Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
You should read the following discussion of our financial condition and results of operations in conjunction with the combined consolidated financial statements and the related notes included elsewhere in this Annual Report on Form 10-K. The following discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from such forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Annual Report on Form 10-K, particularly in the section Item 1A, “ Risk Factors ” and below in Item 7A, “ Quantitative and Qualitative Disclosures about Market Risk ” .
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 the Elgato streaming suite for content creators, which provide unified, intuitive performance, and aesthetic control and customization across their respective product families. During 2020, we further enhanced our streaming product offerings through acquiring EpocCam software and Gamer Sensei gaming coaching services.
We group our products into two categories (segments):
•
Gamer and creator peripherals. Includes our high-performance gaming keyboards, mice, headsets, controllers, and our streaming gear including capture cards, Stream Decks, USB microphones, studio accessories, and EpocCam software, as well as coaching and training services, among others.
•
Gaming components and systems. Includes our high-performance power supply units, or PSUs, cooling solutions, computer cases, 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. We subsequently completed three more immaterial acquisitions. I n August 2020, we acquired EpocCam to enhance the Elgato streaming camera software offering; in October 2020, we acquired Gamer Sensei to offer gaming coaching services to the wide audience of gamers looking to improve their skills and in February 2021, we acquired Visuals by Impulse to provide creative services to streamers looking to professionalize the look of their broadcast. Origin is part of our gaming components and systems segment and SCUF, EpocCam, Gamer Sensei and Visual by Impulse are part of our gamer and creator peripherals segment. See Note 5 of the Notes to our combined consolidated financial statements for additional information.
Our net revenue was $1.7 billion, $1.1 billion, and $937.6 million for 2020, 2019, and 2018, respectively, representing year-over-year increases of 55.2% and 17.0% for 2020 and 2019, respectively. We had net income (loss) of $103.2 million, $(8.4) million, and $(13.7) million for 2020, 2019, and 2018, respectively. Net cash provided by operating activities was $169.0 million, $37.1 million and $0.4 million for 2020, 2019, and 2018, respectively.
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 I, Item 1A of this Annual Report on Form 10-K and those described below.
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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 is 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 24.6%, 25.1% and 22.4% of our net revenue for 2020, 2019, and 2018, respectively, and sales to our ten largest customers accounting for approximately 52.7%, 51.6%, and 51.0% 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.
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 results, such as the introduction of our new high-performance Elgato Wave microphone in the second quarter of 2020. However, there can be no assurance that our new product introductions will have a favorable impact on our operating results or that customers will choose our new gear over those 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.
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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. A s 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 continued into the second half of 2020 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. In contrast, if the COVID-19 pandemic subsides in 2021, resulting in shelter-in-place and other similar restrictions being eased, it could result in consumers returning to other alternative forms of entertainment and interaction. This in turn could result in a decline in demand for our products.
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.
Components of our Operating Results
Net Revenue
We generate materially 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,
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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 sales, general and administrative expenses and product development 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 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.
Income taxes 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.
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Results of Operations
The following tables set forth the components of our combined consolidated statements of operations, in dollars and as a percentage of total net revenue, for each of the periods presented.
Year Ended December 31,
2020
2019
2018
(in thousands)
Net revenue
$
1,702,367
$
1,097,174
$
937,553
Cost of revenue
1,236,938
872,887
744,858
Gross profit
465,429
224,287
192,695
Operating expenses:
Sales, general and administrative
257,004
163,033
138,915
Product development
50,064
37,547
31,990
Total operating expenses
307,068
200,580
170,905
Operating income
158,361
23,707
21,790
Other (expense) income:
Interest expense
(35,137
)
(35,548
)
(32,680
)
Other (expense) income, net
(1,182
)
(1,558
)
183
Total other expense, net
(36,319
)
(37,106
)
(32,497
)
Income (loss) before income taxes
122,042
(13,399
)
(10,707
)
Income tax (expense) benefit
(18,825
)
5,005
(3,013
)
Net income (loss)
$
103,217
$
(8,394
)
$
(13,720
)
Year Ended December 31,
2020
2019
2018
Net revenue
100.0
%
100.0
%
100.0
%
Cost of revenue
72.7
79.6
79.4
Gross profit
27.3
20.4
20.6
Operating expenses:
Sales, general and administrative
15.1
14.9
14.8
Product development
2.9
3.4
3.4
Total operating expenses
18.0
18.3
18.2
Operating income
9.3
2.2
2.3
Other (expense) income:
Interest expense
(2.0
)
(3.2
)
(3.5
)
Other (expense) income, net
(0.1
)
(0.1
)
0.0
Total other expense, net
(2.1
)
(3.4
)
(3.5
)
Income (loss) before income taxes
7.2
(1.2
)
(1.1
)
Income tax (expense) benefit
(1.1
)
0.5
(0.3
)
Net income (loss)
6.1
%
(0.8
)%
(1.5
)%
Components of Results of Operations
Net Revenue
Year Ended December 31,
2020
2019
2018
(in thousands)
Net revenue
$
1,702,367
$
1,097,174
$
937,553
Net revenue increased $605.2 million, or 55.2%, in 2020 as compared to 2019. This increase was due to strong revenue growth in both our gaming components and systems segment and gamer and creator peripherals segment. 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.
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Net revenue increased $159.6 million, or 17 .0 %, in 2019 as compared to 2018, due to strong growth in both of our segments largely as a result of higher sales of Corsair -branded products and also from the addition of the Elgato product portfolio after its acquisition in July 2018.
Gross Profit and Gross Margin
Year Ended December 31,
2020
2019
2018
(in thousands)
Gross profit
$
465,429
$
224,287
$
192,695
Gross margin
27.3
%
20.4
%
20.6
%
Gross margin for 2020 increased to 27.3% from 20.4% for 2019. The increase in gross margin was primarily driven by increased sales volume, an improved product mix with more higher margin products being sold in 2020 as compared to 2019 and less promotional activity, and was partially offset by increased air freight costs driven primarily by tightness in inventory supply due to the COVID-19 pandemic.
Gross margin for 2019 was positively impacted by a favorable shift in product mix but was largely offset by a negative impact from additional tariff costs, resulting in relatively flat gross margin of 20.4% in 2019 as compared to 20.6% in 2018.
Sales, General and Administrative (SG&A)
Year Ended December 31,
2020
2019
2018
(in thousands)
Sales, general and administrative
$
257,004
$
163,033
$
138,915
SG&A expenses increased $94.0 million, or 57.6%, in 2020 as compared to 2019. The increase was primarily due to the inclusion of $29.1 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 $27.4 million increase in distribution costs including outbound freight and the costs to operate our distribution hubs due to increased sales volume, a $24.3 million increase in personnel-related costs due to headcount growth and higher bonus expense, a $6.0 million increase in marketing expenses and a $4.4 million increase in fees primarily related to increased credit card fees due to increased sales through our webstore and fees from our insurance policies.
SG&A expenses increased $24.1 million, or 17.4%, in 2019 as compared to 2018. The increase was primarily driven by a $9.0 million increase in personnel-related costs due to headcount growth, a $4.4 million increase in marketing and advertising expenses to increase worldwide brand awareness for our products, a $3.6 million increase in outbound freight costs due to increased sales, an inclusion of $4.0 million of SCUF’s post acquisition SG&A expense, including debt refinancing costs for funding the acquisition, and acquisition and integration costs related to the SCUF acquisition, a $2.1 million increase in professional fees, and a $1.0 million one-time severance and separation cost with an executive.
Product Development
Year Ended December 31,
2020
2019
2018
(in thousands)
Product development
$
50,064
$
37,547
$
31,990
Product development expenses increased $12.5 million, or 33.3%, in 2020 as compared to 2019. The increase was primarily driven by a $5.7 million increase in personnel-related expenses due to headcount growth and higher bonus expense, the inclusion of $5.8 million of SCUF’s post-acquisition product development expenses and a $5.5 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.
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Product development expenses increased $5.6 million, or 17.4%, in 2019 as compared to 2018. The increase was primarily driven by a $3.2 million increase in personnel-related expenses due to headcount growth, a $1.6 million increase in consultant and contractor expenses and a $0.5 million increase in IT-related expenses to support product development efforts.
Interest Expense and Other (Expense) Income, Net
Year Ended December 31,
2020
2019
2018
(in thousands)
Interest expense
$
(35,137
)
$
(35,548
)
$
(32,680
)
Other (expense) income, net
(1,182
)
(1,558
)
183
Interest expense decreased $0.4 million, or 1.2%, in 2020 as compared to 2019. The decrease was primarily due to lower interest expense paid in 2020 for our First Lien Term Loan and Second Lien Term Loan as a result of the partial extinguishment of our First Lien Term Loan and full extinguishment of our Second Lien Term Loan as well as a decrease in interest from borrowings from our line of credit. The decrease in interest expense was partially offset by an aggregate of $4.2 million write-off of deferred debt discounts and issuance costs associated with extinguishments of our term loans and a $0.5 million loss recognized for the change in fair value of our interest rate cap contracts.
Interest expense increased $2.9 million, or 8.8%, in 2019 as compared to 2018. The increase was primarily due to additional cash interest and amortization of debt issuance costs and debt discounts for our additional debt borrowings entered into in March 2018, October 2018 and December 2019, as well as an increase in borrowings from our line of credit throughout 2019, as compared to 2018.
Other (expense) income, net relates primarily to the gains and losses resulting from the impact of foreign exchange rate changes on our cash, accounts receivable and intercompany balances denominated in currencies other than the functional currencies in 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
Year Ended December 31,
2020
2019
2018
(in thousands)
Income (Loss) Before Income Taxes
$
122,042
$
(13,399
)
$
(10,707
)
Income Tax (Expense) Benefit
$
(18,825
)
$
5,005
$
(3,013
)
Effective Tax Rate
15.4
%
37.4
%
28.1
%
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 net operating loss and tax credit carry 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 15.4% and tax benefit of 37.4% for 2020 and 2019, respectively. The change in effective tax rate for 2020 as compared to 2019 was primarily due to an increase in income before income tax compared to 2019, the change in the mix of income and losses in the various tax jurisdictions in which we operate, the recognition of a $4.6 million tax benefit 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.
Our effective tax rates were tax benefit of 37.4% and tax expense of 28.1% for 2019 and 2018, respectively. The change in effective tax rate for 2019 as compared to 2018 was primarily due to an increase in loss before income tax compared to 2018, realizing a tax benefit of a net operating loss of a foreign subsidiary and management’s reassessment of the realizability of our deferred tax assets from our U.S. net operating loss carried forward. In 2018, we recognized an income tax expense of $3.0 million primarily due to management’s assessment of the realizability of our deferred tax assets from tax credits and stock-based compensation expenses that may not be realized.
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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:
Year Ended December 31,
2020
2019
2018
Gamer and Creator Peripherals Segment
$
539,366
31.7
%
$
294,141
26.8
%
$
233,536
24.9
%
Memory Products
609,053
35.8
463,406
42.2
405,642
43.3
Other Component Products
553,948
32.5
339,627
31.0
298,375
31.8
Gaming Components and Systems Segment
1,163,001
68.3
803,033
73.2
704,017
75.1
Total Net Revenue
$
1,702,367
100.0
%
$
1,097,174
100.0
%
$
937,553
100.0
%
Gamer and Creator Peripherals Segment
Net revenue of the gamer and creator peripherals segment increased $245.2 million, or 83.4%, in 2020 as compared to 2019 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.
Net revenue of the gamer and creator peripherals segment increased $60.6 million, or 26.0%, in 2019 as compared to 2018 primarily due to the addition of Elgato product portfolio which increased the volume of the segment’s sales.
Gaming Components and Systems Segment
Net revenue of the gaming components and systems segment increased $360.0 million, or 44.8%, in 2020 as compared to 2019 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.
Net revenue of the gaming components and systems segment increased $99.0 million, or 14.1%, in 2019 as compared to 2018 primarily due to an increase in other components products sales following the normalization of the DIY PC market after the surge in the cryptocurrency mining in 2018, as well as an increase in sales volume in our DRAM products. The increase in our DRAM product sales was primarily due to market share gain in United States and China coupled with increased volumes due to lower selling prices.
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:
Year Ended December 31,
2020
2019
2018
Gamer and Creator Peripherals Segment
$
189,742
35.2
%
$
81,363
27.7
%
$
73,489
31.5
%
Memory Products
125,026
20.5
74,781
16.1
48,490
12.0
Other Component Products
150,661
27.2
68,143
20.1
70,716
23.7
Gaming Components and Systems Segment
275,687
23.7
142,924
17.8
119,206
16.9
Total Gross Profit
$
465,429
27.3
%
$
224,287
20.4
%
$
192,695
20.6
%
Gamer and Creator Peripherals Segment
The gross profit of the gamer and creator peripherals segment increased in 2020 by $108.4 million, or 133.2%, as compared to 2019, largely due to strong revenue growth of 83.4% in the same period. The 7.5% increase in gross margin was primarily driven by 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.
The gross profit of the gamer and creator peripherals segment increased in 2019 by $7.9 million, or 10.7%, compared to 2018, largely due to the net revenue growth of 26.0% in the same period. The 3.8% decrease in gross margin was primarily due to increased
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promotional activity, additional tariff costs in 2019 and higher return and rework costs, partially offset by a favorable shift in product mix towards sales of higher margin Elgato products.
Gaming Components and Systems Segment
The gross profit of the gaming components and systems segment increased in 2020 by $132.8 million, or 92.9%, compared to 2019, primarily due to strong revenue growth in the same period. The 5.9% increase in gross margin was primarily driven by a higher margin product mix and less promotional activities.
The gross profit of the gaming components and systems segment increased in 2019 by $23.7 million, or 19.9%, compared to 2018, largely due to the net revenue growth of 14.1% in the same period. The 0.9% increase in gross margin was primarily due to efficiencies from our leading position in the consumer, high performance memory market, which were offset partially by unfavorable margin impact from higher tariff costs and lower selling prices of our PSU products resulting from the volatility in the cryptocurrency mining market.
Liquidity and Capital Resources
Our principal sources of liquidity have been the payments received from customers purchasing our products, the net proceeds we received from private sales of equity securities, the borrowings under our credit facilities and the net proceeds we received from our IPO. 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 $12.0 million. As of December 31, 2020, we had cash and restricted cash, in aggregate of $133.6 million and $48.1 million capacity under our revolving credit facility. Our total borrowings outstanding as of December 31, 2020 consisted of $321.4 million of long-term debt.
We anticipate our principal uses of cash will include purchases of inventory, payroll and other operating expenses related to the development and marketing of our gear, repayments of debt and related interest, 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 (if any), 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 and demand for 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. There can be no assurance that any such equity or debt financing will be available on favorable terms, or at all.
Cash Flows
The following table summarizes our cash flows for the periods indicated (in thousands):
Year Ended December 31,
2020
2019
2018
Net cash provided by (used in):
Operating activities
$
168,953
$
37,103
$
422
Investing activities
(10,280
)
(145,427
)
(38,555
)
Financing activities
(79,131
)
132,314
47,354
Cash Flows from Operating Activities
Net cash provided by operating activities for 2020 was $169.0 million and consisted of net income of $103.2 million, non-cash adjustments of $50.8 million and $14.9 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, loss on debt extinguishment and amortization of debt issuance costs, which were partially offset by changes in deferred income taxes. 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. The increase in accounts payable was mainly due to timing of payments and purchases with longer payment terms, and the
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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 2019 was $37.1 million and consisted of non-cash adjustments of $32.5 million and a net cash inflow of $13.0 million from changes in our net operating assets and liabilities, which were offset partially by a net loss of $8.4 million. The non-cash adjustments consisted primarily of amortization of intangibles and depreciation, stock-based compensation expense and amortization of debt issuance costs, which were partially offset by changes in deferred income taxes. The net cash inflow from changes in our net operating assets and liabilities was primarily related to increases in accounts payable and other liabilities and accrued expenses mainly due to timing of payments, as well as a decrease in inventories. The cash inflow was partially offset by an increase in accounts receivable and other assets.
Cash Flows from Investing Activities
Cash used in investing activities was $10.3 million for 2020 and consisted of $9.0 million for the purchase of capital equipment and software and $1.3 million for acquisitions of immaterial businesses.
Cash used in investing activities was $145.4 million for 2019 and consisted primarily of $126.0 million that was used for the acquisition of SCUF and Origin, $10.3 million payment for the deferred consideration of Elgato acquisition and $8.8 million for the purchase of capital equipment and software.
Cash Flows from Financing Activities
Cash used in financing activities was $79.1 million for 2020 and consisted of repayments of debt of $190.4 million and the payment of offering costs of $8.5 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 employee stock options of $1.3 million.
Cash provided by financing activities was $132.3 million for 2019 and consisted of the net proceeds from issuance of debt of $113.9 million and the proceeds from issuance of common stock of $53.5 million, which were partially offset by the cash used for the repayment of our credit facilities of $27.0 million, the repayment of debt of $4.0 million, the payment of debt issuance costs of $2.5 million and the repurchase of common stock of $1.5 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.
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 2018 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.
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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 the fourth quarter of 2020, we prepaid an additional $50.0 million of the First Lien Term Loan with our excess cash on hand .
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 to $50 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 December 31, 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.
Contractual Obligations and Other Commitments
The following table summarizes our contractual obligations and commitments as of December 31, 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)
$
384,699
$
15,745
$
31,490
$
337,464
$
—
Purchase obligations (2)
95,972
91,171
3,381
1,420
—
Operating leases (3)
28,691
9,457
12,799
4,843
1,592
Contingent and deferred consideration in connection with business acquisitions
5,642
5,642
—
—
—
Total
$
515,004
$
122,015
$
47,670
$
343,727
$
1,592
(1)
Represents our syndicated First Lien Term Loan and our anticipated repayment schedule for the loan as of December 31, 2020. See Note 8 “Debt” to our 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 December 31, 2020.
(3)
Consists of contractual obligations from our non-cancelable operating leases for office and warehouse spaces.
(4)
As of December 31, 2020, we had $0.8 million in non-current income tax payable, including interest and penalties, related to our income tax liability for uncertain tax positions. At this time, we are unable to make a reasonably reliable estimate of the timing of payments in individual years in connection with these tax liabilities; therefore, such amounts are not included in the contractual obligation table above.
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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 combined consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these 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 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.
We believe that the accounting policies discussed below are critical to understanding our historical and future performance, as these policies relate to the more significant areas involving management’s estimates, assumptions, and judgments.
Revenue Recognition
Our products are primarily sold through a network of distributors and retailers, including online retailers, and to a lesser extent direct to consumers. We sell hardware products, such as gamer and creator peripherals and gaming components and systems, which may include embedded software that provides advanced performance tuning, user customization and system monitoring.
Hardware devices are generally plug and play, requiring no configuration and little or no installation. Revenue is recognized at a point in time when control of the products is transferred to the customer, which generally occurs upon shipment or delivery to the customer.
We offer return rights and customer incentive programs. Customer incentive programs include special pricing arrangements, promotions, rebates and volume-based incentives.
Rights of return vary by customer and range from the right to return products to limited stock rotation rights allowing the exchange of a percentage of the customer’s quarterly purchases. Estimates of expected future product returns qualify as variable consideration and are recorded as a reduction of the transaction price of the contract at the time of sale based on historical return trends. Return trends are influenced by product life cycle status, new product introductions, market acceptance of products, sales levels, the type of customer, seasonality, product quality issues, competitive pressures, operational policies and procedures, and other factors. Return rates can fluctuate over time but are sufficiently predictable to allow us to estimate expected future product returns.
Customer incentive programs are considered variable consideration, which we estimate and record as a reduction to revenue at the time of sale based on actual sales data, historical experiences and forecasted incentives. Certain customer incentives require management to estimate the percentage of those programs which will not be claimed or will not be earned by customers based on historical experience and on the specific terms and conditions of particular programs. The percentage of these customer programs that will not be claimed or earned is commonly referred to as “breakage”. We account for breakage as part of variable consideration, subject to constraint, and record the estimated impact in the same period when revenue is recognized at the expected value. Significant management judgments and estimates are used to determine the amount of variable consideration to be recognized, as well as any subsequent adjustments to it, such that it is probable that a significant reversal of revenue will not occur.
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Business Combinations
We allocate the fair value of purchase consideration to tangible assets, liabilities including contingencies assumed, and intangible assets acquired in a business combination. Any excess fair value of purchase consideration over the estimated fair value of assets acquired and liabilities assumed is recorded as goodwill. The allocation of the purchase consideration requires management to make estimates and assumptions, based in part on our judgments, in determining the fair value of assets acquired and liabilities assumed, especially with respect to intangible assets. These estimates are inherently difficult, subjective and have varying degrees of estimation uncertainty, and if different estimates were used, the fair value allocation to the acquired intangible assets could be different. Therefore, our assessment of the estimated fair value of each of these assets can have a material effect on our combined consolidated financial statements.
Recent Accounting Pronouncements
Refer to Note 1 to the combined consolidated financial statements included in this Annual Report on Form 10-K for recent accounting pronouncements adopted and to be adopted.
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