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 the Elgato suite for content creators, which provide unified, intuitive performance, and aesthetic control and customization across their respective product families. Recently, we further enhanced our streaming product offerings through acquiring EpocCam software, Gamer Sensei gaming coaching services and Visuals by Impulse (“ VBI ”) content creative design platform. We group our products into two categories (operating segments): • Gamer and creator peripherals. Includes our high-performance gaming keyboards, mice, headsets, controllers, and streaming gear, which includes capture cards, Stream Decks, USB microphones, studio accessories, and EpocCam software, as well as coaching and training services and content design services, 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, and gaming monitor, 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 continue 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 VBI 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 VBI are part of our gamer and creator peripherals segment. Our net revenue was $391.1 million and $457.1 million for the three months ended September 30, 2021 and 2020, respectively, representing a period-over-period decrease of 14.4%. We had net income of $1.8 million and $36.4 million for the three months ended September 30, 2021 and 2020, respectively . Our net revenue was $1.4 billion and $1.1 billion for the nine months ended September 30, 2021 and 2020, respectively, representing a period-over-period increase of 21.6%. We had net income of $76.2 million and $60.2 million for the nine months ended September 30, 2021 and 2020, respectively. Net cash provided by operating activities was $25.1 million and $100.3 million for the nine months ended September 30, 2021 and 2020, respectively. 22 Table of Contents 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 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 and availability 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, as well as the availability and pricing of such 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 (including eRetailers), 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 eRetailer Amazon accounting for 26.4% and 25.1% of our net revenue for the nine months ended September 30, 2021 and 2020, respectively, and sales to our ten largest customers accounting for approximately 50.5% and 51.0% of our net revenue for the nine months ended September 30, 2021 and 2020, 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 that helps eRetailers such as 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 K65 mini RGB keyboard and Elgato’s new accessories in the first quarter of 2021 and our new Facecam in the third quarter of 2021. 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. Notwithstanding the results of operations for the third quarter of 2021, which were adversely impacted by the COVID-19 pandemic, historically, 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. Historical seasonal patterns may not continue in the future and have been impacted, and may be further impacted in 23 Table of Contents the future, by increasing supply constraints, GPUs shortages, shifts in customer behavior and the evolving impacts of the COVID-19 pandemic . 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. Due to the COVID-19 pandemic, there has been and will continue to be uncertainty and disruption in the global economy and financial markets. Since early 2020, we have experienced some business disruptions due to COVID-19, including the stoppage in our factories in early 2020, disruption in our supply chain and increased distribution costs, which led to increases in operating costs such as the significantly elevated ocean freight costs we incurred in the third quarter of 2021 as compared to the same quarter from the prior year and the most recent trailing quarter. As a result of the COVID-19 pandemic, we are continuing to experience logistics challenges globally. These negative financial impacts have been 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, which we believe 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. In contrast, as the COVID-19 pandemic subsides, it has, and could continue to result in shelter-in-place and other similar restrictions being eased. Such easing of restrictions likely has, and will continue to result in consumers returning to other alternative forms of entertainment and interaction. This in turn has, and could continue to, result in a decline in demand for our products. The full extent of the impact of the COVID-19 pandemic on our business, results of operations, cash flows and financial position will depend on future developments, which are highly uncertain and cannot be predicted, including, but not limited to, the duration and spread of the outbreak, its severity, the prevalence and severity of any variants, the actions to contain the virus or treat its impact, and how quickly and to what extent normal economic and operating conditions can resume. Even after the COVID-19 outbreak has subsided, we may continue to experience significant impacts to our business as a result of its global economic impact, including any economic downturn or recession that has occurred or may occur in the future. We continue to closely monitor the impact of the COVID-19 pandemic to our business, and we have implemented various measures to mitigate the disruptive logistic impact specifically around managing inventory stocking levels 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 primarily 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. 24 Table of Contents 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. 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 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. 25 Table of Contents 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, 2021 2020 2021 2020 (In thousands) Net revenue $ 391,121 $ 457,103 $ 1,393,438 $ 1,146,028 Cost of revenue 289,759 329,159 1,001,397 834,398 Gross profit 101,362 127,944 392,041 311,630 Operating expenses: Sales, general and administrative 76,112 65,321 234,134 175,877 Product development 14,495 12,902 45,150 36,285 Total operating expenses 90,607 78,223 279,284 212,162 Operating income 10,755 49,721 112,757 99,468 Other (expense) income: Interest expense (7,202 ) (10,170 ) (16,656 ) (29,116 ) Other (expense) income, net (1,402 ) 23 (4,002 ) (29 ) Total other expense, net (8,604 ) (10,147 ) (20,658 ) (29,145 ) Income before income taxes 2,151 39,574 92,099 70,323 Income tax expense (374 ) (3,217 ) (15,854 ) (10,149 ) Net income $ 1,777 $ 36,357 $ 76,245 $ 60,174 Three Months Ended September 30, Nine Months Ended September 30, 2021 2020 2021 2020 Net revenue 100.0 % 100.0 % 100.0 % 100.0 % Cost of revenue 74.1 72.0 71.9 72.8 Gross profit 25.9 28.0 28.1 27.2 Operating expenses: Sales, general and administrative 19.5 14.3 16.8 15.3 Product development 3.7 2.9 3.2 3.2 Total operating expenses 23.2 17.2 20.0 18.5 Operating income 2.7 10.8 8.1 8.7 Other (expense) income: Interest expense (1.8 ) (2.2 ) (1.2 ) (2.5 ) Other (expense) income, net (0.4 ) 0.0 (0.3 ) (0.0 ) Total other expense, net (2.2 ) (2.2 ) (1.5 ) (2.5 ) Income before income taxes 0.5 8.6 6.6 6.1 Income tax expense (0.1 ) (0.7 ) (1.1 ) (0.9 ) Net income 0.4 % 7.9 % 5.5 % 5.3 % Components of Results of Operations Net Revenue Three Months Ended September 30, Nine Months Ended September 30, 2021 2020 2021 2020 (In thousands) Net revenue $ 391,121 $ 457,103 $ 1,393,438 $ 1,146,028 26 Table of Contents Net revenue decreased $66.0 million, or 14.4%, for the three months ended September 30, 2021 as compared to the same period last year. The decrease was due to a 13.8% decrease in sales for our gamer and creator peripherals segment and a 14.8% decrease in sales for our gaming components and systems segment . We believe the decrease in sales in both segments was primarily due to supply and logistic constraints caused by the COVID-19 pandemic, as well as the shortage of reasonably priced GPUs. Net revenue increased $247.4 million, or 21.6%, for the nine months ended September 30, 2021 as compared to the same period last year. The increase was due to a 35.3% increase in sales for our gamer and creator peripherals segment and a 15.6% increase in sales for our gaming components and systems segment . Overall, we saw strong growth in revenue for both our gamer and creator peripherals segment and gaming components and systems segments year-over-year primarily resulting from a larger number of consumers that are gaming and working from home due to the COVID-19 pandemic, but this revenue growth was partially offset by a decrease in revenue in the third quarter of 2021 in both segments primarily due to supply and logistic constraints caused by the COVID-19 pandemic, as well as the shortage of reasonably priced GPUs. Gross Profit and Gross Margin Three Months Ended September 30, Nine Months Ended September 30, 2021 2020 2021 2020 (In thousands) Gross profit $ 101,362 $ 127,944 $ 392,041 $ 311,630 Gross margin 25.9 % 28.0 % 28.1 % 27.2 % Gross margin decreased to 25.9% for the three months ended September 30, 2021 from 28.0% for the same period last year. The decrease was driven primarily by an increase in logistic costs which were largely driven by the COVID-19 pandemic, and increased promotional activity. Gross margin increased to 28.1% for the nine months ended September 30, 2021 from 27.2% for the same period last year. This increase was primarily driven by improved product mix towards our gamer and creator peripherals segment and the increase in sales volume, particularly the strong revenue growth in our Elgato streaming products. The increase in gross margin was partially offset by increased logistics costs largely due to the COVID-19 pandemic, and pandemic related port shutdowns in addition to increased promotional activity. Sales, General and Administrative (SG&A) Three Months Ended September 30, Nine Months Ended September 30, 2021 2020 2021 2020 (In thousands) Sales, general and administrative $ 76,112 $ 65,321 $ 234,134 $ 175,877 27 Table of Contents SG&A expenses increased $10.8 million, or 16.5%, for the three months ended September 30, 2021 as compared to the same period last year. The increase was primarily due a $2.7 million increase in personnel-related costs due to headcount growth and higher stock-based compensation, a $2.5 million increase in marketing expenses, mainly due to increase in sponsorships and digital marketing programs, a $2.0 million increase in director and officer insurance fees, and a $1.9 million increase in distribution costs including outbound freight and the costs to operate our distribution hubs largely due to the COVID-19 pandemic impact to logistic constraints. Other increases in SG&A expenses included increased credit card processing fees, driven by an increase in our webstore sales and professional services expenses. SG&A expenses increased $58.3 million, or 33.1%, for the nine months ended September 30, 2021 as compared to the same period last year. The increase was primarily due to a $20.7 million increase in distribution costs including outbound freight expenses and the costs to operate our distribution hubs, in each case, due to increased sales volume as well as the COVID-19 pandemic impact to logistic constraints, a $19.4 million increase in personnel-related costs due to headcount growth and higher stock-based compensation, a $6.0 million increase in director and officer insurance fees, a $5.8 million increase in marketing expenses, mainly due to increase in sponsorships and digital marketing programs, and a $3.0 million increase in credit card processing fees driven by an increase in our webstore sales. Other increases in SG&A expenses included increased professional services expenses. Product Development Three Months Ended September 30, Nine Months Ended September 30, 2021 2020 2021 2020 (In thousands) Product development $ 14,495 $ 12,902 $ 45,150 $ 36,285 Product development expenses increased $1.6 million, or 12.3%, for the three months ended September 30, 2021 as compared to the same period last year. The increase was primarily due to a $0.6 million increase in consultant and contractor expense, a $0.7 million increase in other product development related costs to support our continued innovation and broadening of our product portfolio, and a $0.3 million increase in personnel-related expense. Product development expenses increased $8.9 million, or 24.4%, for the nine months ended September 30, 2021 as compared to the same period last year. The increase was primarily due to a $5.7 million increase in personnel-related expenses due to headcount growth and higher stock-based compensation, a $1.8 million increase in other product development related costs to support our continued innovation and broadening of our product portfolio, and a $1.4 million increase in consultant and contractor expense. Interest Expense and Other (Expense) Income, Net Three Months Ended September 30, Nine Months Ended September 30, 2021 2020 2021 2020 (In thousands) Interest expense $ (7,202 ) $ (10,170 ) $ (16,656 ) $ (29,116 ) Other (expense) income, net (1,402 ) 23 (4,002 ) (29 ) Interest expense decreased $3.0 million, or 29.2%, for the three months ended September 30, 2021 as compared to the same period last year. Interest expense decreased $12.5 million, or 42.8%, for the nine months ended September 30, 2021 as compared to the same period last year. The decreases in interest expense in both the three and nine-months ended September 30, 2021 compared to the same periods last year were due to lower interest expense paid for our First Lien Term Loan as a result of the partial and full extinguishment of our First Lien Term Loan in 2020 and 2021, respectively, and no interest paid for our Second Lien Term Loan due to the full extinguishment of our Second Lien Term Loan in 2020. Additionally, the decreases in interest expense were due in part, to a lesser extent, lower interest rate on our new Term Loan executed in September 2021 which replaced our First Lien Term Loan. 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. 28 Table of Contents Income Tax Expense Three Months Ended September 30, Nine Months Ended September 30, 2021 2020 2021 2020 (In thousands) Income before income taxes $ 2,151 $ 39,574 $ 92,099 $ 70,323 Income tax expense (374 ) (3,217 ) (15,854 ) (10,149 ) Effective tax rate 17.4 % 8.1 % 17.2 % 14.4 % 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 17.4% and 8.1% for the three months ended September 30, 2021 and 2020, respectively. The effective tax rate was higher in the three months ended September 30, 2021 as compared to the same period last year primarily due to a $4.3 million tax benefit recognized in the three 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. The increase to the effective tax rate for such three-month period was partially offset by the favorable impacts on the effective tax rate for 2021 from higher excess tax benefits related to stock-based compensation recognized in the three months ended September 30, 2021, as well as the change in the mix of income and losses in the various tax jurisdictions in which we operate. Our effective tax rates were 17.2% and 14.4% for the nine months ended September 30, 2021 and 2020, respectively. The effective tax rate was higher in the nine months ended September 30, 2021 as compared to the same period last year primarily due to a $4.3 million tax benefit recognized 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 tax benefit from the change in tax law resulting from the enactment of the CARES Act. In the nine months ended September 30, 2021, we recorded a $1.4 million one-time tax expense related to the remeasurement of our United Kingdom deferred tax liabilities as a result of the enactment of the increased corporate tax rate in the United Kingdom. The increase to the effective tax rate for such nine-month period was partially offset by the favorable impacts on the effective tax rate for 2021 from higher excess tax benefits related to stock-based compensation recognized in the nine months ended September 30, 2021, as well as the change in the mix of income and losses in the various tax jurisdictions in which we operate. 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, 2021 2020 2021 2020 Gamer and Creator Peripherals Segment $ 139,260 35.6% $ 161,555 35.3% $ 470,329 33.8% $ 347,531 30.3% Gaming Components and Systems Segment Memory Products 115,524 29.5 141,298 30.9 436,123 31.3 424,150 37.0 Other Component Products 136,337 34.9 154,250 33.7 486,986 34.9 374,347 32.7 251,861 64.4 295,548 64.7 923,109 66.2 798,497 69.7 Total Net Revenue $ 391,121 100.0% $ 457,103 100.0% $ 1,393,438 100.0% $ 1,146,028 100.0% Gamer and Creator Peripherals Segment Net revenue of the gamer and creator peripherals segment decreased $22.3 million, or 13.8%, for the three months ended September 30, 2021 as compared to the same period last year, due to decreased sales across all products in this segment. The decrease in sales was primarily driven by supply and logistics constraints caused by the COVID-19 pandemic. 29 Table of Contents Net revenue of the gamer and creator peripherals segment increased $122.8 million, or 35.3%, for the nine months ended September 30, 2021 as compared to the same period last year due to strong growth across all product categories in the first half of 2021, led primarily by increased sales of our Elgato branded streaming and peripherals products, as well as our SCUF branded console products. We believe the revenue growth year-over-year was driven in part by the COVID-19 shelter-in-place orders as consumers spend more time working and gaming at home and gamers seeking to improve their performance by upgrading their gear. This revenue growth was partially offset by decreased sales in the third quarter of 2021 which was primarily driven by supply and logistic constraints caused by the COVID-19 pandemic. Gaming Components and Systems Segment Net revenue of the gaming components and systems segment decreased $43.7 million, or 14.8%, for the three months ended September 30, 2021 as compared to the same period last year, due to decreased sales across all products in this segment, The decrease was primarily attributable to the shortage of reasonably priced GPUs which curtailed the demand for new PC builds and its components, as well as supply and logistic constraints caused by the COVID-19 pandemic. Net revenue of the gaming components and systems segment increased $124.6 million, or 15.6%, for the nine months ended September 30, 2021 as compared to the same period last year. We believe the revenue growth year-over-year was driven in part by the COVID-19 shelter-in-place orders, particularly, for our PSUs and pre-built systems. This revenue growth was partially offset in the third quarter of 2021 due to the shortage of reasonably priced GPUs which curtailed the demand for new PC builds and its components, as well as supply and logistic constraints caused by the COVID-19 pandemic. 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, 2021 2020 2021 2020 Gamer and Creator Peripherals Segment $ 48,580 34.9% $ 60,010 37.1% $ 172,080 36.6% $ 120,886 34.8% Gaming Components and Systems Segment Memory Products 15,935 13.8 26,552 18.8 77,984 17.9 89,507 21.1 Other Component Products 36,847 27.0 41,382 26.8 141,977 29.2 101,237 27.0 52,782 21.0 67,934 23.0 219,961 23.8 190,744 23.9 Total Gross Profit $ 101,362 25.9% $ 127,944 28.0% $ 392,041 28.1% $ 311,630 27.2% Gamer and Creator Peripherals Segment The gross profit of the gamer and creator peripherals segment decreased in the three months ended September 30, 2021 by $11.4 million, or 19.0%, as compared to the same period last year. The 2.2% decrease in gross margin in the three-month period, compared to the same period last year, was driven by increased logistics costs, largely due to the COVID-19 pandemic, and increased promotional activity. The gross profit of the gamer and creator peripherals segment increased in the nine months ended September 30, 2021 by $51.2 million, or 42.3%, as compared to the same period last year. The 1.8% increase in gross margin in the nine-month period, compared to the same period last year, was primarily driven by the strong growth in sales of higher margin Elgato branded streaming products and the increase in sales volume in the same period. This increase was partially offset by increased logistics costs, largely due to the COVID-19 pandemic, and increased promotional activity. Gaming Components and Systems Segment The gross profit of the gaming components and systems segment decreased in the three months ended September 30, 2021 by $15.2 million, or 22.3%, as compared to the same period last year. The 2.0% decrease in gross margin in the three-month period, compared to the same period last year, was driven by increased logistic costs, largely due to the COVID-19 pandemic, and increased promotional activity. 30 Table of Contents The gross profit of the gaming components and systems segment increased in the nine months ended September 30, 2021 by $29.2 million , or 15.3% , as compared to the same period last year . Gross margin for the nine -month period , compare d to the same period last year, remained relatively flat. 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, completed in September 2020. As of September 30, 2021, we had cash and restricted cash, in aggregate of $76.3 million. On September 3, 2021, we entered into a new Credit Agreement (defined below) which replaced our previous credit facilities under the First Lien and Credit Guaranty Agreement (defined below). As of September 30, 2021, under the new Credit Agreement, we had $100 million capacity under the Revolving Facility and $250.0 million Term Loan outstanding (face value). Please see the section below under the heading “Credit Agreement” for additional information on the Credit Agreement and the loans thereunder. 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 presented (in thousands): Nine Months Ended September 30, 2021 2020 Net cash provided by (used in): Operating activities $ 25,061 $ 100,324 Investing activities (14,039 ) (5,908 ) Financing activities (67,183 ) (26,371 ) 31 Table of Contents Cash Flows from Operating Activities Net cash provided by operating activities for the nine months ended September 30, 2021 was $25.1 million and consisted of net income of $76.2 million, non-cash adjustments of $48.7 million and was partially offset by $99.8 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 and change in deferred tax assets. The net cash outflow from changes in our net operating assets and liabilities was primarily related to increase in inventory, prepaid expenses and other assets, and a decrease in accounts payable mainly due to timing of payments. The net cash outflow was partially offset by a decrease in accounts receivable and an increase in other liabilities and accrued expenses. Net cash provided by operating activities for the nine months ended September 30, 2020 was $100.3 million and consisted of a 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 and change in deferred tax assets. The net cash inflow from changes in our net operating assets and liabilities was primarily related to an increase in accounts payable and other liabilities and accrued expenses. The net cash inflow was partially offset by an increase in inventory, accounts receivable and prepaid expenses and other assets. Cash Flows from Investing Activities Cash used in investing activities was $14.0 million for the nine months ended September 30, 2021 and consisted of $7.7 million for the purchase of capital equipment and software, $4.7 million for the payment of deferred and contingent consideration primarily related to the Origin business acquisition, and $1.7 million for the acquisition of an immaterial business. 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 Flows from Financing Activities Cash used in financing activities was $67.2 million for the nine months ended September 30, 2021 and consisted primarily of $327.0 million repayments of debt (First Lien Term Loan) and $0.2 million payment of taxes related to net share settlement of equity awards. These cash outflows were partially offset by $248.5 million net proceeds from our new Term Loan executed in September 2021 and $11.5 million proceeds received from the issuance of shares through the employee equity incentive plans. Cash used in financing activities was $26.4 million for the nine months ended September 30, 2020 and consisted primarily of $140.4 million repayments of debt, $5.6 million payment of offering costs, and $0.2 million payment of debt issuance costs. These cash outflows were partially offset by $118.6 million proceeds received from the issuance of our common stock in connection with our IPO, after deducting underwriting discounts and commissions, and $1.2 million proceeds received from the issuance of shares through the employee equity incentive plans. Credit Facilities First Lien Credit and Guaranty Agreement (Extinguished in September 2021) 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 was to 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, primarily to fund various business acquisitions and operation needs. 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 32 Table of Contents 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. According to the repayment schedule, the Consolidated Excess Cash Flow (as defined in the First Lien) and the IPO repayment provisions as set forth in the First Lien, we made required repayments of the First Lien Term Loan of $59.6 million, in aggregate, in 2020 using the net proceeds from our IPO and excess cash on hand. Further, we may prepay the First Lien Term Loan and the Revolver at any time without premium or penalty other than customary LIBOR breakage. In 2020, we began to prepay the First Lien Term loan using our excess cash on hand, resulting in $80.8 million in 2020 and $78.3 million in 2021 through September 2021. The remainder of First Lien Term Loan of $248.5 million was fully prepaid with the proceeds from the Term Loan (defined below) on September 3, 2021, and as a result, all obligations and covenants thereunder were terminated. Second Lien Credit and Guaranty Agreement (Extinguished in September 2020) 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%. In 2020, with excess cash on hand, we prepaid the entire outstanding balance of $50 million on the Second Lien Term Loan without paying any premium or penalty, and as a result, all obligations and covenants thereunder were terminated. Credit Agreement (Executed on September 3, 2021) On September 3, 2021, we entered into a new Credit Agreement (“ Credit Agreement ”) which provides for a $100.0 million five-year revolving credit facility (“ Revolving Facility ”) and a $250.0 million five-year term loan facility (“ Term Loan ”), with each maturing in September 2026. The Credit Agreement also permits, subject to conditions stated therein, additional incremental facilities in a maximum aggregate principal amount not to exceed $250.0 million. We may prepay the Term Loan and the Revolving Facility at any time without premium or penalty. The credit facilities under the Credit Agreement replaced our senior credit facilities under the First Lien Credit and Guaranty Agreement. The net proceeds from borrowings under the Credit Agreement of $248.5 million (net of $1.5 million of debt discount) were used to repay all amounts outstanding under the First Lien Term Loan on September 3, 2021. The Term Loan and Revolving Facility under the Credit Agreement will each bear interest at the Company’s election, either (a) LIBOR plus a percentage spread (ranging from 1.25% to 2.0%) based on our total net leverage ratio, or (b) the base rate (described in the Credit Agreement as the greatest of (i) the prime rate, (ii) the federal funds rate plus 0.50% and (iii) one-month LIBOR plus 1.0%) plus a percentage spread (ranging from 0.25% to 1.0%) based on our net leverage ratio. Our obligations under the Credit Agreement are guaranteed by substantially all of our U.S. subsidiaries and secured by a security interest in substantially all assets of the Company and the guarantor subsidiaries, subject to certain exceptions detailed in the Credit Agreement and related ancillary documentation. The Credit Agreement contains covenants with which we must comply during the term of the agreement, which we believe are ordinary and standard for agreements of this nature, including the maintenance of a maximum Consolidated Total Net Leverage Ratio of 3.0 to 1.0 and a minimum Consolidated Interest Coverage Ratio of 3.0 to 1.0 (as defined in our credit facilities) . The Credit Agreement also includes events of default customary for facilities of this nature and upon the occurrence of such events of default, among other things, all outstanding amounts under the Credit Agreement may be accelerated and/or the lenders’ commitments terminated. In addition, upon the occurrence of certain events of default, the interest on the Term loan and Revolving Facility can be 33 Table of Contents increased by 2.0%. As of September 30, 2021, we were not in default under the Credit Agreement and our Consolidated Total N et L everage R atio and Consolidated Interest Coverage R atio were 0.8 to 1.0 and 10.4 to 1.0 as of September 30, 2021 , respectively . Contractual Obligations and Other Commitments The following table summarizes our contractual obligations and commitments as of September 30, 2021: 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) $ 265,693 $ 8,596 $ 23,961 $ 233,136 $ — Purchase obligations (2) 84,608 79,594 4,281 733 — Operating leases (3) 73,326 9,257 20,981 12,165 30,923 Total $ 423,627 $ 97,447 $ 49,223 $ 246,034 $ 30,923 (1) Represents our new Term Loan and related interests according to the repayment schedule for the Term Loan as of September 30, 2021. 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, 2021. (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 nine months ended September 30, 2021 as compared to the critical accounting policies and estimates described in our Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2020 filed with the SEC on March 11, 2021. Recent Accounting Pronouncements Refer to Note 2 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. 34 Table of Contents