Corsair Gaming, Inc. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS You should read the following discussion and analysis of our financial condition and results of operations together with the condensed combined consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q. This discussion contains forward-looking statements based upon current expectations that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed in the section titled “Risk Factors” and in other parts of this Quarterly Report on Form 10-Q. Overview We are a leading global provider and innovator of high-performance gear for gamers, streamers and content creators. We design industry-leading gaming gear that helps digital athletes, from casual gamers to committed professionals, to perform at their peak across PC or console platforms, and streaming gear that enables creators to produce studio-quality content to share with friends or to broadcast to millions of fans. Our solution is a complete suite of gear that addresses the most critical components for both game performance and streaming. Our product offering is enhanced by our two proprietary software platforms: iCUE for gamers and Elgato branded streaming suite for content creators. These software platforms provide unified, intuitive performance, and aesthetic control and customization across their respective product families. We group our gear into two categories (operating segments): • Gamer and creator peripherals. Includes our high-performance gaming keyboards, mice, headsets and controllers, as well as our streaming gear including capture cards, studio accessories, and microphones, among others. • Gaming components and systems. Includes our high-performance power supply units, or PSUs, cooling solutions, computer cases, and DRAM modules, as well as high-end prebuilt and custom-built gaming PCs, among others. Our gear is sold to gaming enthusiasts worldwide through either our retail channel or our direct-to-consumer channel. In our retail channel, we distribute our gear either directly to the retailer, such as Amazon and Best Buy, or through key distributors. While we historically have sold a small percentage of our gear directly to consumers through our website, following the SCUF Acquisition and the Origin Acquisition in 2019, the volume of direct-to-consumer sales has increased as both of these companies primarily generated sales through direct-to-consumer channels. We expect net revenue from our direct-to-consumer channel to increase as a percentage of total net revenue in future periods. From time to time, we may seek to partner with or, when appropriate, acquire companies that have products, personnel, and technologies that complement our strategic direction. In July 2019, we acquired Origin PC Corporation, a company based in Florida, specializing in delivering hand-built, personalized high-end gaming PCs and in December 2019, we acquired SCUF Holdings, Inc. and its subsidiaries. SCUF, headquartered in Georgia, specializes in delivering superior accessories and customized gaming controllers for gaming consoles and PCs that are used by top professional gamers as well as competitive amateur gamers. The addition of Origin’s and SCUF’s products enhances and expands our product offering to PC and console gamers, respectively. See Note 5 of the Notes to our condensed combined consolidated financial statements for additional information. Origin is part of our gaming components and systems segment and its results of operations are included in our condensed combined consolidated statements of operations beginning July 22, 2019. SCUF is now part of our gamer and creator peripherals segment and its results of operations are included in our condensed combined consolidated statements of operations beginning December 19, 2019. Our net revenue was $457.1 million and $284.4 million for the three months ended September 30, 2020 and 2019, respectively, representing a period-over-period increase of 61%. We had net income of $36.4 million and $1.5 million for the three months ended September 30, 2020 and 2019, respectively. Our net revenue was $1.1 billion and $770.6 million for the nine months ended September 30, 2020 and 2019, respectively, representing a period-over-period increase of 49%. We had net income of $60.2 million for the nine months ended September 30, 2020 and we had $14.4 million net loss for the nine months ended September 30, 2019. Initial Public Offering On September 22, 2020, we priced the initial public offering of our common stock pursuant to a registration statement that was declared effective by the SEC, or the IPO, and our common stock began trading on the Nasdaq Global Select Market under the symbol “CRSR” the next day. On September 25, 2020, we closed our IPO. 28 Table of Contents In connection with the IPO, we sold 7,500,000 shares of common stock at $17.00 per share, resulting in proceeds of $118.6 million, net of the underwriting discounts and commissions and before offering costs. In connection with the IPO, certain stockholders so ld 6,500,000 shares of common stock at $17.00 per share. Subsequent to the IPO, certain stockholders further sold 1,135,375 shares pursuant to the underwriters’ exercise of their option to purchase additional shares. We did not receive any of the proceeds from the sale of shares by the selling stockholders. In September 2020, we used a portion of the net proceeds from the IPO to repay $86.6 million, in aggregate, of the principal amount of our First Lien Term Loan and $0.4 million of related accrued interest. Key Factors Affecting Our Business Our results of operations and financial condition are affected by numerous factors, including those discussed in the section titled “Risk Factors” in Part II, Item 1A of this Quarterly Report on Form 10-Q and those described below. Impact of Industry Trends . Our results of operations and financial condition are impacted by industry trends in the gaming market, including: • Increasing gaming engagement . We believe that gaming’s increasing time share of global entertainment consumption will drive continued growth in spending on both games and gaming gear. Gaming continues to become increasingly social and streaming viewership more widely adopted along with increasing numbers of content creators. We believe this trend, which has accelerated in the current environment, will continue and Corsair is well positioned to serve the streaming market with best-in-class tools for content creation. • Introduction of new high-performance computing hardware and sophisticated games . We believe that the introduction of more powerful CPUs and GPUs that place increased demands on other system components, such as memory, power supply or cooling, has a significant effect on increasing the demand for our gear. In addition, we believe that our business success depends in part on the introduction and success of games with sophisticated graphics that place increasing demands on system processing speed and capacity and therefore require more powerful CPUs or GPUs, which in turn drives demand for our high-performance gaming components and systems, such as PSUs and cooling solutions, and our gaming PC memory. As a result, our operating results may be materially affected by the timing of, and the rate at which computer hardware companies introduce, new and enhanced CPUs and GPUs, the timing of, and rate at which computer game companies and developers introduce, sophisticated new and improved games that require increasingly high levels of system and graphics processing power, and whether these new products and games are widely accepted by gamers. Impact of Product Mix . Our gamer and creator peripherals segment has a higher gross margin than our gaming components and systems segment. As a result, our overall gross margin is affected by changes in product mix. External factors can have an impact on our product mix, such as popular game releases that can increase sales of peripherals and availability of new CPUs and GPUs that can impact component sales. In addition, within our gamer and creator peripherals and gaming components and systems segments, gross margin varies between products, and significant shifts in product mix within either segment may also significantly impact our overall gross margin. Impact of Customer Concentration . We operate a global sales network that consists primarily of retailers, as well as distributors we use to access certain retailers. Further, a limited number of retailers and distributors represent a significant portion of our net revenue, with Amazon accounting for 22.4% and 25.1% of our net revenue for the three months and nine months ended September 30, 2020, respectively, and sales to our ten largest customers accounting for approximately 49.0% and 51.2% of our net revenue for the same periods, respectively. Our customers typically do not enter into long-term agreements to purchase our gear but instead enter into purchase orders with us. As a result of this concentration and the lack of long-term agreements with our customers, a primary driver of our net revenue and operating performance is maintaining good relationships with these retailers and distributors. To help maintain good relationships, we implement initiatives such as our updated packaging design which helps Amazon process our packages more efficiently. Further, given our global operations, a significant percentage of our expenses relate to shipping costs. Our ability to effectively optimize these shipping expenses, for example utilizing expensive shipping options such as air freight for smaller packages and more urgent deliveries and more cost-efficient options, such as train or boat, for other shipments, has an impact on our expenses and results of operations. 29 Table of Contents Impact of New Product Introductions . Gamers demand new technology and product features, and we expect our ability to accurately anticipate and meet these demands will be one of the main drivers for any future sales growth and market share expansion. To date, we have had several new product introductions that had a favorable impact on our net revenue and operating resu lts, such as the introduction of our new high-end wireless headset in 2019, Virtuoso. However, we cannot assure you that our new product introductions will have a favorable impact on our operating results or that customers will choose our new gear over tho se of our competitors. Impact of Seasonal Sales Trends. We have experienced and expect to continue to experience seasonal fluctuations in sales due to the buying patterns of our customers and spending patterns of gamers. Our net revenue has generally been lowest in the first and second calendar quarters due to lower consumer demand following the fourth quarter holiday season and because of the decline in sales that typically occurs in anticipation of the introduction of new or enhanced CPUs, GPUs, and other computer hardware products, which usually take place in the second calendar quarter and which tend to drive sales in the following two quarters. Further, our net revenue tends to be higher in the third and fourth calendar quarter due to seasonal sales such as “Black Friday,” “Cyber Monday” and “Singles Day” in China, as retailers tend to make purchases in advance of these sales, and our sales also tend to be higher in the fourth quarter due to the introduction of new consoles and high-profile games in connection with the holiday season. As a consequence of seasonality, our net revenue for the second calendar quarter is generally the lowest of the year followed by the first calendar quarter. We expect these seasonality trends to continue. Impact of Fluctuations in Currency Exchange Rates . We are subject to inherent risks attributed to operating in a global economy. Some of our international sales are denominated in foreign currencies and any unfavorable movement in the exchange rate between U.S. dollars and the currencies in which we conduct sales in foreign countries, in particular the Euro and the British Pound could have an adverse impact on our net revenue. In addition, we generally pay our employees located outside the United States in the local currency, with a significant portion of those payments being made in Taiwan dollars and Euros. Additionally, as a result of our foreign sales and operations, we have other expenses, assets and liabilities that are denominated in foreign currencies, in particular the Chinese Yuan, Euro and British Pound. Impact of COVID-19. In March 2020, the World Health Organization declared a global pandemic related to the rapidly growing outbreak of a novel strain of coronavirus known as COVID-19. In the following weeks, many countries responded by implementing a number of measures designed to prevent its spread, including stay-at-home or shelter-in-place orders, quarantines and closure of all non-essential businesses. We have operations and employees in various regions affected by coronavirus, including our headquarters in California, which is subject to a shelter-in-place order. Our manufacturing facilities in Atlanta and the United Kingdom, and our contract manufacturing facilities in Southeast Asia, many of which closed between one to two months in early 2020 have caused some disruptions in our supply chain which also resulted in increased air freight costs. Although we have seen some significant business disruptions due to COVID-19, the broader implications of COVID-19 on our results of operations and overall financial performance remain uncertain. The negative financial impact from the temporary stoppage in our factories, disruption in our supply chain and increased air freight costs experienced in the first quarter of 2020 was offset by strong revenue growth year-over-year partly due to an increase in demand for our gear as more people in more countries are under shelter-in-place restrictions. We believe that shelter-in-place and other similar restrictions have resulted in increased demand for our gear because such restrictions have limited people’s access to alternative forms of entertainment and social interaction, and thus have increased the demand for home entertainment and connecting with others through content creation. Further, we believe the increased demand for our gear has been driven in part by individuals seeking to improve their work from home setup. This increase in demand has continued into the third quarter and we expect it to continue through the remainder of the year as the COVID-19 pandemic continues. However, as global economic activity slows down, the demand for our gear could decline despite these trends. Moreover, travel restrictions, factory closures and disruptions in our supply chain are likely to happen and we or our suppliers may not be able to obtain adequate inventory to sell. The dynamic nature and uncertainty of the circumstances surrounding COVID-19 pandemic may have adverse consequences on our results of operations for 2020 and may negatively impact future fiscal periods in the event of prolonged disruptions associated with the outbreak. We continue to evaluate the nature and extent of the impact of the COVID-19 pandemic to our business and we have implemented various measures to attempt to mitigate the disruptive logistic impact specifically around managing inventory stocking level at our distribution hubs and determining the mode of shipment used to deploy our gear to the customers, and we are also ready to implement adjustments to our expenses and cash flow in the event of declines in revenues. Impact of Fluctuations in Integrated Circuits Pricing . Integrated circuits, or ICs, account for most of the cost of producing our high-performance memory products. IC prices are subject to pricing fluctuations which can affect the average sales prices of memory modules, and thus impact our net revenue, and can have an effect on gross margins. The impact on net revenues can be significant as our high-performance memory products, included within our gaming components and systems segment, represent a significant portion of our net revenue. 30 Table of Contents Components of our Operating Results Net Revenue We generate all of our net revenue from the sale of gamer and creator peripherals and gaming components and systems to retailers, including online retailers, gamers and distributors worldwide. Our revenue is recognized net of allowances for returns, discounts, sales incentives and any taxes collected from customers. Cost of Revenue Cost of revenue consists of product costs, including costs of contract manufacturers, inbound freight costs from manufacturers to our distribution hubs as well as inter-hub shipments, cost of materials and overhead, duties and tariffs, warranty replacement cost to process and rework returned items, depreciation of tooling equipment, warehousing costs, excess and obsolete inventory write-downs, and certain allocated costs related to facilities and information technology, or IT, and personnel-related expenses and other operating expenses related to supply chain logistics. Operating Expenses Operating expenses consist of product development and sales, general and administrative expenses. Sales, general and administrative. Sales, general and administrative, or SG&A expenses represent the largest component of our operating expenses and consist of distribution costs, sales, marketing and other general and administrative costs. Distribution costs include outbound freight and the costs to operate our distribution hubs. Sales and marketing costs relate to the costs to operate our global sales force that works in conjunction with our channel partners, gaming team and event sponsorships, advertising and marketing promotions of our products and services, costs of maintaining our web store and credit card processing fees related to sales on our webstore, and personnel-related cost. General and administrative costs consist primarily of personnel-related expenses for our finance, legal, human resources, IT and administrative personnel, as well as the costs of professional services related to these functions. We expect our total sales, general and administrative expenses to increase in absolute dollars as we continue to actively promote and distribute a higher volume of our products and also due to the anticipated growth of our business and related infrastructure, including increase in legal, accounting, insurance, compliance, investor relations and other costs associated with becoming a public company. Product development . Product development costs are generally expensed as incurred and reported in the condensed combined consolidated statements of operations. Product development costs consist primarily of the costs associated with the design and testing of new products and improvements to existing products. These costs relate primarily to compensation of personnel and consultants involved with product design, definition, compatibility testing and qualification. We expect our product development expenses to increase in absolute dollars as we continue to make significant investments in developing new products and enhancing existing products. Interest Expense Interest expense consists of interest associated with our debt financing arrangements, including our revolving line of credit, amortization of debt issuance costs and debt discounts, loss from debt extinguishment, consisting of the write-off of unamortized debt discount and fees associated with the prepayment of our term loans, and the change in fair value of our interest rate cap contracts. Other (Expense) Income, Net Other (expense) income, net consists primarily of our foreign currency exchange gains and losses relating to transactions and remeasurement of asset and liability balances denominated in currencies other than the U.S. dollar. We expect our foreign currency gains and losses to continue to fluctuate in the future due to changes in foreign currency exchange rates. Income Tax (Expense) Benefit We are subject to income taxes in the United States and foreign jurisdictions in which we do business. These foreign jurisdictions have statutory tax rates different from those in the United States. Accordingly, our effective tax rates will vary depending on the relative proportion of foreign to United States income, the utilization of foreign tax credits and changes in tax laws. Deferred tax assets are reduced through the establishment of a valuation allowance, if, based upon available evidence, it is determined that it is more likely than not that the deferred tax assets will not be realized. 31 Table of Contents Income ta xes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the tax and financial reporting bases of our assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in future years in which those temporary differences are expected to be recovered or settled. Results of Operations The following tables set forth the components of our condensed combined consolidated statements of operations, in dollars and as a percentage of total net revenue, for each of the periods presented. Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 (in thousands) Net revenue $ 457,103 $ 284,372 $ 1,146,028 $ 770,619 Cost of revenue 329,159 224,145 834,398 616,785 Gross profit 127,944 60,227 311,630 153,834 Operating expenses: Sales, general and administrative 65,321 39,811 175,877 115,992 Product development 12,902 9,454 36,285 28,353 Total operating expenses 78,223 49,265 212,162 144,345 Operating income 49,721 10,962 99,468 9,489 Other (expense) income: Interest expense (10,170 ) (9,119 ) (29,116 ) (27,063 ) Other (expense) income, net 23 (399 ) (29 ) (1,477 ) Total other expense, net (10,147 ) (9,518 ) (29,145 ) (28,540 ) Income (loss) before income taxes 39,574 1,444 70,323 (19,051 ) Income tax (expense) benefit (3,217 ) 75 (10,149 ) 4,645 Net income (loss) $ 36,357 $ 1,519 $ 60,174 $ (14,406 ) Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 Net revenue 100.0 % 100.0 % 100.0 % 100.0 % Cost of revenue 72.0 78.8 72.8 80.0 Gross profit 28.0 21.2 27.2 20.0 Operating expenses: Sales, general and administrative 14.3 14.0 15.3 15.1 Product development 2.8 3.3 3.2 3.7 Total operating expenses 17.1 17.3 18.5 18.7 Operating income 10.9 3.9 8.7 1.2 Other (expense) income: Interest expense (2.2 ) (3.2 ) (2.5 ) (3.5 ) Other (expense) income, net 0.0 (0.1 ) (0.0 ) (0.2 ) Total other expense, net (2.2 ) (3.3 ) (2.5 ) (3.7 ) Income (loss) before income taxes 8.7 0.5 6.1 (2.5 ) Income tax (expense) benefit (0.7 ) 0.0 (0.9 ) 0.6 Net income (loss) 8.0 % 0.5 % 5.3 % (1.9 )% 32 Table of Contents Components of Results of Operations Net Revenue Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 (in thousands) Net revenue $ 457,103 $ 284,372 $ 1,146,028 $ 770,619 Net revenue increased $172.7 million, or 60.7%, for the three months ended September 30, 2020 as compared to the same period last year. Net revenue increased $375.4 million, or 48.7%, for the nine months ended September 30, 2020 as compared to the same period last year. We experienced at least double-digit revenue growth in both our gaming components and systems segment and gamer and creator peripherals segment, for both the three- and nine-month periods. We believe the increased demand of our products is generally due to a larger number of consumers, gaming and working from home due to the COVID-19 pandemic, in addition to existing customers upgrading their systems and gear for a better gaming and/or streaming experience, and to a lesser extent, the inclusion of post-acquisition revenues from the SCUF Acquisition and the Origin Acquisition. Gross Profit and Gross Margin Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 (in thousands) Gross profit $ 127,944 $ 60,227 $ 311,630 $ 153,834 Gross margin 28.0 % 21.2 % 27.2 % 20.0 % Gross margin increased to 28.0% for the three months ended September 30, 2020 from 21.2% for the same period last year and increased to 27.2% for the nine months ended September 30, 2020 from 20.0% for the same period last year. The increase in gross margins for both the three- and nine-month periods was primarily driven by increased sales volume, improved product mix and less promotional activity, and were partially offset by increased air freight costs incurred in order to meet increased customer demand. Sales, General and Administrative (SG&A) Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 (in thousands) Sales, general and administrative $ 65,321 $ 39,811 $ 175,877 $ 115,992 SG&A expenses increased $25.5 million, or 64.1%, for the three months ended September 30, 2020 as compared to the same period last year. The increase was primarily due to a $9.2 million increase in distribution costs including outbound freight and the costs to operate our distribution hubs due to increased sales volume, the inclusion of $7.7 million of SCUF’s post-acquisition SG&A expenses, a $6.9 million increase in personnel-related costs due to headcount growth and higher bonus expense, and a $1.7 million increase in marketing and advertising expenses. SG&A expenses increased $59.9 million, or 51.6%, for the nine months ended September 30, 2020 as compared to the same period last year. The increase was primarily due to the inclusion of $22.2 million of SCUF’s post-acquisition SG&A expenses, including debt refinancing costs for funding the SCUF acquisition, and acquisition and integration costs related to the SCUF Acquisition, a $17.2 million increase in personnel-related costs due to headcount growth and higher bonus expense, a $15.2 million increase in distribution costs including outbound freight and the costs to operate our distribution hubs due to increased sales volume, a $2.7 million increase in professional fees in connection with our IPO and our preparation to become a public company, and a $2.6 million increase in marketing and advertising expenses. 33 Table of Contents Product Development Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 (in thousands) Product development $ 12,902 $ 9,454 $ 36,285 $ 28,353 Product development expenses increased $3.4 million, or 36.5%, for the three months ended September 30, 2020 as compared to the same period last year. The increase was primarily driven by a $1.7 million increase in personnel-related expenses due to headcount growth and higher bonus expense, the inclusion of $1.6 million of SCUF’s post-acquisition product development expenses and a $1.2 million increase in other product development related costs. These increases were partially offset by a $1.1 million decrease in amortization expense of developed technologies intangible assets. Product development expenses increased $7.9 million, or 28.0%, for the nine months ended September 30, 2020 as compared to the same period last year. The increase was primarily driven by a $4.5 million increase in personnel-related expenses due to headcount growth and higher bonus expense, the inclusion of $4.3 million of SCUF’s post-acquisition product development expenses, and a $3.6 million increase in other product development related expenses. These increases were partially offset by a $4.5 million decrease in amortization expense of developed technologies intangible assets. Interest Expense and Other (Expense) Income, Net Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 (in thousands) Interest expense $ (10,170 ) $ (9,119 ) $ (29,116 ) $ (27,063 ) Other (expense) income, net 23 (399 ) (29 ) (1,477 ) Interest expense increased $1.1 million, or 11.5%, for the three months ended September 30, 2020 as compared to the same period last year. The increase was primarily due to a $2.9 million write-off of deferred debt discounts and issuance costs associated with the partial extinguishment of our First Lien Term Loan and the full extinguishment of our Second Lien Term Loan. The increase in interest expense from debt extinguishments was partially offset by lower interest paid on our term loans during the three months ended September 30, 2020 resulting from lower principal balance after the repayments as well as a decrease in interest from borrowings from our line of credit. Interest expense increased $2.1 million, or 7.6%, for the nine months ended September 30, 2020 as compared to the same period last year. The increase was primarily due to an aggregate of $3.3 million write-off of deferred debt discounts and issuance costs associated with the partial extinguishment of our First Lien Term Loan and the full extinguishment of our Second Lien Term Loan during the second and third quarter of 2020 and to a lesser extent, due to a $0.5 million loss recognized for the change in fair value of our interest rate cap contracts. The increase in interest expense was partially offset by a decrease in interest from borrowings from our line of credit . Other (expense) income, net is primarily comprised of foreign exchange gains and losses on cash, accounts receivable and intercompany balances denominated in currencies other than the functional currencies of our subsidiaries . Our foreign currency exposure is primarily driven by fluctuations in the foreign currency exchanges rates of the Euro, British Pound and the Chinese Yuan. Income Tax (Expense) Benefit Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 (in thousands) Income (Loss) Before Income Taxes $ 39,574 $ 1,444 $ 70,323 $ (19,051 ) Income Tax (Expense) Benefit (3,217 ) 75 (10,149 ) 4,645 Effective Tax Rate 8.1 % 5.2 % 14.4 % 24.4 % 34 Table of Contents We are subject to income taxes in the United States and foreign jurisdictions in which we do business. These foreign jur isdictions have statutory tax rates different from those in the United States. Accordingly, our effective tax rates will vary depending on the relative proportion of foreign to United States income, the utilization of net operating loss and tax credit carr y forwards, changes in geographic mix of income and expense, and changes in management’s assessment of matters such as the ability to realize deferred tax assets, and changes in tax laws. Our effective tax rates were tax expense of 8.1% and tax benefit of 5.2% for the three months ended September 30, 2020 and 2019, respectively, and tax expense of 14.4% and tax benefit of 24.4% for the nine months ended September 30, 2020 and 2019, respectively. The change in the effective income tax rate for the three months ended September 30, 2020, compared to the same period last year was primarily due to the mix of income and losses in the various tax jurisdictions in which we operate, as well as the recognition of a $1.5 million tax benefit in the three months ended September 30, 2019 versus a $4.3 million tax benefit recognized in the three months September 30, 2020, resulting from the change in management’s assessment of the realizability of certain deferred tax assets as a result of the Reorganization. The change in the effective tax rate for the nine months ended September 30, 2020, compared to the same period last year was primarily due to the recognition of a $4.3 million tax benefit in the nine months ended September 30, 2020 resulting from the change in management’s assessment of the realizability of certain deferred tax assets as a result of the Reorganization, and a $0.6 million one-time benefit from the change in tax law resulting from the enactment of the CARES Act in the first quarter 2020. Segment Results Segment Net Revenue The following table sets forth our net revenue by segment expressed both in dollars (thousands) and as a percentage of net revenue: Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 Gamer and Creator Peripherals Segment $ 161,555 35.3 % $ 70,606 24.8 % $ 347,531 30.3 % $ 200,084 26.0 % Memory Products 141,298 31.0 119,467 42.0 424,150 37.0 331,433 43.0 Other Component Products 154,250 33.7 94,299 33.2 374,347 32.7 239,102 31.0 Gaming Components and Systems Segment 295,548 64.7 213,766 75.2 798,497 69.7 570,535 74.0 Total Net Revenue $ 457,103 100.0 % $ 284,372 100.0 % $ 1,146,028 100.0 % $ 770,619 100.0 % Gamer and Creator Peripherals Segment Net revenue of the gamer and creator peripherals segment increased $90.9 million, or 128.8%, for the three months ended September 30, 2020 as compared to the same period last year, primarily due to strong sales growth of Elgato branded streaming products and growth across all product categories, in addition to the inclusion of SCUF post-acquisition revenue. We believe the strong revenue growth year-over-year is driven in part by the COVID-19 shelter-in-place orders as consumers spend more time working and gaming at home. Net revenue of the gamer and creator peripherals segment increased $147.4 million, or 73.7%, for the nine months ended September 30, 2020 as compared to the same period last year, primarily due to strong sales growth in sales of Elgato branded streaming products, we believe driven in part by the COVID-19 shelter-in-place orders as consumers spend more time working and gaming at home, and the inclusion of SCUF post-acquisition revenue. Gaming Components and Systems Segment Net revenue of the gaming components and systems segment increased $81.8 million, or 38.3%, for the three months ended September 30, 2020 as compared to the same period last year, primarily as a result of strong sales growth across all products due to continued strong market demand, we believe driven in part by the COVID-19 shelter-in-place orders. Net revenue of the gaming components and systems segment increased $228.0 million, or 40.0%, for the nine months ended September 30, 2020 as compared to the same period last year, primarily as a result of strong sales growth across all products due to continued strong market demand, we believe driven in part by the COVID-19 shelter-in-place orders, and to a lesser extent, the inclusion of Origin post-acquisition revenue. 35 Table of Contents Segment Gross Profit and Gross Margin The following table sets forth our gross profit expressed in dollars (thousands) and gross margin (which we define as gross profit as a percentage of net revenue) by segment: Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 Gamer and Creator Peripherals Segment $ 60,010 37.1 % $ 19,948 28.3 % $ 120,886 34.8 % $ 58,234 29.1 % Memory Products 26,552 18.8 21,882 18.3 89,507 21.1 48,234 14.6 Other Component Products 41,382 26.8 18,397 19.5 101,237 27.0 47,366 19.8 Gaming Components and Systems Segment 67,934 23.0 40,279 18.8 190,744 23.9 95,600 16.8 Total Gross Profit $ 127,944 28.0 % $ 60,227 21.2 % $ 311,630 27.2 % $ 153,834 20.0 % Gamer and Creator Peripherals Segment The gross profit of the gamer and creator peripherals segment increased in the three months ended September 30, 2020 by $40.1 million, or 200.8%, as compared to the same period last year. The gross profit of the gamer and creator peripherals segment increased in the nine months ended September 30, 2020 by $62.7 million, or 107.6%, as compared to the same period last year. The increase in gross profit for both the three- and nine-month periods was primarily due to strong revenue growth in those periods. Gross margin increased by 8.9% and 5.7% for the gamer and creator peripherals segment in the three- and nine-month periods, respectively, compared to the same periods last year, primarily driven by the increase in sales volume in the same periods, the addition of higher margin SCUF products, and the strong growth in sales of higher margin Elgato branded streaming products, coupled with less promotional activities. Gaming Components and Systems Segment The gross profit of the gaming components and systems segment increased in the three months ended September 30, 2020 by $27.7 million, or 68.7% as compared to the same period last year. The gross profit of the gaming components and systems segment increased in the nine months ended September 30, 2020 by $95.1 million, or 99.5% as compared to the same period last year. The increase in gross profit for both the three- and nine-month periods was primarily due to strong revenue growth in those periods. Gross margin increased by 4.1% and 7.1% for the gaming components and systems segment in the three- and nine-month periods, respectively, compared to the same periods last year, primarily driven by the increase in sales volume in the same periods in addition to product mix and less promotional activities. Liquidity and Capital Resources To date, our principal sources of liquidity have been the net proceeds we received from private sales of equity securities, borrowings under our credit facilities, as well as payments received from customers purchasing our gear. On September 25, 2020, we completed our IPO which resulted in aggregate net proceeds of $118.6 million, after underwriting discounts and commissions, and before deducting offering costs of $11.8 million. As of September 30, 2020, we had cash and restricted cash, in aggregate of $120.1 million and $48.0 million capacity under our revolving credit facility. Our total borrowings outstanding as of September 30, 2020 consisted of $370.1 million of long-term debt. We anticipate our principal uses of cash will include repayments of debt and related interest, purchases of inventory, payroll and other operating expenses related to the development and marketing of our gear, and purchases of property and equipment and other contractual obligations for the foreseeable future. We believe that our existing cash balances and cash flow from operations will be sufficient to fund our principal uses of cash for at least the next 12 months. Our future capital requirements may vary materially from those currently planned and will depend on many factors, including our rate of revenue growth, the timing and extent of spending on research and development efforts and other business initiatives, the expansion of sales and marketing activities, the timing of new product introductions, market acceptance of our products and overall economic conditions. To the extent that current and anticipated future sources of liquidity are insufficient to fund our future business activities and requirements, we may be required to seek additional equity or debt financing. In addition, we may enter into other arrangements for potential investments in, or acquisitions of, complementary businesses, services or technologies, which could require us to seek additional equity or debt financing. The sale of additional equity would result in additional dilution to our stockholders. The incurrence of debt financing would result in debt service obligations and the instruments governing such debt could provide for operating and financial covenants that would restrict our operations. We cannot assure you that any such equity or debt financing will be available on favorable terms, or at all. 36 Table of Contents Cash Flows The following table summarizes our cash flows for the periods indicated (in thousands): Nine Months Ended September 30, 2020 2019 Net cash provided by (used in): Operating activities $ 100,324 $ 1,134 Investing activities (5,908 ) (22,149 ) Financing activities (26,371 ) 5,178 Cash Flows from Operating Activities Net cash provided by operating activities for the nine months ended September 30, 2020 was $100.3 million and consisted of net income of $60.2 million, non-cash adjustments of $35.7 million and $4.4 million from changes in our net operating assets and liabilities. The non-cash adjustments consisted primarily of amortization of intangibles and depreciation, stock-based compensation expense, loss on debt extinguishment and amortization of debt issuance costs. The net cash inflow from changes in our net operating assets and liabilities was primarily related to increase in accounts payable, other liabilities and accrued expenses and deferred revenue. The increase in accounts payable was mainly due to timing of payments and purchases with longer payment terms, and the increase in other liabilities and accrued expenses was mainly from an increase in the bonus accrual and a higher accrual for sales returns and customer incentives. The cash inflow was partially offset by an increase in inventory, accounts receivable and prepaid expenses and other assets. Net cash provided by operating activities for the nine months ended September 30, 2019 was $1.1 million and consisted of a net cash inflow of non-cash adjustments of $27.4 million, which was offset partially by a net loss of $14.4 million and $11.9 million from changes in our net operating assets and liabilities. The non-cash adjustments consisted primarily of amortization of intangibles and depreciation, stock-based compensation expense, amortization of debt issuance costs and loss on foreign exchange, which were partially offset by changes in deferred income taxes. The net cash outflow from changes in our net operating assets and liabilities was primarily related to increases in inventory, accounts receivable and prepaid expenses and other assets, which were partially offset by an increase in other liabilities and accrued expenses and accounts payable mainly due to timing of payments. Cash Flows from Investing Activities Cash used in investing activities was $5.9 million for the nine months ended September 30, 2020 and consisted of $5.1 million for the purchase of capital equipment and software and $0.8 million for the acquisition of an immaterial business. Cash used in investing activities was $22.1 million for the nine months ended September 30, 2019 and consisted of $10.3 million payment for the deferred consideration of Elgato acquisition, $7.0 million for the purchase of capital equipment and software and $4.8 million for the acquisition of Origin. Cash Flows from Financing Activities Cash used in financing activities was $26.4 million for the nine months ended September 30, 2020 and consisted of repayments of debt of $140.4 million and the payment of offering costs of $5.6 million. These cash outflows were partially offset by proceeds received from issuance of our common stock in connection with our IPO of $118.6 million, after deducting underwriting discounts and commissions , and proceeds received from exercises of stock options of $1.2 million. Cash provided by financing activities was $5.2 million for the nine months ended September 30, 2019 and consisted of borrowings under our credit facilities of $8.7 million. The cash inflow was partially offset by the repayment of debt of $2.8 million, repurchase of common stock of $0.6 million and payment of debt issuance costs of $0.2 million. Credit Facilities and Dividend In August 2017, we entered into a syndicated First Lien Credit and Guaranty Agreement, or the First Lien, with various financial institutions. The First Lien originally provided a $235 million term loan, or the First Lien Term Loan, for a business acquisition and to repay existing indebtedness of the acquired company and a $50 million revolving line-of-credit, or the Revolver. The First Lien and the Revolver mature on August 28, 2024 and August 28, 2022, respectively. 37 Table of Contents Subsequently, we entered into several amendments to the First Lien and the principal amount of the First Lien Term Loan was increased by $10 million in 2017 and increased by $115 million in each of 201 8 and 2019. The increase in First Lien in 2018 was primarily to fund an $85 million dividend distribution to the unitholders of EagleTree and for operational needs. The increase in the First Lien in 2019 was primarily to fund the SCUF Acquisition. The First Lien Term Loan initially carried interest at a rate equal to, at our election, either the (a) greatest of (i) the prime rate, (ii) sum of the Federal Funds Effective Rate plus 0.5%, (iii) one month LIBOR plus 1.0% and (iv) 2%, plus a margin of 3.5%, or (b) the greater of (i) LIBOR and (ii) 1.0%, plus a margin of 4.5%. The Revolver initially carried interest at a rate equal to, at our election, either the (a) greatest of (i) the prime rate, (ii) sum of the Federal Funds Effective Rate plus 0.5%, (iii) one month LIBOR plus 1.0% and (iv) 2%, plus 3.5%, or (b) the greater of (i) LIBOR and (ii) 1.0%, plus a margin of 4.5%. As a result of the First Lien amendment in October 2018, the margin for the First Lien term loan and Revolver margin were both changed to range from 2.75% to 3.25% for base rate loans and to range from 3.75% to 4.25% for Eurodollar loans, in each case, based on our net leverage ratio. Additionally, new contingent repayment provisions were added as a result of the First Lien amendment in October 2018. Five business days after our IPO, we were required to prepay all amounts (principal and interest) outstanding under the Second Lien Term Loan (as defined below). Concurrently, we were also required to prepay the First Lien Term Loan in an amount equal to the proceeds from the IPO, less the amount used to repay the Second Lien Term Loan, multiplied by 50%. Accordingly, in September 2020, with the IPO proceeds, we repaid the mandatory minimum amount of $55.8 million and made an additional $30.8 million voluntary repayment from the use of the IPO proceeds. We may prepay the First Lien Term Loan and the Revolver at any time without premium or penalty other than customary LIBOR breakage. According to the Consolidated Excess Cash Flow clause as defined in the First Lien, in April 2020, we prepaid $2.6 million of the First Lien Term Loan. In August 2017, we also entered into a syndicated Second Lien Credit and Guaranty Agreement, or the Second Lien, with various financial institutions. The Second Lien initially provided a $65 million term loan, or the Second Lien Term Loan, with a maturity date of August 28, 2025, for a business acquisition and for general corporate operations purposes. The Second Lien Term Loan initially carried interest at a base rate equal to that of the First Lien loan, plus a margin of 7.25% for base rate loans and 8.25% for Eurodollar loans. In October 2017, we entered into an amendment to the Second Lien and the principal amount of the Second Lien Term Loan was reduced by $15 million and the applicable interest rate margins for both the base rate loans and Eurodollar loans were increased by 0.25%. We had the ability to prepay the Second Lien Term Loan any time after the first and second anniversary without premium or penalty . In the second and third quarter of 2020, with excess cash on hand, we repaid an aggregate of $50 million of the outstanding principal balance of the Second Lien Term Loan and following this repayment, the Second Lien Term Loan was fully repaid and all obligations and covenants thereunder were terminated. All accrued and unpaid interest on the borrowed amounts is due and payable on a quarterly basis. Our obligation under the First Lien is secured by substantially all of our personal property assets and those of our United States-organized subsidiaries, including intellectual property. The First Lien Term Loan includes customary restrictive covenants that impose operating and financial restrictions on us, including restrictions on our ability to take actions that could be in our best interests. These restrictive covenants include operating covenants restricting, among other things, our ability to incur additional indebtedness, effect certain acquisitions or make other fundamental changes. We were in compliance with all of the covenants as of September 30, 2020. In addition, the First Lien contains events of default that include, among others, non-payment of principal, interest or fees, breach of covenants, inaccuracy of representations and warranties, cross defaults to certain other indebtedness, bankruptcy and insolvency events, material judgments and events constituting a change of control. Upon the occurrence and during the continuance of an event of default, interest on the obligations may accrue at an increased rate in the case of a non-payment or bankruptcy and insolvency and the lenders may accelerate our obligations under the First Lien Term Loan, except that acceleration will be automatic in the case of bankruptcy and insolvency events of default. 38 Table of Contents Contractual Obli gations and Other Commitments The following table summarizes our contractual obligations and commitments as of September 30, 2020: Payments Due by Period Total Less than 1 Year 1-3 Years 3-5 Years More than 5 Years (in thousands) Debt principal and interest (1) $ 448,109 $ 4,576 $ 36,306 $ 407,227 $ — Purchase obligations (2) 103,094 98,525 4,569 — — Operating leases (3) 28,912 2,310 15,444 9,171 1,987 Total $ 580,115 $ 105,411 $ 56,319 $ 416,398 $ 1,987 (1) Represents our syndicated First Lien Term Loan and our anticipated repayment schedule for the loan as of September 30, 2020. See Note 8 “Debt” to our condensed combined consolidated financial statements for more information. (2) Represents an estimate of our non-cancelable open purchase orders and contractual obligations in the ordinary course of business for which we have not received the goods or services as of September 30, 2020. (3) Consists of contractual obligations from our non-cancellable operating leases for office and warehouse spaces. Off-Balance Sheet Arrangements We have not entered into any off-balance sheet arrangements and do not have any holdings in variable interest entities. Critical Accounting Polices and Estimates Our management’s discussion and analysis of our financial condition and results of operations is based on our condensed combined consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these condensed combined consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the condensed combined consolidated financial statements, as well as the reported revenue generated and expenses incurred during the reporting periods. Our estimates are based on our historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. There have been no material changes to our critical accounting policies and estimates during the three months ended September 30, 2020 as compared to the critical accounting policies and estimates described in our Management's Discussion and Analysis of Financial Condition and Results of Operations, set forth in our Prospectus. Recent Accounting Pronouncements Refer to Note 1 to the condensed combined consolidated financial statements included in this Quarterly Report on Form 10-Q for recent accounting pronouncements adopted and to be adopted. 39 Table of Contents Item 3. Quantitative and Qualitati ve Disclosures About Market Risk. Interest Rate Risk We are exposed to market risks in the ordinary course of our business. Market risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and rates. Our market risk exposure is primarily a result of fluctuations in interest rates and foreign currency exchange rates. As of September 30, 2020, we had cash and restricted cash of $120.1 million, which consisted primarily of bank deposits. Our cash is held for working capital purposes. As of September 30, 2020, we had indebtedness of $370.1 million under the syndicated First Lien Term Loan which bears variable market rates, primarily LIBOR. A significant change in these market rates may adversely affect our operating results. As of September 30, 2020, a hypothetical 100 basis point change in interest rates would result in a change to interest expense by approximately $0.1 million and $0.4 million for the three and nine months ended September 30, 2020, respectively. Foreign Currency Risk Approximately 19% of our net revenue in the nine months ended September 30, 2020 was denominated in foreign currencies. Any unfavorable movement in the exchange rate between U.S. dollars and the currencies in which we conduct sales in foreign countries could have an adverse impact on our net revenue and gross margins as we may have to have to adjust local currency product pricing due to competitive pressures if there is significant volatility in foreign currency exchange rates. Our operating expenses are denominated in the currencies of the countries in which our operations are located, which are primarily in the United States, Europe, China and Taiwan. Our operating results and cash flows are, therefore, subject to fluctuations due to changes in foreign currency exchange rates. The primary currency fluctuations to which we are exposed are the Euro, British Pound and the Chinese Yuan. We enter into forward currency contracts to reduce the short-term effects of currency fluctuations on Euro, British Pound, and Chinese Yuan denominated cash, accounts receivable, and intercompany receivable and payable balances. These forward contracts generally mature within three months and we do not enter into foreign currency forward contracts for trading purposes. The outstanding notional principal amount was $21.5 million and $18.3 million as of September 30, 2020 and December 31, 2019, respectively. The gains or losses on these contracts are recognized in earnings based on the changes in fair value. The impact of changes in foreign currency rates recognized in other (expense) income, net was $(0.2) million and $(0.4) million for the three months ended September 30, 2020 and 2019, respectively, and $(0.3) million and $(1.5) million for the nine months ended September 30, 2020 and 2019, respectively. 40 Table of Contents