Turtle Beach Corp (TBCH) FY 2023 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with our consolidated financial statements and the notes thereto. This discussion summarizes the significant factors affecting our results of operations and the financial condition of our business during each of the fiscal years in the three-year period ended December 31, 2023.
Turtle Beach Corporation (herein referred to as the “Company,” “we,” “us,” or “our”), headquartered in White Plains, New York, 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 ROCCAT® brands. Turtle Beach is a worldwide leader of feature-rich gaming solutions for use across multiple platforms, including video game and entertainment consoles, handheld consoles, personal computers (“PC”), tablets and mobile devices. ROCCAT is a gaming headsets, keyboards, mice, and other accessories brand focused on the personal computer peripherals market.
Business Trends
Console Headset Market
Turtle Beach is the leading console gaming headset manufacturer in the U.S. and other major console markets. Turtle Beach has achieved these global market shares by delivering high-quality products that often include first-to-market innovations, robust features, superior sound, unmatched comfort, and top customer support – all key factors that consumers seek when shopping for a gaming headset.
The global market for console gaming headsets, in which Turtle Beach has been the market leader for the past 14 years, is estimated to be approximately $1.4 billion. PlayStation and Xbox consoles continue to be dominant gaming platforms in North America and Europe for games that drive headset usage. Consistent with a historical pattern of major new console launches every 7-8 years, Microsoft and Sony launched their latest consoles, Xbox Series X|S and PlayStation 5, ahead of the 2020 holiday season, and in 2021/2022 demand for the latest Xbox and PlayStation consoles exceeded the available supply for consumers to purchase. In 2023, the demand for gaming consoles increased as additional supplies became available, which resulted in our improved market share.
Nintendo has sold over 132.5 million units of its highly popular Nintendo Switch since the platform's release in early 2017. Nintendo continues adding and expanding its library of games, including an increased number of multiplayer chat-enabled games. Nintendo also sells the Nintendo Switch Lite, a follow-on product that offers gamers the hand-held only version of their popular gaming console.
PC Accessories Market
The market for PC gaming headsets, mice, and keyboards is estimated to be approximately $3.2 billion. PC gaming continues to be a main gaming platform in the U.S. and internationally, driven by big AAA game launches, PC-specific esports leagues, popular teams and players, content creators and influencers and cross-platform play. While most games are available on multiple platforms, gaming on PC offers advantages including improved graphics, increased speed and precision of mouse/keyboard controls, and the ability for deeper customization. Gaming mice and keyboards are engineered to provide gamers with high-end performance and a superior gaming experience through features such as faster response times, improved materials and build quality, programmable buttons and keys, and software suites to customize and control devices and settings.
PC gaming mice come in a variety of different ergonomic shapes and sizes, are available in both wired and wireless models, offer options for different sensors (optical and laser) and responsiveness, and often feature integrated RGB LED lighting and software to unify the lighting with other devices for a visually consistent PC gaming appearance. Similarly, PC gaming keyboards often deliver a competitive advantage by offering options for mechanical and optical key switches that feel and sound different and offer customizable lighting.
Gamepad/Controllers Market
The market for gamepad controllers is estimated to be approximately $0.5 billion, and shares the same retail footprint and consumer base that Turtle Beach gaming headsets compete in. Controllers now come in various ergonomic shapes, sizes, and colors. Gamers can even further customize their controllers with unique thumbsticks and better grips/textures, weights, and more. Game controllers also range in price from ~$40 to $300+ for ultra premium options, with premium controllers featuring improved materials, cooling, swappable parts and more. Turtle Beach entered the controllers market in 2021 with the introduction of its wired Recon™ Controller for Xbox and PC. Turtle Beach then launched the lower-cost wired REACT-R™ Controller in 2022, as well as introduced the mobile focused Recon™ Cloud and Atom™ controllers. In 2023, Turtle Beach launched its first wireless controller for Xbox and PC, the premium Stealth™ Ultra controller. Turtle Beach’s controllers not only provide the same responsive, quality controls as first party, but also offer Turtle Beach’s signature gaming audio experience when gamers connect a wired headset to the controller.
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Gaming Simulation Accessories Market
The market for gaming simulation accessories is estimated to be approximately $1.2 billion. Flight and racing simulation gaming are more dominant on higher-end PCs able to deliver the most realistic visuals. However, jumps in visual quality made possible in the latest consoles/games have made flight simulation gaming on Xbox more accessible. In 2020, Microsoft redefined the graphics flight sim gamers can expect while playing with the launch of the latest generation of its Flight Sim games and, in subsequent years, Microsoft expanded the game to Xbox Series X|S1, Xbox One, lower-end gaming PCs, and mobile via Xbox Cloud.
Long-running popular flight sim games like Flight Simulator 2024, X-Plane, and others allow pilots to learn to fly and pilot various aircraft through picture-perfect skies and scenery, with typical flight sim accessories including yokes and pedals, combat flightsticks, and HOTAS (Hands-On Throttle And Stick) controllers. The flight sim market is niche, but with a dedicated, older fanbase willing to spend more on accessories to create the ultimate flight simulation setups, with a variety of expert pilots and creators showcasing their latest content on YouTube and other mediums. Turtle Beach launched the original VelocityOne Flight universal control system in 2021, followed by the VelocityOne™ Rudder and VelocityOne™ Stand in 2022, the VelocityOne™ Flightstick in 2023, and the VelocityOne™ Flightdeck HOTAS controller in 2024
Racing simulation gaming follows a similar trajectory as flightl simulation gaming. The audience of racing sim gamers is also niche, dedicated, slightly older and willing to spend more on creating high-end racing simulation setups predominantly on PC, but also on consoles. There are also a variety of long-running, successful racing game franchises including Forza, Assetto Corsa, and more that allow drivers to get behind the wheel and experience the rush of racing. Typical racing simulation accessories include wheel and pedal setups, swappable steering wheels, shifters, handbrakes and more, ranging in price from a few hundred dollars to thousands of dollars for the most involved simulators. Racing simulation fans also regularly create content and share with the community. Turtle Beach introduced its first VelocityOne™ Race racing simulation wheel and pedals setup in 2024, with additional racing sim accessory launches planned for the future.
Seasonality
Our gaming accessories business is seasonal with a significant portion of sales and profits typically occurring around the holiday period. Historically, more than 45% of revenues are generated during the period between September and December as new products are introduced and consumers engage in holiday shopping. In addition, launches of major new online multiplayer games, and specific retailer purchasing behavior, can drive significant revenue shifts between months and quarters in a given year. In the past few years, normal seasonal patterns have been significantly changed due to pandemic-driven shifts in consumer demand.
In connection with the seasonality of the business, historically the Company’s borrowings on the revolving credit facility increase as a result of the holiday inventory build leading up to year-end and decline on gross receipts during the first quarter of the following year.
Supply Chain and Operations
We have a global network of suppliers that manufacture products to meet the quality standards sought by our customers and our cost objectives. We have worked closely with component, manufacturing, and global logistic partners to build a supply chain that we consider dependable, scalable, and efficient to provide high-quality, reliable products employing leading cost management practices. The use of outsourced manufacturing facilities is designed to take advantage of specific expertise and allow for flexibility and scalability to respond to both seasonality and changing demands for our products.
We have experienced and may continue to experience increased freight costs and component availability challenges. Further, market conditions have significantly increased the lead time on many product components, causing us to purchase components earlier than normal to meet forecasted demand, which, in some cases, led to excess inventories of certain components ordered with long lead times ahead of shifting demand. We expect to continue to experience challenges impacting our supply chain and logistics operations. As a result, we continue to take proactive steps to limit the impact of these challenges and are working closely with our manufacturing and freight providers to reduce costs.
We believe we have strong, long-term relationships with our suppliers and that, subject to the discussion in Item 1A, “Risk Factors” and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources,” we expect to continue to be able to obtain a sufficient supply of quality products on satisfactory terms.
Results of Operations
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Management Overview
In 2023, we continued our position as the number one console gaming headset provider and, showcased strong operational and financial execution with increased revenues, earnings and adjusted EBITDA compared to a year ago.
Despite the console gaming market being down slightly, we delivered net revenue of $258.1 million as our industry-leading console headsets, including the launch of the Stealth Pro multi-platform headset into the top price tier, continued to drive both revenue growth and market share gains. Additionally, our simulation product related revenue increased due to product expansion, led by our Velocity One flight simulator, which became the market share leader in 2023.
As a result of the execution against our strategic pillars and ongoing cost management initiatives, the overall operating environment improved throughout the year, demonstrated by improved margins due to lower freight and more normalized promotional spend.
Looking forward, demand for gaming accessories is normalizing higher than pre-pandemic levels and we believe the replacement cycle for pandemic accessory purchases will drive ongoing demand into 2024. We expect our brand to continue leading the headset category with new, innovative console gaming headsets as demonstrated by the nearly $1 billion in U.S. retail sales that three of our top sellers, Stealth 600, Stealth 700 and Recon 70, have collectively delivered since their respective launches. In addition, we exceeded 20% of our revenues in categories outside the console gaming headset category and, as we continue to launch exciting new products across these categories, we believe there are further opportunities to extend our growth in PC gaming, simulation, and controllers.
Financial Results
The following table sets forth the Company’s statements of operations for the periods presented:
| Year Ended | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| December 31, | ||||||||||||
| 2023 | 2022 | 2021 | ||||||||||
| (in thousands) | ||||||||||||
| Net revenue | $ | 258,122 | $ | 240,166 | $ | 366,354 | ||||||
| Cost of revenue | 182,618 | 190,979 | 237,971 | |||||||||
| Gross profit | 75,504 | 49,187 | 128,383 | |||||||||
| Gross margin | 29.3 | % | 20.5 | % | 35.0 | % | ||||||
| Operating expenses | 91,947 | 100,667 | 107,952 | |||||||||
| Operating income (loss) | (16,443 | ) | (51,480 | ) | 20,431 | |||||||
| Interest expense, net | 504 | 1,220 | 383 | |||||||||
| Other non-operating expense (income), net | 394 | 1,753 | (101 | ) | ||||||||
| Income (loss) before income tax | (17,341 | ) | (54,453 | ) | 20,149 | |||||||
| Income tax expense | 338 | 5,093 | 2,428 | |||||||||
| Net income (loss) | $ | (17,679 | ) | $ | (59,546 | ) | $ | 17,721 |
Net Revenue and Gross Profit
Comparison of the Year Ended December 31, 2023 to the Year Ended December 31, 2022
Net revenue for the year ended December 31, 2023 was $258.1 million, an $18.0 million, or 7.5%, increase from $240.2 million in the prior year period driven by revenue and share gains for both the console headset gaming and simulation products.
For the year ended December 31, 2023, as a result of lower freight and promotional spending, gross profit as a percentage of net revenue increased to 29.3% compared to 20.5% in the comparable prior year period, which included $9.8 million of pandemic-related excess components and product inventory impairment charges.
Comparison of the Year Ended December 31, 2022 to the Year Ended December 31, 2021
Net revenue for the year ended December 31, 2022 was $240.2 million, a $126.2 million, or 34.4% decrease from $366.4 million in the record prior year period reflecting lower customer demand as a result of a challenging macroeconomic environment, channel inventory compression and increased promotional spend.
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For the year ended December 31, 2022, gross profit as a percentage of net revenue decreased to 20.5% from 35.0% in the prior year. The decrease was primarily due to a $9.8 million charge for potential excess components and product inventory relating to pandemic driven supply chain and logistic impacts, higher freight and warehouse costs to ensure product supply, higher promotional spend driven by more aggressive competitive pricing actions to reduce channel inventory levels and volume-driven fixed cost deleveraging.
Operating Expenses
| Year Ended | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| December 31, | |||||||||||
| 2023 | 2022 | 2021 | |||||||||
| (in thousands) | |||||||||||
| Selling and marketing | $ | 43,489 | $ | 47,090 | $ | 58,883 | |||||
| Research and development | 17,137 | 19,123 | 17,490 | ||||||||
| General and administrative | 31,321 | 32,558 | 31,501 | ||||||||
| Other intangible asset impairment | — | 1,896 | — | ||||||||
| Acquisition integration costs | — | — | 78 | ||||||||
| Total operating expenses | $ | 91,947 | $ | 100,667 | $ | 107,952 |
Selling and Marketing
Selling and marketing expense for the year ended December 31, 2023 totaled $43.5 million, or 16.8% as a percentage of net revenue, compared to $47.1 million, or 19.6% as a percentage of net revenue, for the prior year. This decrease was primarily due to lower headcount and the alignment of marketing to support demand and product launches.
Selling and marketing expense for the year ended December 31, 2022 totaled $47.1 million, or 19.6% as a percentage of net revenue, compared to $58.9 million, or 16.1% as a percentage of net revenue, for the year ended December 31, 2021. This decrease was primarily due to lower revenue-based expenses, reduction of marketing initiatives to align with lower consumer demand and strategic priorities.
Research and Development
For the year ended December 31, 2023, we invested $17.1 million in research and development, compared to $19.1 million for the year ended December 31, 2022, which reflects certain expense management, including lower headcount and costs associated with our product portfolio plans.
For the years ended December 31, 2022 and 2021, we invested $19.1 million and $17.5 million, respectively, as we continued to invest in new product categories and portfolio expansion to support strategic growth initiatives.
General and Administrative
General and administrative expenses for the year ended December 31, 2023 decreased $1.2 million to $31.3 million compared to $32.6 million for the year ended December 31, 2022. Excluding certain non-recurring executive compensation, proxy contest and shareholders' litigation costs, expenses decreased $2.7 million primarily due lower non-cash stock-based compensation, employee expenses and certain corporate legal costs.
General and administrative expenses for the year ended December 31, 2022 increased $1.1 million to $32.6 million compared to $31.5 million for the year ended December 31, 2021. Excluding certain non-recurring fees related to the proxy contest in both years with respect to the 2022 annual meeting of stockholders ($2.2 million) and other litigation costs, expenses decreased $1.1 million primarily due to lower personnel costs and professional fees.
Income Taxes
Income tax expense for the year ended December 31, 2023 was $0.3 million at an effective tax rate of (1.9)% compared to income tax expense of $5.1 million for the year ended December 31, 2022 at an effective tax rate of (9.4%). The effective tax rate was primarily impacted by foreign taxes, state taxes and interest on uncertain tax positions. In 2022 the Company recorded a valuation allowance on its deferred tax assets.
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Income tax expense for the year ended December 31, 2022 was $5.1 million at an effective tax rate of (9.4%) compared to income tax expense of $2.4 million for the year ended December 31, 2021 at an effective tax rate of 12.1%. The effective tax rate was primarily impacted by the establishment of a valuation allowance on our net U.S. deferred tax assets as well as state income tax.
Other Non-Operating Expense (Income)
Other non-operating expense totaled $0.4 million and $1.8 million for the years ended December 31, 2023 and 2022, respectively, due to negative effect of exchange rates as it relates to our European operations, compared to other non-operating income of $0.1 million for the year ended December 31, 2021, which included a $1.9 million fair value of contingent consideration reversal.
Key Performance Indicators and Non-GAAP Measures
Management routinely reviews key performance indicators, including revenue, operating income and margins, and earnings per share, among others. In addition, we believe certain other measures provide useful information to management and investors about us and our financial condition and results of operations for the following reasons: (i) they are measures used by our Board of Directors and management team to evaluate our operating performance; (ii) they are measures used by our management team to make day-to-day operating decisions; (iii) the adjustments made are often viewed as either non-recurring or not reflective of ongoing financial performance and/or have no cash impact on operations; and (iv) the measures are used by securities analysts, investors and other interested parties as a common operating performance measure to compare results across companies in our industry by adjusting for potential differences caused by variations in capital structures (affecting relative interest expense), and the age and book value of facilities and equipment (affecting relative depreciation and amortization expense). These other 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 believe that the presentation of Adjusted EBITDA, defined as net income (loss) before interest, taxes, depreciation and amortization, stock-based compensation (non-cash) and certain non-recurring special items that we believe are not representative of core operations, is appropriate to provide additional information to investors about our operating profitability adjusted for certain non-cash items, non-routine items that we do not expect to continue at the same level in the future, as well as other items that are not core to our operations. Further, we believe Adjusted EBITDA provides a meaningful measure of operating profitability because we use it for evaluating our business performance, making budgeting decisions, and comparing our performance against that of other peer companies using similar measures. However, Adjusted EBITDA is not a measure of financial performance under 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.
Adjusted EBITDA
Adjusted EBITDA (and a reconciliation to Net income (loss), the nearest GAAP financial measure) for the years ended December 31, 2023, 2022 and 2021 are as follows:
| Year Ended | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| December 31, | ||||||||||||
| 2023 | 2022 | 2021 | ||||||||||
| (in thousands) | ||||||||||||
| Net income (loss) | $ | (17,679 | ) | $ | (59,546 | ) | $ | 17,721 | ||||
| Interest expense | 504 | 1,220 | 383 | |||||||||
| Depreciation and amortization | 4,839 | 5,816 | 5,313 | |||||||||
| Stock-based compensation (1) | 11,983 | 7,984 | 7,656 | |||||||||
| Income tax expense | 338 | 5,093 | 2,428 | |||||||||
| Impairment charge (2) | — | 1,896 | — | |||||||||
| Restructuring expense (3) | 1,061 | 556 | — | |||||||||
| CEO transition related costs (4) | 2,874 | — | — | |||||||||
| Change in fair value of contingent consideration | — | — | (1,928 | ) | ||||||||
| Business transaction expense (5) | 653 | — | 78 | |||||||||
| Proxy contest and other (6) | 1,921 | 7,092 | 4,934 | |||||||||
| Adjusted EBITDA | $ | 6,494 | $ | (29,889 | ) | $ | 36,585 |
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(1)
Increase in stock-based compensation in the year-ended December 31, 2023 over the comparable prior year period primarily driven by $4.0 million charge related to the accelerated vesting of equities of the Company's former Chief Executive Officer.
(2)
Impairment charge includes costs related to impairment of intangible assets. See Note 5 to our condensed consolidated financial statements included elsewhere in this Annual Report.
(3)
Restructuring charges are expenses that are paid in connection with reorganization of our operations. These costs primarily include severance and related benefits.
(4)
Chief Executive Officer transition related expense includes one-time costs associated with the separation of its former executive. Such costs included severance, bonus, medical benefits and the tax impact of vesting of stock-based compensation.
(5)
Business transaction expense includes one-time costs in connection with acquisition-related activities including professional fees such as legal and accounting along with other certain integration related costs of the acquisitions.
(6)
Proxy contest and other primarily includes (a) one-time legal and other professional fee associated with proxy challenges presented by certain shareholder activists and (b) the settlement of an intellectual property lawsuit in 2022.
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:
| Year Ended | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| December 31, | ||||||||||||
| 2023 | 2022 | 2021 | ||||||||||
| (in thousands) | ||||||||||||
| Cash and cash equivalents at beginning of period | $ | 11,396 | $ | 37,720 | $ | 46,681 | ||||||
| Net cash provided by (used for) operating activities | 27,044 | (41,846 | ) | (327 | ) | |||||||
| Net cash used for investing activities | (2,159 | ) | (3,549 | ) | (8,121 | ) | ||||||
| Net cash provided by (used for) financing activities | (17,846 | ) | 19,706 | (56 | ) | |||||||
| Effect of foreign exchange on cash | 291 | (635 | ) | (457 | ) | |||||||
| Cash and cash equivalents at end of period | $ | 18,726 | $ | 11,396 | $ | 37,720 |
Operating activities
Cash provided by operating activities for the year ended December 31, 2023 was $27.0 million, an increase of $68.9 million as compared to cash used for operating activities totaling $41.8 million for the year ended December 31, 2022. The increase is primarily the result of lower working capital driven by reductions in inventory levels, higher gross receipts and expense management initiatives.
Cash used for operating activities for the year ended December 31, 2022 was $41.8 million, a decrease of $41.5 million as compared to cash provided by operating activities of $0.3 million for the year ended December 31, 2021. The increase in the cash used for operations is primarily the result of lower gross receipts due to lower demand and retailers compressing channel inventories.
Investing activities
Cash used for investing activities was $2.2 million for the year ended December 31, 2023, which was related to certain capital investments, compared to $3.5 million in 2022.
Cash used for investing activities was $3.5 million for the year ended December 31, 2022, which was related to certain capital investments, compared to $8.1 million in 2021, which consisted of capital expenditures related to in-store advertising displays and new product manufacturing tooling, as well as $2.5 million related to the Neat Microphones acquisition.
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Financing activities
Net cash used for financing activities was $17.8 million during the year ended December 31, 2023 compared to net cash provided by financing activities of $19.7 million and net cash used for financing activities of $0.1 million during the years ended December 31, 2022 and 2021, respectively. Financing activities during the year ended December 31, 2023 consisted primarily of $19.1 million revolving credit facility net repayments and $1.0 million of common stock repurchases, partially offset by $2.3 million of stock option exercise proceeds.
Financing activities in 2022 consisted primarily of revolving credit facility borrowings. Financing activities in 2021 included stock option exercise proceeds of $5.3 million and repurchases of common stock of $4.9 million.
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 short-term and long-term funding for working capital and capital expenditures including amounts to develop new products, fund future stock repurchases and to pursue strategic opportunities. Significant assumptions underlie this belief, including, among other things, that there will be no material adverse developments in our business, liquidity or capital requirements, or strategic opportunities that require additional capital.
In addition, the Company monitors the capital markets on an ongoing basis and may consider raising capital if favorable market conditions develop.
Foreign cash balances at December 31, 2023 and December 31, 2022 were $8.0 million and $6.5 million, respectively.
Revolving Credit Facility
On March 5, 2018, Turtle Beach and certain of its subsidiaries entered into an amended and restated loan, guaranty and security agreement (the “Credit Facility”) with Bank of America, N.A. (“Bank of America”), as administrative agent, collateral agent and security trustee for Lenders (as defined therein), which replaced the then existing asset-based revolving loan agreement. The Credit Facility was amended on each of December 17, 2018, May 31, 2019, and March 10, 2023. The Credit Facility, as amended, expires on April 1, 2025 and provides for a line of credit of up to $80 million inclusive of a sub-facility limit of $15 million for TB Europe, a wholly-owned subsidiary of Turtle Beach. In addition, the Credit Facility provides for a $40 million accordion feature.
On March 10, 2023, the Company entered into a Third Amendment to Amended and Restated Loan, Guaranty and Security Agreement (the “Third Amendment”), by and among the Company, VTB, TBC Holding Company LLC, TB Europe, VTBH, the financial institutions party thereto from time to time and Bank of America, as administrative agent, collateral agent and security trustee for the lenders.
The Third Amendment provided for, among other things: (i) extending the maturity date of the Credit Facility from March 5, 2024 to April 1, 2025; (ii) updating the interest rate and margin terms; (iii) removing the FILO Loan facility; (iv) updating the sub-facility limit for TB Europe to $15 million; (v) increasing our undrawn commitment fee by 0.125%; and (vi) transitioning the reference interest rates from LIBOR to BSBY, SONIA and EUIBOR, as applicable.
The maximum credit availability for loans and letters of credit under the Credit Facility is governed by a borrowing base determined by the application of specified percentages to certain eligible assets, primarily eligible trade accounts receivable and inventories, and is subject to discretionary reserves and revaluation adjustments. The Credit Facility may be used for working capital, the issuance of bank guarantees, letters of credit and other corporate purposes.
Amounts outstanding under the Credit Facility bear interest at a rate equal to (i) a rate published by Bank of America or the U.S. Bloomberg Short-Term Bank Yield Index (“BSBY”) rate for loans denominated in U.S. Dollars, (ii) the Sterling Overnight Index Average Reference Rate (“SONIA”) for loans denominated in Sterling, and (iii) the Euro Interbank Offered Rate (“EUIBOR”) for loans denominated in Euros, plus in each case, an applicable margin, which is between 0.50% to 2.50% for base rate loans and UK base rate loans, and 1.50% and 3.50% for BSBY rate loans, BSBY daily floating rate loans and UK alternative currency loans. In addition, Turtle Beach is required to pay a commitment fee on the unused revolving loan commitment at a rate ranging from 0.375% to 0.50%, and letter of credit fees and agent fees. As of December 31, 2023, interest rates for outstanding borrowings were 11.00% for base rate loans and 8.90% for SONIA rate loans.
The Company is subject to financial covenant testing if certain availability thresholds are not met or certain other events occur (as defined in the Credit Facility). The Credit Facility requires the Company and its restricted subsidiaries to maintain a fixed charge coverage ratio of at least 1.00 to 1.00 as of the last day of each fiscal quarter.
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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.
As of December 31, 2023, the Company was in compliance with all the financial covenants under the Credit Facility, as amended, and excess borrowing availability was approximately $60.6 million.
In 2017, the United Kingdom’s Financial Conduct Authority announced that it intends to stop persuading or compelling banks to submit LIBOR rates. LIBOR’s administrator ceased publishing one-week and two-month U.S. Dollar LIBOR immediately after the LIBOR publication on December 31, 2021, and is scheduled to cease publication of the remaining U.S. Dollar LIBOR tenors immediately after the publication on June 30, 2023. In January 2023, the Company and Bank of America entered into LIBOR Transition Amendments with respect to the Credit Facility, including the sub-facility for TB Europe. These amendments replaced applicable LIBOR rates for interest, fees, commissions and other amounts based on LIBOR with successor rates based on BSBY, SONIA and EURIBOR, as applicable.
Contractual Obligations
Our principal commitments primarily consist of obligations for minimum payment commitments to lessors for office space and the revolving credit facility. As of December 31, 2023, we had operating lease obligations totaling $9.8 million which represents our obligations to make payments under non-cancelable lease agreements for our facilities. See Part II, Item 7,“Management’s Discussion and Analysis of Financial Condition and Results of Operations –Liquidity and Capital Resources–Revolving Credit Facility” above for more information regarding obligations under our revolving credit facility.
| Payments Due by Period | |||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (in thousands) | Total | Less Than One Year | 1 - 3 Years | 3 - 5 Years | More Than Five Years | ||||||||||||||
| Contractual Obligations: (1) | |||||||||||||||||||
| Operating lease obligations (2) | $ | 9,830 | $ | 1,463 | $ | 4,209 | $ | 1,917 | 2,241 | ||||||||||
| Long term debt (3) | — | — | — | — | — | ||||||||||||||
| Total | $ | 9,830 | $ | 1,463 | $ | 4,209 | $ | 1,917 | $ | 2,241 |
(1)
Contractual obligations exclude tax liabilities of $2.3 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)
The Credit Facility, as amended, expires on April 1, 2025 and provides for a line of credit of up to $80 million inclusive of a sub-facility limit of $15 million for TB Europe, a wholly-owned subsidiary of Turtle Beach. Interest payments are not reflected under the Credit Facility because the amount that will be borrowed in future years is uncertain.
Critical Accounting Estimates
Our discussion and analysis of our results of operations and capital resources are based on our consolidated financial statements, which have been prepared in conformity with GAAP. The preparation of these consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses and the disclosure of contingent assets and liabilities. Management bases its estimates, assumptions, and judgments on historical experience and on various other factors that it believes to be reasonable under the circumstances.
Different assumptions and judgments would change the estimates used in the preparation of the condensed consolidated financial statements, which, in turn, could change the results from those reported. Management evaluates its estimates, assumptions, and judgments on an ongoing basis.
Based on the above, we have determined that our most critical accounting policies are those related to revenue recognition and sales return reserve, inventory valuation, asset impairment, and income taxes.
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Revenue Recognition and Sales Return Reserve
Net revenue consists primarily of revenue from the sale of gaming headsets and accessories to wholesalers, retailers and to a lesser extent, on-line customers. These products function on a standalone basis (in connection with a readily available gaming console, personal computer, or stereo) and are not sold with additional services or rights to future goods or services. Revenue is recorded for a contract through the following steps: (i) identifying the contract with the customer; (ii) identifying the performance obligations in the contract; (iii) determining the transaction price; (iv) allocating the transaction price to the performance obligations; and (v) recognizing revenue when or as each performance obligation is satisfied.
Each contract at inception is evaluated to determine whether the contract should be accounted for as having one or more performance obligations. The Company's business activities were determined to be a single performance obligation with revenue recognized when obligations under the terms of a contract with its customer are satisfied; generally, this occurs at a point in time when the risk and title to the product transfers to the customer. The Company's standard terms of delivery are included in its contracts of sale, order confirmation documents, and invoices. The Company excludes sales taxes collected from customers from “Net Revenue” on the consolidated statements of operations.
Certain customers may receive cash-based incentives (including cash discounts, quantity rebates, and price concessions), which are accounted for as variable consideration based upon the expected value method. Provisions for sales returns are recognized in the period the sale are based upon the expected value method and is recorded based upon the Company's prior experience and current trends. Cash-based incentive allowances are based on historical and expected performance of the customers, types and levels of promotions including any contractual commitments, claims received and forecasted economic trends in comparison to historical trends. Sales return reserves are based on historical and current return activity and forecasted economic trends in comparison to historical trends. As of December 31, 2023 and 2022, the Company had an allowance for cash-based incentives of $28.6 million and $29.5 million, respectively, and an allowance for sales returns of $8.4 million and $7.8 million, respectively. These amounts are recorded as a reduction of accounts receivable on the consolidated balance sheets.
Inventory Valuation
Inventories consist primarily of finished goods and related component parts and are stated at the lower of cost or net realizable value using the first in, first out (“FIFO”) method. The Company maintains an inventory allowance for returned goods, slow-moving and unused inventories based on the historical trend and estimates. Inventory write-downs, once established, are not reversed as they establish a new cost basis for the inventory. Inventory write-downs are included as a component of cost of revenue on the consolidated statements of operations.
Income Taxes
We account for income taxes using the asset and liability method. Under the asset and liability method, deferred tax assets and liabilities are recognized based on the differences between the financial statement carrying value of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates and laws expected to be in effect when the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date. Inherent in the measurement of these deferred balances are certain judgments and interpretations of existing tax law and other published guidance as applied to our operations. Our effective tax rate considers our judgment of expected tax liabilities in the various jurisdictions within which we are subject to tax.
The determination of the need for a valuation allowance on deferred tax assets requires management to make assumptions and to apply judgment, including forecasting future earnings, and the reversal pattern of deferred tax assets and liabilities.
The tax effects of uncertain tax positions taken or expected to be taken in income tax returns are recognized only if they are “more likely-than-not” to be sustained on examination by the taxing authorities based on the technical merits as of the reporting date. The tax benefits recognized in the financial statements from such positions are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. We recognize estimated accrued interest and penalties related to uncertain tax positions in income tax expense.
There have been no material changes to the critical accounting policies and estimates. See Note 1, “Summary of Significant Accounting Policies,” in the notes to the 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.
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