametric Sound On January 15, 2014, VTB Holdings, Inc. ("VTBH") and Parametric Sound Corporation ("Parametric") completed a merger that resulted in a company with a new investment profile and unaudited pro forma combined net revenue of $179 million for the year ended December 31, 2013. As a result, VTBH became a wholly-owned subsidiary of Parametric. For accounting purposes, the merger was treated as a "reverse acquisition" and VTBH was considered the accounting acquirer. Accordingly, VTBH's historical results of operations replace Parametric's historical results of operations for all periods prior to the merger, and for all periods following the merger, the results of operations of both companies will be included. As such, the historical revenues are primarily derived from the sale of gaming headsets and accessories, including replacement parts for gaming headsets and audio cables. During 2014, revenues will also include the sale of HyperSound products for commercial applications. On May 20, 2014, Parametric filed a Certificate of Amendment to its Articles of Incorporation to change the company's name from "Parametric Sound Corporation" to "Turtle Beach Corporation" effective May 28, 2014. Business Overview Turtle Beach Corporation (herein referred to as the "Company," "we," "us," or "our") is a premier audio innovation company with deep expertise and relevant experience in developing, commercializing and marketing audio technologies across a range of large addressable markets under the Turtle Beach and HyperSound brands. Turtle Beach (TurtleBeach.com) is the worldwide leading provider of feature-rich headset solutions for use across multiple platforms, including video game and entertainment consoles, handheld consoles, PC and Macintosh computers, tablets and mobile devices. HyperSound (HyperSound.com) is a novel patent-protected sound delivery technology that delivers immersive, directional audio offering unique benefits in a variety of commercial settings and consumer devices, including improved clarity and comprehension for hearing impaired listeners. Our mission is to utilize innovative technology to create exceptional audio experiences across a wide range of consumer and commercial applications. 24 -------------------------------------------------------------------------------- Audio technology and digital signal processing are core competencies of the combined companies, and we intend to leverage these competencies to continue to expand both our headset and HyperSound product portfolios. We consider continued innovation and state-of-the-art product development key factors to our future success. The merger combined the unique intellectual property and HyperSound product platform with the commercialization skills and resources of Turtle Beach, including proven product design, product development, supply chain management, sales and marketing. We believe that the strength of the Turtle Beach headset business provides a strong foundation that will enable us to invest in the advancement and commercialization of HyperSound. The Company's stock is traded on NASDAQ under the symbol HEAR. Headset Business Overview Turtle Beach launched its first gaming headset in 2005 and played a significant role in developing the market for advanced gaming headsets. Today's consumers know Turtle Beach for advanced gaming headsets, which allow video game players to experience high-quality, immersive surround sound and to communicate with others while playing video games. Turtle Beach has licensing agreements with major software and entertainment brands, including Activision, Blizzard, Disney and Marvel to create co-branded headsets with popular franchises, such as Call of Duty® and Star Wars. Turtle Beach branded headsets are distributed internationally across North America, South America, Europe, the Middle East, Africa, Australia, and Asia, and sold at thousands of storefronts, including major retailers such as Amazon, Apple, Best Buy, GameStop, HMV, Target and Walmart. We offer a variety of headsets at retail price points ranging from $30 to $300 and have offerings across all major gaming platforms. As gaming consoles have evolved from dedicated video game platforms to home entertainment hubs, and mobile devices have become platforms for entertainment, we have continued to evolve our headsets to reflect how content is consumed. We believe that the primary growth drivers for our console gaming headset business are: • Cumulative sales of 163 million consoles, in the aggregate, of Xbox 360, Xbox One, PlayStation®3, and PlayStation®4 consoles as of year-end 2013, as estimated in the June 2014 DFC Intelligence: Worldwide Console Forecast; • Projected sales of next-generation Xbox One and PlayStation®4 consoles, which are forecasted to reach 178 million cumulative units by the end of 2018, as estimated in the June 2014 DFC Intelligence: Worldwide Console Forecast; • The increase in multiplayer online gaming, whether console-, mobile-, or PC-based, in which a gaming headset provides the additional benefit of being a communication device; • The launch of new console video game titles, which we believe increases foot traffic into retail stores and lifts console gaming headset sales; and • The installed base of more than 7 million Turtle Beach headsets, which we expect to drive upgrades and replacements. Business Trends The gaming industry experienced a cyclical event in 2013 as Microsoft and Sony each introduced new consoles for the first time in eight years. Turtle Beach's gaming headset business was materially impacted in 2013 by the beginning of this multi-year transition from sixth generation consoles to seventh generation consoles. After Sony announced the PlayStation®4 in February 2013 and Microsoft announced the Xbox One in May 2013, consumers began delaying gaming purchases in advance of the introduction of the new consoles, negatively impacting global sales of console hardware and software. Therefore, we focused on investment in personnel and infrastructure with the goal of positioning for renewed growth in 2014 and to enter or strengthen our position in new geographic regions and expand the product line into areas outside of console gaming headsets. 25 -------------------------------------------------------------------------------- PlayStation®4 console launch In preparation for the launch of the PlayStation®4 in November 2013, we introduced two headsets designed for the new console, the P4C and PX4, and aggressively marketed many current generation headsets in our portfolio that are also compatible with the new console. As a result, sales of PlayStation®4 compatible headsets played a large role in the improved performance at the end of 2013, which carried over to the first half of 2014. In January 2014 we announced an agreement with Sony Computer Entertainment Inc. to make officially licensed headsets for the PlayStation®4. In June 2014 we revealed the ELITE 800 and Stealth 400, two new wireless headsets that will come to retail during the 2014 holiday season, and in July 2014 we launched the P12, a new entry-level headset for the PlayStation®4. These developments will expand our core portfolio of headsets for the PlayStation®4 from two to six models by the end of the year. Xbox One console launch In order for headsets to receive integrated voice and chat audio from the Xbox One, a Microsoft proprietary hardware adapter is currently required, and in the future a Microsoft proprietary computer chip will be required, to receive the integrated voice and chat audio. Due to the inclusion of this proprietary adapter, older headsets lacking a license from Microsoft, including older Turtle Beach headsets, are not compatible with the Xbox One without the separately purchased adapter. In October 2013, Microsoft informed us that the adapter and software created by Microsoft and required to enable full headset functionality on the Xbox One would not be implemented until the first quarter of 2014. As a result, we deferred the launch of the first-ever Xbox One compatible headsets -- the XO FOUR, XO SEVEN and Titanfall Atlas -- until March 6, 2014. In June 2014 we unveiled the XO ONE and Stealth 500X, which will expand our portfolio of Xbox One compatible headsets for the 2014 holiday season. The consumer response to Xbox One and PlayStation®4 has been overwhelmingly positive, creating a growing installed base of users and a market for next generation headsets. We believe we are well positioned to benefit from the anticipated growth in the segment as consumers purchase new consoles over the next three years and beyond. DFC Intelligence estimates Xbox One cumulative sales will increase approximately 25 times from a base of 3.0 million in 2013 to 73.9 million in 2018, and estimates PlayStation®4 cumulative sales will increase approximately 22 times from a base of 4.7 million to 103.9 million over the same period. In addition, industry analysts expect Microsoft and Sony to continue to support their current generation consoles over the next few years and, as a result, we anticipate that there will continue to be a significant market through 2014 for our headsets that are compatible with Xbox 360 and PlayStation®3. 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. Geographic Expansion We have a strong market position in North America, United Kingdom, and Australia, and believe there is further opportunity for growth in the rest of Europe. Asia, in particular China, and Latin America are viewed as additional long-term growth opportunities. The Company intends to continue investing in a stronger presence and growth in these regions. Total points of distribution is a standard retail trade term used to summarize distribution breadth by multiplying the number of retail outlets selling a product by the number of those products in each location. It takes into account how widely products are available and how many items are available. Points of distribution for our headset business nearly tripled overall from 2011 to 2013, increasing from approximately 128,000 to approximately 370,000. The international growth rate over the three-year period was 490%, with points of distribution increasing from approximately 27,000 to 159,000. HyperSound Business Overview Technology Target Markets Several innovations have made HyperSound a distinctly different technology from previous utltrasonic audio solutions. These patent-protected innovations provide a competitive advantage over other solutions in the marketplace. Digital signal processing 26 -------------------------------------------------------------------------------- has significantly improved audio quality and frequency response, electronics advancements have enabled the use of low voltage cables and lowered overall power consumption, and innovations in emitter panel design have improved the ratio of audio volume to panel size, allowing for the production of much smaller panels. Combined, these improvements open the door to the use of HyperSound in a host of commercial and consumer applications that was closed to past ultrasonic sound technologies. We are currently focusing our product development efforts for HyperSound-based products in the following three areas: commercial, health care and consumer applications. We are also pursuing licensing opportunities in addition to the products we are commercializing. Commercial Applications Among potential commercial applications, we are currently marketing our HyperSound technology to retailers and audio-visual integrators for use in settings where directed audio and sound zones are beneficial, such as digital signage and interactive retail displays. Digital signage is a growing form of direct advertising, capturing an increasing share of advertising spending. Restaurants, banking, retail outlets, museums and other outlets and organizations employ commercial displays to communicate with patrons, many of which currently have no audio. Interactive retail displays and related computer terminals such as ATMs, power applications for communication, commerce, entertainment and education. Electronic gaming and casino slot machines are also becoming increasingly sophisticated computerized entertainment devices. We believe the ability to focus sound on the user in front of such displays or devices, while limiting or removing sound disruption outside the listening area, offers utility unavailable with traditional speakers. HyperSound creates discrete in-store promotional audio zones that offer a personal experience to an individual while preventing noise pollution that could be heard by surrounding customers. Health Care Our research indicates that HyperSound technology delivers improved clarity and comprehension for hard of hearing listeners. Individuals with normal and impaired hearing reported improved comprehension and clarity of sounds generated by HyperSound Audio Systems compared to standard speakers in our consumer preference research involving more than 90 subjects. Data from our clinical study involving ten adult subjects demonstrated improvement in sound clarity over conventional speakers in those with mild to severe hearing loss. In February 2014 we received clearance from the U.S. Food and Drug Administration, or FDA, to market the HyperSound Audio System to improve the clarity and comprehension of sounds from various sources for listeners with or without hearing loss and with or without the use of hearing aids. There are over 48 million people with hearing impairments in the United States. We believe that a large percentage of that market can use HyperSound Audio Systems to improve their listening experiences from sources such as TV, CD/DVD players and stereo systems. Consumer Applications Our HyperSound technology has the potential to be developed into consumer products for various applications, including computers, video game consoles, televisions, home theater and home audio. With the advent of flat panel displays for use in televisions and mobile devices, manufacturers have been focused on creating thinner products often at the expense of sound quality. We believe this has created an opportunity to develop integrated and companion HyperSound products that improve the audio experience by providing immersive 3D sound. We believe that our ability to create a 3D sound image from two thin emitters, compared to a five- or seven-speaker surround sound set-up using conventional speakers can deliver a compelling and enhanced audio experience for consumers. 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 consider other certain measures to be useful to management and investors evaluating our operating performance for the periods presented, and believe these additional measures provide a tool for evaluating our ongoing operations, liquidity and management of assets. These metrics, however, are not measures of financial performance under accounting principles generally accepted in the United States of America ("GAAP") and should not be considered a substitute for net income (loss) or other consolidated income statement data as determined in accordance with GAAP. These other measures may not be comparable to similarly titled measures employed by other companies. 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: 27 -------------------------------------------------------------------------------- Adjusted EBITDA "Adjusted EBITDA" is defined as net income (loss) before interest, taxes, depreciation and amortization, stock-based compensation (non-cash), non-cash amortization of payments to founders and certain business transaction expenses. Management adjusts net income (loss) for business transaction costs because it believes that such items are not representative of core operations. For the three and six months ended June 30, 2014, business transaction costs consisted of acquisition-related costs in the amount of $(0.5) million and $3.7 million related to the merger. We believe Adjusted EBITDA provides useful information to 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 in our calculation of Adjusted EBITDA (business transaction costs, payments to our founders, and stock-based compensation) 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 expense). Adjusted EBITDA has limitations as an analytical tool, and when assessing our operating performance, it should not consider Adjusted EBITDA in isolation or as a substitute for net income (loss) or other consolidated income statement data. Some of these limitations include, but are not limited to: • Adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs; • Adjusted EBITDA does not reflect interest expense, or the cash requirements necessary to service interest or principal payments, on our debt; • Adjusted EBITDA does not reflect income taxes or the cash requirements for any tax payments; and • Other companies may calculate Adjusted EBITDA differently than we do, limiting its usefulness as a comparative measure. Adjusted EBITDA (and a reconciliation to Net loss, the nearest GAAP financial measure) for the three and six months ended June 30, 2014 and 2013 are as follows: Three Months Ended Six Months Ended June 30, June 30, 2014 2013 2014 2013 (in thousands) Net loss $ (9,302 )$ (3,338 )$ (12,208 )$ (5,642 ) Interest expense 1,055 1,249 5,295 2,563 Depreciation and amortization 1,494 1,184 3,545 2,351 Stock-based compensation 1,348 555 2,397 1,263 Income tax benefit (835 ) (3,750 ) (6,667 ) (3,487 ) Business transaction costs (484 ) 680 3,744 680 Payments to founders - - - 527 Adjusted EBITDA $ (6,724 )$ (3,420 )$ (3,894 )$ (1,745 ) Adjusted EBITDA decreased for the three and six months ended June 30, 2014 as compared to the prior year periods due to driven largely by non-recurring costs to package the Microsoft Xbox One Headset Chat Adapter with our headsets and ship them to retailers, an increase to inventory reserves, and incremental costs related to the HyperSound business. 28 -------------------------------------------------------------------------------- Results of Operations The following table sets forth the Company's statement of operations for the periods presented: Three Months Ended Six Months Ended June 30, June 30, 2014 2013 2014 2013 (in thousands) Net Revenue $ 22,296$ 24,520$ 60,584$ 54,053 Cost of Revenue 17,465 18,198 43,477 39,106 Gross Profit 4,831 6,322 17,107 14,947 Operating expenses 13,983 12,077 30,782 21,040 Operating loss (9,152 ) (5,755 ) (13,675 ) (6,093 ) Interest expense 1,055 1,249 5,295 2,563 Other non-operating expense (income), net (70 ) 84 (95 ) 473 Loss before income tax benefit (10,137 ) (7,088 ) (18,875 ) (9,129 ) Income tax benefit (835 ) (3,750 ) (6,667 ) (3,487 ) Net loss $ (9,302 )$ (3,338 )$ (12,208 )$ (5,642 ) Net Revenue Net revenues for the three months ended June 30, 2014 decreased 9.1% over the comparable 2013 period to $22.3 million. While revenues of Xbox One compatible headsets remained strong and sales of licensed headsets for the Titanfall release were better than expected, overall, both domestic and international sales for the quarter were negatively impacted by strong retailer demand for the first Xbox One headsets that shifted shipments into the first quarter and continued industry-wide sales declines in consumer electronics. For the six months ended June 30, 2014, net revenues increased $6.5 million, or 12.1%, compared to the six months ended June 30, 2013 reflecting the combined benefits of positive consumer reaction to the launch of our XO FOUR and XO SEVEN headsets, continued strong response to our PlayStation®4 compatible headsets as well as a delay in gaming headset audio for the Xbox One console that deferred headset sales from the holiday season to the first half of 2014. Cost of Revenue and Gross Profit Gross profit as a percentage of net revenues for the three months ended June 30, 2014 was 21.7% versus 25.8% in the comparable 2013 period. We experienced a year-over-year decrease in gross margin rate performance driven largely by non-recurring costs to package the Microsoft Xbox One Headset Chat Adapter with our headsets and ship them to retailers and higher promotional credits. For the six months ended June 30, 2014, gross profit as a percentage of net sales increased to 28.2% from 27.7% in the comparable 2013 period driven by an increased penetration of higher margin headsets and absorption of non-recurring shipping and handling costs. 29 --------------------------------------------------------------------------------

Operating Expenses Three Months Ended Six Months Ended June 30, June 30, 2014 2013 2014 2013 (in thousands)



Selling and marketing $ 7,698$ 8,412$ 14,698$ 14,118 Research and development 2,071 1,325 4,069 2,212 General and administrative 4,698 1,660 8,271 4,030 Business transaction costs (484 ) 680 3,744 680 Total operating expenses $ 13,983$ 12,077$ 30,782$ 21,040

Selling and Marketing Selling and marketing expense for the three months ended June 30, 2014 totaled $7.7 million, or 34.5% as a percentage of net revenues, compared to $8.4 million, or 34.3% as a percentage of net revenues, for the three months ended June 30, 2013. The 8.5% decrease was primarily due to lower spending on trade show related marketing costs, offset, in part, by incremental costs related to the HyperSound business and higher depreciation on display units. For the six months ended June 30, 2014, selling and marketing expense totaled $14.7 million, or 24.3% as a percentage of net revenues, compared to $14.1 million, or 26.1% as a percentage of net revenues, for the prior year period. The increase in expense was primarily due to $0.7 million of incremental costs related to the HyperSound business, additional depreciation costs related to the expansion of interactive retail display kiosks into two large retailers in the fourth quarter of 2013, offset, in part, by reduced trade show related marketing costs. Research and Development The increase in research and development expenses for the three and six months ended June 30, 2014 versus the comparable prior-year periods was primarily due to higher costs associated with additional headcount and additional incremental costs related to our product development efforts for HyperSound-based products. General and Administrative The increase in general and administrative expenses for the three and six months ended June 30, 2014 versus the comparable prior-year periods was primarily due to approximately $0.6 million and $0.8 million, respectively, of incremental costs to support being a public company, as well as higher consultant and legal fees in connection with the bank refinancing and equity offering and additional headcount to continue to build our internal capabilities. Business Transaction Business transaction expenses for the six months ended June 30, 2014 related to investment banker success fees of $2.2 million payable upon the close of the Merger as well as associated legal and accounting fees. Business transaction expenses of $0.7 million from the six months ended June 30, 2013 related to due diligence and legal costs incurred in connection with the Merger. Interest Expense Interest expense decreased by $0.2 million for the three months ended June 30, 2014, as compared to June 30, 2013, primarily due to lower average borrowings outstanding on our credit facility which was paid down with funds from our equity offering. The decrease was offset, in part, by additional interest charges related to the subordinated notes. Interest expense increased $2.7 million for the six months ended June 30, 2014 primarily due to the write-off of $2.2 million of unamortized debt issuance costs related to the refinancing of our credit facility on March 31, 2014, additional interest related to the issuance of the subordinated notes and higher interest rates on the revolver and term loan balance outstanding under our previous credit facility. 30 -------------------------------------------------------------------------------- Income Taxes Income tax benefit for the three and six months ended June 30, 2014 was $0.8 million at an effective tax rate of 8.2% and $6.7 million at an effective tax rate of 35.3%, respectively. The effective tax rate for the three and six months ended June 30, 2014 was impacted by differences in book and tax treatment of transaction costs, interest on the Series B Redeemable Preferred Stock and other non-deductible expenses. Income tax benefit for the three and six months ended June 30, 2013 was $3.8 million at an effective tax rate of 52.9% and $3.5 million at an effective tax rate of 38.2%, respectively, which were lower than the federal statutory rate primarily due to non-deductible interest on the Series B Redeemable Preferred Stock. Liquidity and Capital Resources Our primary source of working capital is cash flow from operations. We have funded operations and acquisitions in recent periods with operating cash flows, proceeds from debt financings and invoice factoring.



The following table summarizes our sources and uses of cash:

Six Months Ended June 30, 2014 2013 (in thousands)



Cash and cash equivalents at beginning of period $ 6,509$ 5,219 Net cash provided by operating activities

476 22,271



Net cash provided by (used for) investing activities 3,479 (2,862 ) Net cash used for financing activities

(1,859 ) (22,500 ) Effect of foreign exchange on cash 353 (109 ) Cash and cash equivalents at end of period $ 8,958$ 2,019 Operating activities During the six months ended June 30, 2014, net cash provided by operating activities declined by $21.8 million as compared to the six months ended June 30, 2013. The year-over-year decrease is primarily the result of a reduction in net working capital items, primarily accounts payable payments and lower accounts receivables, and an increase in deferred taxes related to acquired net operating loss credits and higher stock compensation activity. Investing activities Cash provided by investing activities was $3.5 million during the six months ended June 30, 2014 compared to cash used for investing activities of $2.9 million during the six months ended June 30, 2013, as a result of $4.1 million of cash acquired in the merger. Capital expenditures decreased $2.2 million compared to the prior year period to $0.6 million for the six months ended June 30, 2014. Financing activities Net cash used for financing activities was $1.9 million during the six months ended June 30, 2014 compared to $22.5 million during the six months ended June 30, 2013. Financing activities during the first half of 2014 included (i) net payments on our revolving credit facilities of $20.5 million with cash from operations and funds from our equity offering, (ii) repayment of our $14.5 million legacy term loan and (iii) repayment of $10.8 million of outstanding subordinate notes, which were offset by $37.2 million of proceeds from the sale of common stock and the issuance of $7.0 million principal amount of subordinated notes. The net cash used in the six months ended June 30, 2013 was primarily due to net repayments of the revolving line of credit and term loan. 31 -------------------------------------------------------------------------------- Management assessment of liquidity Management believes that its current cash and cash equivalents, proceeds received from the equity offering (see below), and the amounts available under its asset-based credit facility and its 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. On April 24, 2014, we entered into an Underwriting Agreement (the "Underwriting Agreement") with Needham & Company, LLC, as representative for the several other underwriters named therein, relating to an underwritten public offering (the "Offering") of 4,000,000 shares of our common stock, at a price to the public of $10.00 per share (the "Offering Price"). Under the terms of the Underwriting Agreement, we also granted the underwriters a 30-day option to purchase up to an additional 600,000 shares of common stock at the Offering Price less the underwriting discount and estimated offering expenses payable by us. We received net proceeds from the Offering of approximately $37.2 million after deducting the underwriting discount and estimated offering expenses. The net proceeds from the Offering were used to repay certain indebtedness, including $10 million then outstanding under the Credit Facility as contemplated upon the occurrence of a public offering, and for working capital and other general corporate purposes. We may explore additional financing sources to fund expansion, to respond to competitive pressures, to acquire or to invest in complementary products, businesses or technologies, or to lower its cost of capital, which could include equity and debt financings. There can be no guarantee that any additional financing will be available on acceptable terms, if at all. If additional funds are raised through the issuance of equity or convertible debt, existing stockholders could suffer significant dilution, and if we raise additional funds through the issuance of debt securities or other borrowings, these securities or borrowings could have rights senior to common stock and could contain covenants that could restrict operations. Foreign cash balances at June 30, 2014 and December 31, 2013 were $3.4 million and $1.4 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., as Agent, Sole Lead Arranger and Sole Bookrunner, which replaced the then existing loan and security agreement ("the Credit Agreement" as described below). The new 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 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 June 30, 2014, interest rates for outstanding borrowings were 4.75% for base rate loans and 2.75% for LIBOR rate loans, which is referred to as the Base Rate. 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 requires 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 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 32 -------------------------------------------------------------------------------- and encumber and dispose of assets. Obligations under the Credit Facility are secured by a security interest and lien upon substantially all of the Company's assets. As of June 30, 2014, the Company was not subject to the financial covenants, and excess borrowing availability was approximately $7.2 million. As of August 11, 2014, the date of this filing, the Company was in compliance with all financial covenants. Credit Agreement In August 2012, VTBH entered into a loan and security agreement ("the Credit Agreement") with various financial institutions, which amended and restated the then existing $28 million term loan and $15 million credit facility. The Credit Agreement, which was to expire on August 22, 2015, provided for a $45 million term loan that bore interest at VTBH's option at (i) the Adjusted Base Rate plus the applicable margin ranging from 2.50% to 3.25% as determined by VTBH's total leverage ratio, or (ii) LIBOR, plus the applicable margin ranging from 3.50% to 4.25%. The Applicable Base Rate is equal to the highest of (a) the Prime Rate as determined by the syndication agent, (b) the federal funds rate plus 0.5% and (c) the LIBOR rate plus 1.0%. VTBH's obligations under the Credit Agreement were secured by a first priority lien against substantially all of VTBH's assets. Further, the Credit Agreement was amended to increase the borrowing capacity on the revolving line of credit from $15 million to $55 million. The revolving line of credit was subject to limitations based on specific percentages of eligible accounts receivables and inventory. 2013 Amendments VTBH entered into amendments to the Credit Agreement in July 2013 and August 2013 (the "2013 Amendments"). The 2013 Amendments waived certain defaults of the fixed charge coverage ratio and also provided for a new minimum EBITDA financial covenant, modifications of the fixed charge coverage ratio and maximum total leverage ratio for periods ending on or after September 28, 2013, and a modification of annual clean-down requirements with which VTBH would need to comply in order to provide for an increase in the eligible amount outstanding under the facility. In addition, the 2013 Amendments amended the interest rate on the outstanding term loans and required the issuance of $10 million of subordinated notes to reduce the outstanding borrowings on the term loan. 2014 Amendments On January 15, 2014, in connection with the consummation of the Merger, the Company entered into a Third Amendment to the Credit Agreement in which Parametric became an obligor and guarantor under the loan and security agreement, and to (i) allow the Company to incur an additional $7 million of subordinated indebtedness, (ii) provide for the repayment of the term loan portion of the facility by February 28, 2014, (iii) change the maturity of the revolving line of credit portion of the facility to September 27, 2014, (iv) reduce the commitments under the revolving line of credit to $35 million after March 1, 2014, (v) increase the margin pursuant to which interest on outstanding amounts under the Credit Agreement was calculated by 0.75%, and (vi) modify the financial covenants contained in the Credit Agreement. On March 13, 2014, the Company entered into a Fourth Amendment to the Credit Agreement to (i) increase the maximum principal amount of the lenders' revolving loan commitment between February 28, 2014 and April 15, 2014 from $35 million to approximately $39 million, (ii) provide that the borrowers, on or prior to April 15, 2014, would reduce the aggregate dollar amount of revolving loans outstanding under the Credit Agreement to the lesser of $35 million or the Company's borrowing base as of such date, (iii) waive the Company's obligation to deliver certain certificates regarding its liquidity and borrowing base for the fiscal month ended February 28, 2014, and to specify the delivery date of such certificates during March 2014 and April 2014, (iv) eliminate a requirement that the borrowers reduce the aggregate dollar amount of revolving loans and swing loans outstanding to an amount no greater than $25 million for a thirty consecutive day period during the first fiscal quarter of each fiscal year, and (v) eliminate the lenders' obligation to make additional revolving loan commitments after February 28, 2014. In connection with the above, on January 15, 2014, we repaid $7.0 million of the term loan with proceeds from the issuance of a subordinated note, and on February 28, 2014 repaid the remaining $7.5 million principal balance with funds from operations, as required by the "2014 Amendments." 33 -------------------------------------------------------------------------------- Invoice Factoring TB Europe utilized accounts receivable factoring arrangements with a third-party financial institution in order to accelerate its cash collections from product sales. These arrangements provided for the transfer of ownership of eligible trade accounts receivable up to a maximum of £5.0 million at any time, without recourse, to the third-party financial institution in exchange for cash. This invoice factoring arrangement was terminated on March 31, 2014, and related borrowings were fully paid with proceeds from the Credit Facility described above. As of December 31, 2013, TB Europe had sold $5.7 million of trade accounts receivable to the third-party financial institution, which were netted against accounts receivable on the accompanying Condensed Consolidated Balance Sheet. Subordinated Notes - Related Party On August 30, 2013, VTBH issued $10 million of subordinated notes (the "August Notes") to SG VTB Holdings, LLC ("SG VTB"), VTBH's largest shareholder, Ronald Doornink, a director of VTBH, and Juergen Stark, VTBH's chief executive officer, that bear interest at a 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 August Notes quarterly. Principal and interest on the August Notes are due upon maturity, which shall occur on the one year anniversary of the later of (i) the term loan maturity date under the Credit Agreement or (ii) the revolving line of credit termination date thereunder. The proceeds from the August Notes were used to repay an equivalent portion of the then outstanding term loans. In June 2014, we repaid the $10 million outstanding principal amount plus related accrued interest of the August Notes with proceeds from an equity offering. In connection with the Third Amendment to the Credit Agreement, on January 15, 2014, the Company issued an additional $7 million subordinated note (the "January Note") to SG VTB, the proceeds of which were applied against the outstanding balance of the term loan under the Credit Agreement. The January Note bears interest at a rate of (i) 10% per annum until December 31, 2014 (which is the maturity date of the January Note) and (ii) 20% per annum for all periods thereafter, with interest accruing and being added to the principal amount of the January Note quarterly. The other terms of the January Note are substantially similar to the terms of the August Notes. Series A convertible stock In conjunction with the Merger, $24.4 million principal amount of the Series A convertible stock was converted into shares of common stock pursuant to an exchange ratio specified in the Merger Agreement. 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 $14.3 million and $13.7 million as of June 30, 2014 and December 31, 2013, respectively. 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 significant changes in the information concerning our critical accounting estimates as stated in Note 2 - Summary of Significant Accounting Policies in our Prospectus Supplement filed with the SEC on April 24, 2014. 34

-------------------------------------------------------------------------------- Off-Balance Sheet Arrangements Off balance sheet arrangements are transactions, agreements, or other contractual arrangements with an unconsolidated entity for which we have an obligation to the entity that is not recorded in the consolidated financial statements. As of June 30, 2014, there are no significant off-balance sheet arrangements. Contractual Obligations Our principal commitments primarily consist of obligations for minimum payment commitments to leases for office space, redeemable preferred stock and the revolving credit facility. As of June 30, 2014, the future non-cancelable minimum payments under these commitments were as follows: Payments Due by Period (in thousands) Less Than One More Than Five Total Year 1 - 3 Years 3 - 5 Years Years Contractual Obligations: (1) Operating lease obligations (2) $ 3,345$ 857$ 1,202$ 1,101 185 Series B redeemable preferred stock (3) 51,928 - - - 51,928 Principal payments on long term debt (4) 19,256 19,256 - - - Due to shareholders 3,125 3,125 - - - Subordinated notes (5) 7,322 7,322 - - - Total $ 84,976$ 30,560$ 1,202$ 1,101$ 52,113 (1) Contractual obligations exclude tax liabilities of $1.5 million related to uncertain tax positions because we are unable to make a reasonably reliable estimate of the timing of settlement, if any, of these future payments. (2) Operating lease agreements represent obligations to make payments under non-cancelable lease agreements for its facilities. (3) In September 2010, Turtle Beach issued shares of its Series B Redeemable Preferred Stock. If the Series B Redeemable Preferred Stock is still outstanding as of October 2030, the Company will be required to redeem the shares for an aggregate of $51.9 million, which is comprised of the aggregate purchase price of $12.4 million plus cumulative preferred dividends of 8.0% per annum, or $39.5 million in the aggregate. (4) On March 31, 2014 the Company entered into the Credit Facility that expires March 31, 2019. However, due to certain terms of the facility, the indebtedness is required to be classified as a current liability. See Note 9, "Credit Facilities and Long-Term Debt" for further information. (5) On January 15, 2014, Turtle Beach issued $7 million of additional subordinated notes to SG VTB Holdings, LLC the proceeds of which were also applied against the outstanding balance of the term loan. Accrued interest on the subordinated notes was $0.3 million at June 30, 2014. 35



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