Turtle Beach Corporation
Turtle Beach Corp (Form: 10-K, Received: 03/30/2016 17:57:36)


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark one)
ý ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2015
or
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to  

Commission File Number: 001-35465
 
TURTLE BEACH CORPORATION
(Exact name of registrant as specified in its charter)
Nevada
27-2767540
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification Number)
12220 Scripps Summit Drive, Suite 100
San Diego, California 92131
(Address of principal executive offices) (Zip Code)
(888) 496-8001
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, par value $0.001
(Title of Class)
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. ¨ Yes  ý  No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. ¨ Yes  ý  No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   ý Yes  ¨  No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). ý Yes  ¨  No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer ý     Smaller reporting company ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  ¨  Yes  ý  No
The aggregate market value of the registrant’s voting stock held by non-affiliates of the registrant as of June 30, 2015 was $28,386,531.
The number of shares of Common Stock, $0.001 par value, outstanding on February 29, 2016 was 49,229,502 .
DOCUMENTS INCORPORATED BY REFERENCE

The information required by Part III of this Report is incorporated herein by reference from the registrant’s definitive proxy statement relating to its 2015 annual meeting of stockholders or annual report on Form 10-K/A, to be filed with the Securities and Exchange Commission within 120 days after the close of the registrant’s fiscal year.

 

INDEX

 
 
Page
PART I.
 
 
 
 
Item 1.
Item 1A.
Item 1B.
Item 2.
19  
Item 3.
Item 4.
  20
 
 
 
PART II.
 
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 9B.
 
 
 
PART III.
 
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
 
 
PART IV.
 
 
 
 
Item 15.
 
 
SIGNATURES
EXHIBIT INDEX


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PART I

Statement Regarding Forward-Looking Disclosures

This Annual Report on Form 10-K (this “Report”) includes, and incorporates by reference, certain forward-looking statements within the meaning of the federal securities laws. Statements that are not historical facts, including statements about our beliefs and expectations, are forward looking statements. Forward-looking statements include statements preceded by, followed by or that include the words “may,” “could,” “will,” “would,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “intend,” “predict,” “seek,” “contemplate,” “potential” or “continue” and similar expressions. These forward-looking statements reflect the current expectations of Turtle Beach Corporation concerning future events and actual results may differ materially from current expectations or historical results. Any such forward-looking statements are subject to various risks and uncertainties, including without limitation those discussed in the sections of this Report entitled “Business Overview,” “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Forward-looking statements are only predictions and are not guarantees of performance. These statements are based on our management’s beliefs and assumptions, which in turn are based on currently available information. Important assumptions relating to the forward-looking statements include, among others, assumptions regarding demand for our products, the expansion of product offerings geographically or through new marketing applications, the timing and cost of planned capital expenditures, competitive conditions and general economic conditions. These assumptions could prove inaccurate. Forward-looking statements also involve known and unknown risks and uncertainties, which could cause actual results to differ materially from those contained in any forward-looking statement. In addition, even if our actual results are consistent with the forward-looking statements contained in this Annual Report on Form 10-K, those results may not be indicative of results or developments in subsequent periods. Many of these factors are beyond our ability to control or predict. Such factors include, but are not limited to, the following:

The availability of capital under our revolving credit facility and term loan:
Current and future transitions in video gaming console platforms and the potential impact on our business;
Continued relationships with our largest customers;
Our ability to adapt to new technologies and introduce new products on a timely basis;
The impact of competitive products, technologies and pricing;
The impact of seasonality on our business;
Manufacturing capacity constraints and difficulties;
The scope of protection we are able to establish and maintain for intellectual property rights covering our technology;
Our ability to forecast demand for our products;
Estimates of our future revenues, expenses, capital requirements and our needs for additional financing;
Our success at managing the risks involved in the foregoing items;
Our financial performance; and
Other factors discussed under Item 1A - Risk Factors or elsewhere in this Report.

Except as required by applicable law, including the securities laws of the United States and the rules and regulations of the Securities and Exchange Commission (“SEC”), we undertake no obligation to publicly update or revise any forward-looking statements after we file this Annual Report on Form 10-K, whether as a result of any new information, future events or otherwise. Investors, potential investors and other readers are urged to consider the above mentioned factors carefully in evaluating the forward‑looking statements and are cautioned not to place undue reliance on such forward‑looking statements. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results or performance.

Unless the context indicates otherwise, all references in this Report to “we,” “our,” “us,” “the Company,” and “Turtle Beach” refer to Turtle Beach Corporation and its wholly-owned subsidiaries.


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Item 1 - Business Overview
Turtle Beach Corporation, headquartered in San Diego, California and incorporated in the state of Nevada in 2010, is a premier audio technology company with expertise and experience in developing, commercializing and marketing innovative products across a range of large addressable markets under the Turtle Beach® and HyperSound® brands. Turtle Beach is a worldwide leading provider of feature-rich headset solutions for use across multiple platforms, including video game and entertainment consoles, handheld consoles, personal computers, tablets and mobile devices. HyperSound technology is an innovative patent-protected sound technology that delivers immersive, directional audio offering unique potential benefits in a variety of commercial settings and consumer devices, including improved clarity and comprehension for listeners with hearing loss.
VTB Holdings, Inc. (“VTBH”), the parent holding company of the historical headset business, was incorporated in the state of Delaware in 2010 with operations principally located in Valhalla, New York. Voyetra Turtle Beach, Inc. (“VTB”) was incorporated in the state of Delaware in 1975.
The Company's stock is traded on NASDAQ under the symbol HEAR.
Headset Business
Turtle Beach launched its first gaming headset in 2005 and has grown to be the leading brand in gaming audio, and designs and markets premium audio peripherals for video game consoles, personal computers and mobile devices, including headsets for PlayStation®4 consoles and officially-licensed headsets for the Xbox One consoles. Turtle Beach branded headsets are distributed internationally across North America, South America, Europe, the Middle East, Africa, Australia, and Asia, and sold at thousands of storefronts, including major retailers such as Amazon, Argos, Best Buy, GameStop, HMV, Sainsbury, Target, Tesco and Walmart.
We offer a variety of headsets, spanning multiple wired and wireless retail price points ranging from $25 to $300 and have offerings across all major gaming platforms. Our price tiers correspond to customer profiles, beginning with “Entry-Level” gamers and progressing through “Casual,” “Enthusiast” and “Core.” Each successive price tier incorporates a higher level of finishing, features and technology, progressing from passive mono to amplified stereo, surround sound, and programmable surround sound. Premium headsets have padded leather headbands, accent stitching, and noise-isolating memory foam ear cups. Other features in certain of our premium headsets include removable microphones, breakaway cables and “charge-and-play” batteries that allow gamers to continue playing even as they recharge their batteries. As gaming consoles have evolved from dedicated video game platforms to home entertainment hubs, and as mobile devices have become platforms for entertainment, we have continued to evolve our headsets to reflect how content is consumed.
Each headset model is designed for a “primary” platform, such as a specific console or for the PC platform, though many can be used with multiple platforms, and most are compatible with mobile devices. A primary platform and unique packaging often results in the products being represented in the applicable platform area by retailers, increasing the prominence of Turtle Beach products in physical retail locations and online catalogs.
Turtle Beach was the leading console gaming headset manufacturer in the U.S. with a 42% dollar share of the market, as noted by the January 2016 sales tracking data from The NPD Group, Inc, driven by the top selling 3rd party headset for both the Xbox One and PlayStation®4.
Our 2015 was highlighted by:

Surpassed $1 billion in lifetime global revenue generated from our gaming headset business.
Completely transitioned portfolio to new-generation headsets with eight Xbox One and six PlayStation®4 compatible headsets available at retail.
Introduced the first true multiplatform headset that works with PlayStation®4, Xbox One, PC, Mac and mobile/tablet devices.
HyperSound Business
HyperSound is a pioneering audio solution that provides an effective means of projecting sound in a highly directional manner, without use of large speaker arrays, to a specific location creating a precise audio zone. HyperSound technology's ability to beam, focus and control sound empowers solutions for hearing health care such as home entertainment listening systems/solutions, commercial applications such as digital signage and kiosks and, consumer audio.
Our products are designed to deliver controlled audible sound along a tightly formed beam. If the listener is standing outside the path of the beam, the sound is barely audible. This delivery mechanism also maintains sonic clarity and

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intelligibility over longer distances than traditional speakers. We believe our technology offers a number of advantages over regular audio speakers, including:
ability to create a beam of sound and place it where it is intended
ability to deliver a beam of sound over longer distances
ability to penetrate other competing ambient sounds to more effectively communicate
ability to directly deliver left and right audio channels to each ear from across the room
These advantages enable us to create products across a wide variety of applications including:
products for individuals with hearing loss that enable better sound clarity without a body-worn device
products that create dedicated sound zones for use in retail and commercial environments
products that enable headphone-like surround sound without requiring 5 or 7 separate speakers
HyperSound Clear™ 500P, a medical device launched in November 2015 that received 510(k) clearance permitting over-the-counter (“OTC”) commercial distribution from the Food and Drug Administration (“FDA”), is a first-of-its-kind directed audio solution for individuals with hearing loss that has been shown to improve sound clarity and speech intelligibility for people with hearing loss for a crisp, clear home entertainment listening experience. HyperSound Clear 500P works in parallel with the audio from the television or home theater system, so an individual with hearing loss experiences immersive, 3D audio when sitting in the highly directional, narrow beam of audio, while the room hears audio from the traditional speakers or home theater system at normal volumes.
In addition the Company has a secondary product that utilizes the technology, HyperSound Professional Audio Solutions, which is being purchased for commercial retail environments where a targeted zone of sound is desired. In the future, the Company expects to introduce additional products including for consumer use outside of individuals with hearing loss.

Industry Overview
Gaming Headset Market
Sales in the gaming accessories market, which includes headsets and other peripherals such as gamepads, specialty controllers, adapters, batteries, memory and interactive gaming toys are heavily dependent on the global video game industry. In 2013, the gaming industry experienced a cyclical event as Microsoft and Sony each announced new consoles for the first time in eight years, and the consumer response to the Xbox One and PlayStation®4 (the “new generation” or “new-gen” consoles) has been overwhelmingly positive, creating a growing installed base of gamers and a market for new-gen headsets.
Despite industry analysts' prior expectations that Microsoft and Sony would continue to support their sixth- and seventh-generation of gaming consoles, which include the Xbox 360 and Playstation®3 (the “old generation” or “old-gen” consoles) over the next few years, in 2015 the market for old generation consoles declined at a more rapid pace than expected. As a result, we anticipate that in 2016, old-gen headsets will take a final, large drop as the market completes the transition to new-gen compatible headsets.
The May 2015  Intelligence: Worldwide Console Forecast  report by DFC Intelligence Forecasts, or “DFC,” estimated that cumulative new generation consoles will exceed $65 billion by 2018, and sales tracking data from The NPD Group, Inc. indicated that console gaming headset sales in the U.S. in 2015 were nearly $400 million with the market expected to continue to grow at a steady rate.

HyperSound Markets
We are focusing our product development efforts for HyperSound-based products in three areas: health care, commercial and consumer applications. Additionally, we may explore licensing opportunities.
Hearing Health Care. Gradual hearing loss can affect individuals of all ages, varying from mild to profound and is a growing, widespread issue. In the United States, there are nearly 50 million people with some degree of hearing loss significant enough to require a hearing aid. 
HyperSound technology offers a fundamentally new way to deliver sound, and research indicates that it improves sound clarity and speech intelligibility, particularly for those with hearing loss. We believe that a large percentage of persons with hearing loss may be able to use HyperSound Clear 500P to improve their listening experiences from sources such as TV, CD/DVD players and stereo systems.

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Commercial. We are currently marketing our HyperSound technology to retailers and audio-visual integrators for use in settings where directed audio and sound zones are beneficial, such as digital signage and interactive retail displays. Convenience retailers and fast moving consumer good brands face ever-greater challenges as competition for customers intensifies, and as shoppers increasingly rely on in-store cues. As a result, digital signage is a growing form of direct advertising, capturing an increasing share of advertising spending as restaurants, banks, retail outlets, museums and other outlets and organizations employ commercial displays to communicate with patrons.
Consumer Applications. Our HyperSound technology has the potential to be developed into consumer products for various applications, including computers, video game consoles, televisions, home theater and home audio. With the advent of flat panel displays for use in televisions and mobile devices, manufacturers have been focused on creating thinner products often at the expense of sound quality. We believe that our ability to create a 3D sound image from two thin emitters, compared to a five- or seven-speaker surround sound set-up using conventional speakers can deliver a compelling and enhanced audio experience.

Business Strategy
We intend to build upon the Turtle Beach brand awareness, sophisticated audio technology and high quality products to grow the core console and casual gaming business to increase sales and profitability and as HyperSound’s healthcare business scales, we will begin to look at other market opportunities for our unique directed audio technology.

Console Headset Market Share Growth. We have largely completed the transition of our headset portfolio from old generation to new generation with innovative console gaming headsets in every category. We believe that our brand's image among consumers is a competitive advantage and that our success is attributable to our emphasis on delivering the most innovative and advanced headsets.
To maintain our competitive position in our markets, we are focused on the following:
continuing to deliver innovative, high quality console gaming headsets that incorporate advanced audio and wireless technology;
growing our gaming headset business in all areas including personal computer headsets;
maintaining our strategic relationships that provide our brand a larger presence with consumers and create opportunities for retailers to carry our products;
continuing to improve our cost position through increased global sourcing and expanded points of distribution.
HyperSound Healthcare Business Growth. We have built the infrastructure to commercialize the HyperSound Clear 500P product for the hearing healthcare audio business, including channel relationships that give us access to 5,600+ prospective hearing health offices and retail locations in the United States. Our goal is to grow a substantial customer base, including internationally, through key channel partners and continued product development.
Accelerate International Expansion. We have a strong gaming headset market position in North America, United Kingdom, Germany and Australia, and believe there are additional long-term growth opportunities in Latin America and Asia. In particular in China, where in connection with increased console sales following the Chinese government lifting its ban on video game consoles, we intend to begin our sales efforts of our officially-licensed Xbox One headsets under a Chinese language version of the Turtle Beach brand and logo, phonetically pronounced “Huan Jing” (translates as “Fantasy Space.”)
Expand Our Product Lines.   We intend to increase our sales by continuing to develop internally, or through potential acquisitions, products that we offer to our customers. We are investing the resources necessary to maintain and expand our technical capability to manufacture multiple product lines that incorporate the latest technologies.
Product Development
We continue to innovate, make improvements to our technology and develop new products, and anticipate that we will continue to devote substantial resources to research and development in the near future. Our product management team takes a disciplined approach to product design that balances iteration, incremental improvement and innovation to achieve a blend of differentiated technology designed to attract customers, maintain product design continuity and exceed expectations as to quality, reliability and profitability. For the year ended December 31, 2015 , we invested $11.6 million in product development efforts to commercialize the HyperSound Clear 500P product as well as complete our new generation headset portfolio with the

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launch of five new gaming headset models. For the years ended December 31, 2014 and 2013 , we expended $9.4 million and $4.9 million , respectively.

Intellectual Property
We operate in industries where innovations, investment in new ideas and protection of resulting intellectual property rights are critical to success. We have a substantial base of intellectual property assets to protect our current and future product development, such as key innovations in gaming headsets as well as all of the core technology areas behind HyperSound, and intend to vigorously enforce such rights.
As a third-party gaming headset company certain technology used in the new generation of consoles, such as integrated voice and chat audio from the Xbox One, requires a license to enable products to connect to that platform. While Playstation®4 does not require any license to produce headsets that can connect, certain connections on the Xbox One require the purchase of proprietary chips to integrate into the locked chat audio.
While we currently believe that we have the necessary licenses, or can obtain the necessary licenses to produce compatible products, there is no guarantee that licenses will be renewed or granted. Moreover, if these licensing parties enter into exclusive license agreements with companies other than us for their “closed systems” or if we are unable to obtain sufficient quantities of these headset adapters or chips, we would be placed at a competitive disadvantage.

Supply Chain and Operations
We have a global network of suppliers that manufacture products to meet our cost objectives and quality standards sought by our customers. We have worked closely with component, manufacturing and global logistic partners to build a supply chain that we consider predictable, scalable and consistent to provide high-quality, reliable products and leading cost management practices. The use of outsourced manufacturing facilities is designed to take advantage of specific expertise and allow for flexibility and scalability to respond to seasonality and changing demands for our products.
In anticipation of new product development and incremental growth, we made additional investments with a focus on making advancements to our planning systems and reconfiguring our supply chain. In connection with our initiative to improve our operating efficiency and reduce costs, we have continued efforts to focus on company-wide overhead and operating expense cost reduction activities including consolidation of warehouses with our global logistics partnership with Keuhne + Nagel and the transition of certain headset models to the world's largest contract manufacturer, Foxconn.
We believe we have solid relationships with our suppliers and that, subject to the discussion in “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources,” we will continue to have a sufficient supply of quality products on satisfactory terms.

Retail Distribution
Our headsets are sold in over 40 countries, by retailers such as Amazon, Argos, Best Buy, Carrefour, GameStop, HMV, Sainsbury, Target, Tesco and Walmart. We often have a broader assortment and more shelf space than competitors at video game and electronics retailers such as GameStop and Best Buy which we believe reinforces the brand’s authenticity with gaming enthusiasts, and our presence in mass channel retailers such as Walmart and Target enables the brand to reach a wider audience of casual gamers. Our established presence on Amazon.com and other online retail sites, and positive consumer product ratings on those sites, increases the search visibility of our products and helps to influence both online and in-store sales. We also have exclusive licensing and sponsorship relationships with some of the biggest players in competitive gaming, including Twitch, the world's leading broadcast platform and community for video game enthusiasts.
TB Europe serves as a sales office and primary warehouse for sales to the European market, and has strengthened Turtle Beach’s European operations with support for sales, marketing, customer service and distribution.
TurtleBeach.com is an important focal point for our marketing efforts serving as a destination for paid and earned media. Earned media is favorable publicity gained through promotional efforts other than advertising, as compared with paid media, which refers to publicity gained through advertising. The website acts as a hub for both online and offline activity, and provides a direct sales channel for new and refurbished products.


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Customers

The following tables show net revenues by product type:
 
 
December 31,
 
 
2015
 
2014
 
2013
Net Revenues
 
 (in thousands)
Headset
 
$
161,835

 
$
185,469

 
$
178,470

HyperSound  (1)
 
912

 
707

 

Total
 
$
162,747

 
$
186,176

 
$
178,470

(1) Business acquired in January 2014.
The Headset business customer base is comprised primarily of large retailers and distributors, both domestic and international. In 2015 , net sales to our major market channels consisted of $97.5 million to domestic retail customers, $45.6 million to international retail customers, $13.6 million to domestic distributors and $5.1 million to other customers.
Our three largest individual customers accounted for approximately 47% of our gross sales in 2015, 45% of our gross sales in 2014 and 45% of our gross sales in 2013 . During 2015 , our three largest customers, Best Buy, Walmart and Game Stop each accounted for between 14% to 18% of our consolidated net sales.

Geographic Information
In addition to the traditional markets of the United States and United Kingdom, we have pursued growth in countries such as Germany and France and believe that additional long-term growth opportunities exist in Asia Pacific and Latin America. The following table presents total net revenues, and percentage of total, based on where customers are physically located for each of the three years ended  December 31, 2015 :
 
2015
 
 
2014
 
 
2013
 
 
 (in thousands)
 
North America
$
117,526

72.2
%
 
$
123,908

66.6
%
 
$
123,224

69.0
%
United Kingdom
20,881

12.8
%
 
29,425

15.8
%
 
26,439

14.8
%
Europe
17,329

10.6
%
 
24,082

12.9
%
 
18,565

10.4
%
Other
7,011

4.4
%
 
8,761

4.7
%
 
10,242

5.8
%
Total revenues
$
162,747



 
$
186,176

 
 
$
178,470

 

Long-lived assets are largely held in the United States, refer to Note 12 , “Geographic Information” in the Notes to the Consolidated Financial Statements.

Seasonality
Our gaming headset business is seasonal with a significant portion of sales and profits typically occurring around the holiday period. Historically, more than 50% of headset business revenues are generated during the period from September through December as new headsets are introduced and consumers engage in holiday shopping. In addition, launches of major new online multiplayer games and specific retailer purchasing behavior can drive significant revenue shifts between months and quarters in a given year.

Employees
As of December 31, 2015 , Turtle Beach had approximately 221 employees, of which 181 were full-time salaried employees. None of our employees are represented by a labor union. We believe that our relationship with our employees is good.

Available Information
We make available free of charge on or through our website, http://corp.turtlebeach.com, our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission. Information contained on our website is not incorporated by reference unless specifically stated therein.

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In addition, the public may read or copy any materials filed with the SEC at the SEC’s Public Reference Room located at 100 F Street NE, Washington, D.C. 20549. The public may also obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. These reports and other information are also available, free of charge, at  www.sec.gov.

Item 1A - Risk Factors
Set forth below is a summary of certain material risks related to an investment in our securities, which should be considered carefully in evaluating such an investment. Our business, financial condition, operating results and cash flows can be affected by a number of factors, whether currently known or unknown, including but not limited to those described below, any one or more of which could, directly or indirectly, cause the Company’s actual results of operations and financial condition to vary materially from past, or from anticipated future, results of operations and financial condition. Any of these factors, in whole or in part, could materially and adversely affect the Company’s business, financial condition, results of operations, cash flows and common stock price. Additional risks and uncertainties not presently known to us or that we currently consider immaterial may also impair our business operations.
Because of the following factors, as well as other factors affecting the Company’s financial condition and operating results, past financial performance should not be considered to be a reliable indicator of future performance, and investors should not use historical trends to anticipate results or trends in future periods. Please also see “Statement Regarding Forward-Looking Disclosures” in the section immediately preceding Item 1 of this Report.
Risks Related to Liquidity
We depend upon the availability of capital under our revolving credit facility and term loan to finance our operations. Any additional financing that we may need may not be available on favorable terms or at all.
In addition to cash flow generated from sales, we finance our operations with a revolving credit facility (the “Credit Facility”) provided by Bank of America, N.A, (“BofA”), as Agent, Sole Lead Arranger and Sole Bookrunner and our term loan (the “Term Loan Due 2019”) provided by Crystal Financial LLC (“Crystal”), as Agent, Sole Lead Arranger and Sole Bookrunner. If we are unable to comply with the financial and other covenants contained in the Credit Facility or the Term Loan Due 2019 (the “Loan Documents”) and are unable to obtain a waiver under the applicable Loan Documents, for example, as we secured to avoid a default as of the period ending September 30, 2015, BofA or Crystal, as applicable, may declare the outstanding borrowings under the applicable Loan Documents immediately due and payable. Such an event would have an immediate and material adverse impact on our business, results of operations and financial condition. We would be required to obtain additional financing from other sources, and we cannot predict whether or on what terms, if any, additional financing might be available. If we are required to seek additional financing and are unable to obtain it, we may have to change our business and capital expenditure plans, which may have a materially adverse effect on our business, financial condition and results of operations. In addition, the debt under the Loan Documents could make it more difficult to obtain other debt financing in the future, which could put us at a competitive disadvantage to competitors with less debt.
The Loan Documents contain financial and other covenants that we are obligated to maintain. If we violate any of these covenants, we will be in default under the applicable Loan Documents. These covenants include restrictions that prohibit or otherwise limit our ability to pay dividends, incur additional indebtedness, acquire assets or engage in certain other types of transactions, and also require that we maintain certain financial ratios and EBITDA levels during specified periods. If a default occurs and is not timely cured or waived, BofA or Crystal, as applicable, could seek remedies against us, including termination or suspension of obligations to make loans and issue letters of credit and acceleration of amounts due under the applicable Loan Documents. No assurance can be given that we will be able to maintain compliance with these covenants in the future. The Credit Facility is asset based and can only be drawn down in an amount to which eligible collateral exists and can be negatively impacted by extended collection of accounts receivable, unexpectedly high product returns and slow moving inventory, among other factors. As of the date of this Report, we were in compliance with our covenants under the Loan Documents.
The Credit Facility provides our lenders with a first-priority lien against substantially all of our working capital assets, including trade accounts receivable, inventories, and intellectual property and contains certain restrictions on our ability to take certain actions.
The Credit Facility contains certain financial covenants and other restrictions that limit our ability, among other things, to incur certain additional indebtedness; pay dividends and repurchase stock; make certain investments and other payments; enter into certain mergers or consolidations; engage in sale and leaseback transactions and transactions with affiliates; and encumber and dispose of assets.

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In addition, we have granted the lenders a first-priority lien against substantially all of our working capital assets, including trade accounts receivable, inventories and our intellectual property. Failure to comply with the operating restrictions or financial covenants in the Credit Facility could result in a default which could cause the lenders to accelerate the timing of payments and exercise their lien on substantially all of our working capital assets.

If suppliers, customers, landlords, employees or other stakeholders lose confidence in our business, it may be more difficult for us to operate and may materially adversely affect our business, results of operations and financial condition.
Doubts regarding our ability to continue as a going concern could result in further loss of confidence by our customers, suppliers, landlords, employees and other stakeholders, which, in turn, could materially adversely affect our ability to operate. Concerns about our financial condition may cause our suppliers and other counterparties to tighten credit terms or cease doing business with us altogether, which would have a material adverse effect on our business and results of operations.
Risks Related to Our Operations
We depend upon the success and availability of third-party gaming platforms and software to drive sales of our headset products.
The performance of our headset business is affected by the continued success of third-party gaming platforms, such as Microsoft's Xbox consoles and Sony's PlayStation® consoles, as well as video games developed by such manufacturers and other third-party publishers. Our business could suffer if any of these parties fail to continue to drive the success of these platforms, develop new or enhanced videogame platforms, develop popular game and entertainment titles for current or future generation platforms or produce and timely release sufficient quantities of such consoles. If a platform is withdrawn from the market or fails to sell, we may be forced to liquidate inventories relating to that platform or accept returns resulting in significant losses.
In order for our headsets to connect to the Xbox One advanced features and controls, a proprietary computer chip is required. As a result, with respect to our products designed for the Xbox One, we are currently reliant on Microsoft or their designated supplier to provide us with sufficient quantities of the chips. If we are unable to obtain sufficient quantities of these headset adapters or chips, sales of our Xbox One headsets and consequently our revenues would be adversely affected.
In addition, we are licensed and approved by Microsoft to develop and sell Xbox One compatible audio products pursuant to a license agreement under which we have the right to manufacture (through third party manufacturers), market and sell audio products for the Xbox One video game console (the “Xbox One Agreement”). Our Xbox One headsets are dependent on this license. Microsoft has the right to terminate the Xbox One Agreement under certain circumstances set forth in the agreement. Should the Xbox One Agreement be terminated, our headset offerings may be limited, thereby significantly reducing our revenues.
Accordingly, Microsoft, Sony and other third-party gaming platform manufacturers may control our ability to manufacture headsets compatible with their platforms, and could cause unanticipated delays in the release of our products as well as increases to projected development, manufacturing, licensing, marketing or distribution costs, any of which could negatively impact our business.
Our HyperSound business has not generated significant revenues, has a history of operating losses, expects additional losses and may not achieve or sustain profitability.
Our HyperSound business has incurred operating losses since the spin-off of Parametric Sound Corporation from LRAD Corporation in 2010, and we expect additional losses in the near-term as we continue to expend significant resources on personnel, consultants, intellectual property protection, research and development, marketing, production and administration. Our ability to achieve future profitability is dependent on a variety of factors, many of which are outside our control. Failure to achieve profitability or sustain profitability, if achieved, may require us to continue to make additional capital investments in our HyperSound business which could materially impact our results of operations.
Substantially all our HyperSound revenues to date have been derived from sales of a limited number of products to a limited number of customers, and we cannot guarantee that we will be able to develop a larger customer base, introduce new products to generate additional revenues or obtain and fulfill increased orders from both existing and new customers. Further, even if we continue to retain existing customers and obtain new customers, we cannot guarantee that those customers will purchase sufficient quantities of our HyperSound products at prices that will enable us to recover our costs in acquiring those customers and fulfilling orders. We also cannot guarantee that we will be able to generate any future license revenues. Our ability to increase sales of our HyperSound products or generate license revenues depends on a number of factors, including:
our ability to rapidly scale the number of offices that can productively sell the product;

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our ability to generate additional new sales channels in the United States and Europe
our ability to maintain relationships with new customers that drive sales of our HyperSound products;
our ability to develop and expand into new markets for our HyperSound audio products and technology; and
our ability to develop international product distribution or licensing directly or through partners.
Our Turtle Beach brand faces significant competition from other consumer electronics companies and this competition could have a material adverse effect on our financial condition and results of operations.
We compete with other producers of personal computers and video game console headsets, including the video game console manufacturers. Our competitors may spend more money and time on developing and testing products, undertake more extensive marketing campaigns, adopt more aggressive pricing policies, pay higher fees to licensors for motion picture, television, sports, music and character properties, or develop more commercially successful products for the personal computer or video game platforms than we do. In addition, competitors with large product lines and popular products, in particular the video game console manufacturers, typically have greater leverage with retailers, distributors and other customers, who may be willing to promote products with less consumer appeal in return for access to those competitors’ more popular products.
In the event that a competitor reduces prices, we could be forced to respond by lowering our prices to remain competitive. If we are forced to lower prices, we may be required to “price protect” products that remain unsold in our customers’ inventories at the time of the price reduction. Price protection results in our issuing a credit to our customers in the amount of the price reduction for each unsold unit in that customer’s inventory. Our price protection policies, which are customary in the industry, can have a major impact on our sales and profitability.
In addition, if console manufacturers implement new technologies, through hardware or software, which would cause our headsets to become incompatible with that hardware manufacturer’s console, there could be unanticipated delays in the release of our products as well as increases to projected development, manufacturing, marketing or distribution costs, any of which could harm our business and financial results.
The industries in which we operate are subject to competition in an environment of rapid technological change, and if we do not adapt to, and appropriately allocate our resources among, emerging technologies, our revenues could be negatively affected.
We must make substantial product development and other investments to align our product portfolio and development efforts in response to market changes in the gaming industry. We must anticipate and adapt our products to emerging technologies in order to keep those products competitive. When we choose to incorporate a new technology into our products or to develop a product for a new platform or operating system, we are often required to make a substantial investment prior to the introduction of the product. If we invest in the development of a new technology or for a new platform that does not achieve significant commercial success, our revenues from those products likely will be lower than anticipated and may not cover our costs.
Further, our competitors may adapt to an emerging technology more quickly or effectively than we do, creating products that are technologically superior to ours, more appealing to consumers, or both. If, on the other hand, we elect not to pursue the development of products incorporating a new technology or for new platforms that achieve significant commercial success, our revenues could also be adversely affected. It may take significant time and resources to shift product development resources to that technology or platform and it may be more difficult to compete against existing products incorporating that technology or for that platform. Any failure to successfully adapt to, and appropriately allocate resources among, emerging technologies could harm our competitive position, reduce our share and significantly increase the time it takes us to bring popular products to market.
There are numerous steps required to develop a product from conception to commercial introduction and to ensure timely shipment to retail customers, including designing, sourcing and testing the electronic components,   receiving approval of hardware and other third-party licensors, factory availability and manufacturing and designing the graphics and packaging. Any difficulties or delays in the product development process will likely result in delays in the contemplated product introduction schedule. It is common in new product introductions or product updates to encounter technical and other difficulties affecting manufacturing efficiency and, at times, the ability to manufacture the product at all. Although these difficulties can be corrected or improved over time with continued manufacturing experience and engineering efforts, if one or more aspects necessary for the introduction of products are not completed as scheduled, or if technical difficulties take longer than anticipated to overcome, the product introductions will be delayed, or in some cases may be terminated. No assurances can be given that our products will be introduced in a timely fashion, and if new products are delayed, our sales and revenue growth may be limited or impaired.

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A deterioration in future expected profitability or cash flows could result in a further impairment of our recorded goodwill and other intangibles.
At December 31, 2015 , we had recorded goodwill of $31.2 million associated with our HyperSound reporting unit. Under US GAAP, the Company reviews its goodwill and intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. Additionally, goodwill and indefinite lived intangible assets are required to be tested for impairment at least annually. The valuations used to determine the fair values used to test goodwill or intangible assets are dependent upon various assumptions and reflect management’s best estimates. Net sales growth, discount rates, earnings multiples and future cash flows are critical assumptions used to determine these fair values. Slower net sales growth rates in the hearing healthcare industry, an increase in discount rates, unfavorable changes in earnings multiples or a decline in future cash flows, among other factors, may cause a change in circumstances indicating that the carrying value of the Company’s goodwill or intangible assets may not be recoverable. The Company may be required to record a significant charge to earnings in the financial statements during the period in which any impairment of the Company’s goodwill or intangible assets is determined.
Our business could be adversely affected by significant movements in foreign currency exchange rates.
We are exposed to fluctuations in foreign currency transaction exchange rates, particularly with respect to the Euro and British Pound. Any significant change in the value of currencies of the countries in which we do business relative to the value of the U.S. Dollar could affect our ability to sell products competitively and control our cost structure. Additionally, we are subject to foreign exchange translation risk due to changes in the value of foreign currencies in relation to our reporting currency, the U.S. dollar. The translation risk is primarily concentrated in the exchange rate between the U.S. dollar and the British Pound. As the U.S. dollar fluctuates against other currencies in which we transact business, revenue and income can be impacted.
A significant portion of our revenue is derived from a few large customers, and the loss of any such customer, or a significant reduction in purchases by such customer, could have a material adverse effect on our business, financial condition and results of operations.
During 2015 , our three largest individual customers accounted for approximately 47% of our gross sales in the aggregate. The loss of, or financial difficulties experienced by, any of these or any of our other significant customers, including as a result of the bankruptcy of a customer, could have a material adverse effect on our business, results of operations, financial condition and liquidity. We do not have long-term agreements with these or other significant customers and our agreements with these customers do not require them to purchase any specific amount of products. All of our customers generally purchase from us on a purchase order basis. As a result, agreements with respect to pricing, returns, cooperative advertising or special promotions, among other things, are subject to periodic negotiation with each customer. No assurance can be given that these or other customers will continue to do business with us or that they will maintain their historical levels of business. In addition, the uncertainty of product orders can make it difficult to forecast our sales and allocate our resources in a manner consistent with actual sales, and our expense levels are based in part on our expectations of future sales. If our expectations regarding future sales are inaccurate, we may be unable to reduce costs in a timely manner to adjust for sales shortfalls. In addition, financial difficulties experienced by a significant customer could increase our exposure to uncollectible receivables and the risk that losses from uncollected receivables exceed the reserves we have set aside in anticipation of this risk.
The manufacture, supply and shipment of our products are dependent upon a limited number of third parties, and our success is dependent upon the ability of these parties to manufacture, supply and ship sufficient quantities of their product components to us in a timely fashion, as well as the continued viability and financial stability of these third-parties.
Because we rely on a limited number of manufacturers and suppliers for our products, we may be materially and adversely affected by the failure of any of those manufacturers and suppliers to perform as expected or supply us with sufficient quantities of their product components to ensure consumer availability of our own products. Our suppliers’ ability to supply products to us is also subject to a number of risks, including the availability of raw materials, their financial instability, the destruction of their facilities, or work stoppages. Any shortage of raw materials or components or an inability to control costs associated with manufacturing could increase our costs or impair our ability to ship orders in a timely and cost-efficient manner. As a result, we could experience cancellations of orders, refusal to accept deliveries or a reduction in our prices and margins, any of which could harm our financial performance and results of operations.
Moreover, there can be no assurance that such manufacturers and suppliers will not refuse to supply us at prices we deem acceptable, independently market their own competing products in the future, or otherwise discontinue their relationships with or support of us. Our failure to maintain these existing manufacturing and supplier relationships, or to establish new relationships on similar terms in the future, could have a material adverse effect on our business, results of operations, financial condition and liquidity.

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In particular, certain of our products have a number of components and subassemblies produced by outside suppliers. In addition, for certain of these items, we qualify only a single source of supply with long lead times, which can magnify the risk of shortages or result in excess supply and also decreases our ability to negotiate price with our suppliers. For example, in our HyperSound commercial product we depend on one piezo-film supplier to provide expertise and materials used in our proprietary emitters and one supplier for a majority of our plastic and metal parts. For our HyperSound Clear™ 500P medical product we rely on a single supplier for emitter materials and to contract manufacture our product and are subject to commitments required on factory capacity and materials, some of which have very long lead times, to build units. If shortages occur we could lose sales or if we purchase excess inventory, we could be subject to loss from lack of sales or if models change. Also, if we experience quality problems with suppliers, then our production schedules could be significantly delayed or costs significantly increased, which could have an adverse effect on our business, liquidity, results of operation and financial position.
In addition, the ongoing effectiveness of our supply chain is dependent on the timely performance of services by third parties shipping products and materials to and from our warehouse facilities and other locations. If we encounter problems with these shipments, our ability to meet retailer expectations, manage inventory, complete sales and achieve objectives for operating efficiencies could be materially adversely affected. We have experienced some of these problems in the past and we cannot assure you that we will not experience similar problems in the future. 
Our net sales and operating income fluctuate on a seasonal basis and decreases in sales or margins during peak seasons could have a disproportionate effect on our overall financial condition and results of operations.
Historically, a majority of our annual revenues have been generated during the holiday season of September to December. If we do not accurately forecast demand for particular products, we could incur additional costs or experience manufacturing delays. Any shortfall in net sales during this period would cause our annual results of operations to suffer significantly.
Demand for our products depends on many factors such as consumer preferences and the introduction or adoption of game platforms and related content, and can be difficult to forecast. If we misjudge the demand for our products, we could face the following problems in our operations, each of which could harm our operating results:
If our forecasts of demand for products are too high, we may accumulate excess inventories of products, which could lead to markdown allowances or write-offs affecting some or all of such excess inventories. We may also have to adjust the prices of our existing products to reduce such excess inventories.
If demand for specific products increases beyond what we forecast, our suppliers and third-party manufacturers may not be able to increase production rapidly enough to meet the demand. Our failure to meet market demand may lead to missed opportunities to increase our base of gamers, damage our relationships with retailers or harm our business.
The on-going console transition increases the likelihood that we could fail to accurately forecast demand for our new generation console headsets and our existing headsets.
Rapid increases in production levels to meet unanticipated demand could result in increased manufacturing errors, as well as higher component, manufacturing and shipping costs, all of which could reduce our profit margins and harm our relationships with retailers and consumers.
Loss of our key management and other personnel could impact our business.
Our future success depends largely upon the continued service of our executive officers and other key management and technical personnel and on our ability to continue to attract, retain and motivate qualified personnel. In addition, competition for skilled and non-skilled employees among companies like ours is intense, and the loss of skilled or non-skilled employees or an inability to attract, retain and motivate additional skilled and non-skilled employees required for the operation and expansion of our business could hinder our ability to conduct research activities successfully, develop new products, attract customers and meet customer shipments.
If we are unable to continue to develop innovative and popular headset products, or if our design and marketing efforts do not effectively raise the recognition and reputation of our Turtle Beach brand, we may not be able to successfully implement our headset growth strategy.
We believe that our ability to extend the recognition and favorable perception of our Turtle Beach brand is critical to implement our headset growth strategy, which includes further establishing our position in existing gaming headsets, developing a strong position in new console headsets, expanding beyond existing console, PC and mobile applications to new technology applications, accelerating our international growth and expanding complementary product categories. To extend the reach of our Turtle Beach brand, we believe we must devote significant time and resources to headset product design,

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marketing and promotions. These expenditures, however, may not result in a sufficient increase in net sales to cover such expenses.
The on-going console platform transition has adversely affected, and future transitions in console platforms may adversely affect, our headset business.
In 2005, Microsoft released the Xbox 360; in 2006, Sony introduced the PlayStation®3; and in 2012, Nintendo introduced the Wii U. Sony launched its new generation console, PlayStation®4, on November 15, 2013, and Microsoft launched its new generation console, Xbox One, on November 22, 2013. When new console platforms are announced or introduced into the market, consumers have historically reduced their purchases of game console peripherals and accessories, including headsets, for old generation console platforms in anticipation of new platforms becoming available. During these console transition periods, sales of gaming console headsets such as those sold by us, related to old generation consoles slow or decline until new platforms are introduced and achieve wide consumer acceptance, which we cannot guarantee. This decrease or decline may not be offset by increased sales of products for the new console platforms. Over time as the old generation platform user base declines, products for the old platforms are typically discontinued which can result in lower margins, excess inventory, excess parts, or similar costs related to end of life of a product model. In addition, as a third party gaming headset company, we are reliant on working with the console manufacturers for our headsets to be compatible with any new console platforms, which if not done on a timely basis may adversely affect sales. Sony and Microsoft may make changes to their platforms that impact how headset connect with or work with the new consoles which could create a disruption to consumer buying behavior and/or product life-cycles.
As console hardware moves through its life cycle, hardware manufacturers typically enact price reductions, and decreasing prices may put downward pressure on prices for products for such platforms. During platform transitions, we may simultaneously incur costs both in continuing to develop and market new products for prior-generation video game platforms, which may not sell at premium prices, and also in developing products for current-generation platforms, which will not generate immediate or near-term revenue. As a result, our operating results during platform transitions are more volatile and more difficult to predict than during other times.
We are party to ongoing stockholder litigation, and in the future could be party to additional stockholder litigation, any of which could harm our business, financial condition and operating results.
We have had, and may continue to have, actions brought against us by stockholders in connection with the merger, past transactions, changes in our stock price or other matters. Any such claims, whether or not resolved in our favor, could divert our management and other resources from the operation of our business and otherwise result in unexpected and substantial expenses that would adversely and materially impact our business, financial condition and operating results. For example, and as further described in Item 3, “Legal Proceedings” and Note 13 , “Commitments and Contingencies,” we are involved in legal proceedings related to the merger of VTBH and Paris Acquisition Corp. involving certain of our stockholders, including the holder of VTBH’s Series B Redeemable Preferred Stock, (the “Series B Holder”), filing a complaint in Delaware Chancery Court alleging breach of contract against VTBH and requesting a declaratory judgment that he is entitled to damages, including the redemption of his stock. The redemption value of VTBH’s Series B Redeemable Preferred Stock was $16.1 million as of December 31, 2015 .
If we are unable to protect our information systems against service interruption, misappropriation of data or breaches of security, our operations could be disrupted, our reputation may be damaged, and we may be financially liable for damages.
We rely heavily on information systems to manage our operations, including a full range of retail, financial, sourcing and merchandising systems. We regularly make investments to upgrade, enhance or replace these systems, as well as leverage new technologies to support our growth strategies. In addition, we have implemented enterprise-wide initiatives that are intended to standardize business processes and optimize performance. Any delays or difficulties in transitioning to new systems or integrating them with current systems or the failure to implement our initiatives in an orderly and timely fashion could result in additional investment of time and resources, which could impair our ability to improve existing operations and support future growth, and ultimately have a material adverse effect on our business.
The reliability and capacity of our information systems are critical. Despite preventative efforts, our systems are vulnerable from time-to-time to damage or interruption from, among other things, natural disasters, technical malfunctions, inadequate systems capacity, human error, power outages, computer viruses and security breaches. Any disruptions affecting our information systems could have a material adverse impact on our business. In addition, any failure to maintain adequate system security controls to protect our computer assets and sensitive data, including associate and client data, from unauthorized access, disclosure or use could damage our reputation with our associates and our clients. While we have implemented measures to prevent security breaches and cyber incidents, our preventative measures and incident response efforts may not be entirely effective. Finally, our ability to

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continue to operate our business without significant interruption in the event of a disaster or other disruption depends, in part, on the ability of our information systems to operate in accordance with our disaster recovery and business continuity plans.
Our reliance on information systems and other technology also gives rise to cybersecurity risks, including security breach, espionage, system disruption, theft and inadvertent release of information. 
Our results of operations and financial condition may be adversely affected by global business, political, operational, financial and economic conditions.
We face business, political, operational, financial and economic risks inherent in international business, many of which are beyond our control, including:
trade restrictions, higher tariffs, currency fluctuations or the imposition of additional regulations relating to import or export of our products, especially in China, where all of our Turtle Beach products are manufactured, which could force us to seek alternate manufacturing sources or increase our expenses;
difficulties obtaining domestic and foreign export, import and other governmental approvals, permits and licenses, and compliance with foreign laws, which could halt, interrupt or delay our operations if we cannot obtain such approvals, permits and licenses;
difficulties encountered by our international distributors or us in staffing and managing foreign operations or international sales, including higher labor costs;
transportation delays and difficulties of managing international distribution channels;
longer payment cycles for, and greater difficulty collecting, accounts receivable,;
political and economic instability, including wars, terrorism, political unrest, boycotts, curtailment of trade and other business restrictions, any of which could materially and adversely affect our net sales and results of operations; and
natural disasters.
Any of these factors could reduce our net sales, decrease our gross margins, increase our expenses or reduce our profitability. Should we establish our own operations in international territories where we currently utilize a distributor, we will become subject to greater risks associated with operating outside of the United States.
The electronics industry in general has historically been characterized by a high degree of volatility and is subject to substantial and unpredictable variations resulting from changing business cycles. Our operating results will be subject to fluctuations based on general economic conditions, in particular conditions that impact discretionary consumer spending. The audio products sector of the electronics industry has and may continue to experience a slowdown in sales, which adversely impacts our ability to generate revenues and impacts the results of our future operations. A lack of available credit in financial markets may adversely affect the ability of our commercial customers to finance purchases and operations and could result in an absence of orders or spending for our products as well as create supplier disruptions. We are unable to predict the likely duration and severity of any adverse economic conditions and disruptions in financial markets and the effects they will have on our business and its financial condition.
Further, Turtle Beach products are manufactured in China and Mexico for export to the United States and worldwide. As a result of opposition to policies of the Chinese government and China’s growing trade surpluses with the United States, there has been, and in the future may be, opposition to the extension of normal trade relations (“NTR”) status for China. The loss of NTR status for China, changes in current tariff structures or adoption in the United States of other trade policies adverse to China could increase our manufacturing expenses and make it more difficult for us to manufacture our products in China.
If we fail to maintain an effective system of internal controls, we may not be able to accurately report financial results or prevent fraud, which could have an adverse effect on our business and financial condition.
Effective internal controls are necessary to provide reliable financial reports and to assist in the effective prevention of fraud. Any inability to provide reliable financial reports or prevent fraud could harm our business. The Sarbanes-Oxley Act requires, among other things, that we perform system and process evaluation and testing of our internal control over financial reporting to allow management and our independent registered public accounting firm, as applicable, to report on the effectiveness of our internal control over financial reporting. If we are not able to comply with the requirements of Section 404 of the Sarbanes-Oxley Act, or if we or our independent registered public accounting firm identifies deficiencies in our internal control over financial reporting that are deemed to be material weaknesses, investors could lose confidence in the accuracy and completeness of our financial reports, the market price of our common stock could decline and we could be subject to sanctions, investigations by NASDAQ, the SEC or other regulatory authorities, or shareholder litigation.

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In addition, failure to maintain effective internal controls could result in financial statements that do not accurately reflect our financial condition or results of operations. There can be no assurance that we will be able to maintain a system of internal controls that fully complies with the requirements of the Sarbanes-Oxley Act of 2002 or that our management and independent registered public accounting firm will continue to conclude that our internal controls are effective.

If we are unable to successfully remediate the existing material weaknesses in our internal control over financial reporting, the accuracy and timing of our financial reporting may be adversely affected.

        In connection with the audit of our consolidated financial statements for the year ended December 31, 2015, our management identified control deficiencies in our internal control over financial reporting that constitute material weaknesses in our internal control over financial reporting.  As such, our controls over financial reporting were not designed or operating effectively, and as a result there were adjustments required, including with respect to goodwill impairments, in connection with preparing our consolidated financial statements for the year ended December 31, 2015. These control deficiencies resulted in more than a remote likelihood that a material misstatement of our annual and interim financial statements would not be prevented or detected.

        We are currently taking steps in an effort to remediate our material weakness, but there can be no assurance that we will be successful in pursuing these measures or that these measures will significantly improve or remediate the material weaknesses described above. There is also no assurance that we have identified all of our material weaknesses or that we will not in the future have additional material weaknesses. There is no assurance that we will be able to remediate the material weaknesses in a timely manner, or at all, or that in the future, additional material weaknesses will not exist or otherwise be discovered. If our efforts to remediate the material weaknesses identified are not successful, or if other material weaknesses or other deficiencies occur, our ability to accurately and timely report our financial position could be impaired, which could result in late filings of our annual and quarterly reports under the Securities Exchange Act of 1934, as amended ("Exchange Act"), restatements of our consolidated financial statements, a decline in our stock price or suspension or delisting of our common stock from the NASDAQ Market.
Risks Related to our Intellectual Property and other Legal and Regulatory Matters
Our competitive position will be seriously damaged if our products are found to infringe on the intellectual property rights of others.
Other companies and our competitors may currently own or obtain patents or other proprietary rights that might prevent, limit or interfere with our ability to make, use or sell our products. Although we do not believe that our products infringe the proprietary rights of any third parties, there can be no assurance that infringement or other legal claims will not be asserted against us or that we will not be found to infringe the intellectual property rights of others. The electronics industry is characterized by vigorous protection and pursuit of intellectual property rights or positions, resulting in significant and often protracted and expensive litigation. In the event of a successful claim of infringement against us and our failure or inability to license the infringed technology, our business and operating results could be adversely affected. Any litigation or claims, whether or not valid, could result in substantial costs or a diversion of our resources. An adverse result from intellectual property litigation could force us to do one or more of the following:
cease selling, incorporating or using products or services that incorporate the challenged intellectual property;
obtain a license from the holder of the infringed intellectual property right, which license may not be available on reasonable terms, if at all; and/or
redesign products or services that incorporate the disputed technology.
If we are forced to take any of the foregoing actions, we could face substantial costs and shipment delays and our business could be seriously harmed. Although we carry general liability insurance, our insurance may not cover potential claims of this type or may be inadequate to insure us for all liability that may be imposed.
In addition, it is possible that our customers or end users may seek indemnity from us in the event that our products are found or alleged to infringe the intellectual property rights of others. Any such claim for indemnity could result in substantial expenses to us that could harm our operating results.
If we are unable to obtain and maintain intellectual property rights and/or enforce those rights against third parties who are violating those rights, our business could suffer.
We rely on various intellectual property rights, including patents, trademarks, trade secrets and trade dress to protect our Turtle Beach brand name, reputation, product appearance and technology and our proprietary rights in our HyperSound

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technology. Although we have entered into confidentiality and invention assignment agreements with our employees and contractors, and nondisclosure agreements with selected parties with whom we conduct business to limit access to and disclosure of our proprietary information, these contractual arrangements and the other steps we have taken to protect our intellectual property may not prevent misappropriation of that intellectual property or deter independent third-party development of similar technologies. Monitoring the unauthorized use of proprietary technology and trademarks is costly, and any dispute or other litigation, regardless of outcome, may be costly and time consuming and may divert the attention of management and key personnel from our business operations. The steps taken by us may not prevent unauthorized use of proprietary technology or trademarks. Many features of our products are not protected by patents; and as a consequence, we may not have the legal right to prevent others from reverse engineering or otherwise copying and using these features in competitive products. If we fail to protect or to enforce our intellectual property rights successfully, our competitive position could suffer, which could adversely affect our financial results.
We are susceptible to counterfeiting of our products, which may harm our reputation for producing high-quality products and force us to incur expenses in enforcing our intellectual property rights. Such claims and lawsuits can be expensive to resolve, require substantial management time and resources, and may not provide a satisfactory or timely result, any of which may harm our results of operations. As some of our products are sold internationally, we are also dependent on the laws of a range of countries to protect and enforce our intellectual property rights. These laws may not protect intellectual property rights to the same extent or in the same manner as the laws of the United States.
Further, we are party to licenses that grant us rights to intellectual property, including trademarks, which are necessary or useful to our Turtle Beach business. For example, we license the right to market certain products with the trade names and imagery of brands such as Disney and Major League Gaming. One or more of our licensors may allege that we have breached our license agreement with them, and seek to terminate our license. If successful, this could result in our loss of the right to use the licensed intellectual property, which could adversely affect our ability to commercialize our technologies or products, as well as harm our competitive business position and our business prospects.
Our success also depends in part on our ability to obtain and enforce intellectual property protection of our technology, particularly our patents. There is no guarantee any patent will issue on any patent application that we have filed or may file. Claims allowed from existing or pending patents may not be of sufficient scope or strength to protect the economic value of our technologies. Further, any patent that we may obtain will expire, and it is possible that it may be challenged, invalidated or circumvented. If we do not secure and maintain patent protection for our HyperSound technology and products, our competitive position could be significantly harmed. A competitor may independently develop or patent technologies that are substantially similar or superior to our HyperSound technology.
As we expand our HyperSound product line or develop new uses for our HyperSound technology, these products or uses may be outside the protection provided by our current patent applications and other intellectual property rights. In addition, if we develop new HyperSound products or enhancements to existing products we cannot assure you that we will be able to obtain patents to protect them. Even if we do receive patents for our existing or new HyperSound products, these patents may not provide meaningful protection, or may be too costly to enforce protection. In some countries outside of the United States where our HyperSound products may be sold or our HyperSound technology may be licensed, patent protection is not available. Moreover, some countries that do allow for the registration of patents do not provide meaningful redress for violations of patents. As a result, protecting intellectual property in these countries is difficult and our competitors may successfully sell products in these countries that have functions and features that infringe on our intellectual property.
We may initiate claims or litigation against third parties in the future for infringement of our proprietary rights or to determine the scope and validity of our proprietary rights or the proprietary rights of our competitors. These claims could result in costly litigation and divert the efforts of our technical and management personnel. As a result, our operating results could suffer and our financial condition could be harmed.
We are dependent upon third-party intellectual property to manufacture some of our products.
The performance of certain technology used in new generation consoles, such as integrated voice and chat audio from the Xbox One, is improved by a licensed component to ensure compatibility with our products.
While we currently believe that we have the necessary licenses, or can obtain the necessary licenses, in order to produce compatible products, there is no guarantee that our licenses will be renewed or granted in the first instance. Moreover, if these first parties enter into license agreements with companies other than us for their “closed systems” or if we are unable to obtain sufficient quantities of these headset adapters or chips, we would be placed at a competitive disadvantage.

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Our HyperSound technology is subject to government regulation, which could lead to unanticipated expenses and/or enforcement action against us.
Under the Radiation Control for Health and Safety Act of 1968, and the associated regulations promulgated by the Food and Drug Administration (“FDA”), HyperSound products are regulated as electrical emitters of ultrasonic vibrations. Under the terms of such regulations, in August 2012 we provided, and in January 2016 further supplemented, an abbreviated report to the FDA describing the HyperSound commercial product. In September 2015 we provided an initial product report describing the HyperSound Clear 500P product. The FDA may respond to these reports and request changes or safeguards to our HyperSound products, but it has not done so to date. We also are required to notify the FDA in writing should a product be found to have a defect relating to safety of use due to the emission of electronic product radiation. We do not believe our technology poses any human health risks. However, it is possible that we, or one of our customers, could be required to modify the technology, or a product incorporating the technology, to comply with requirements that may be imposed by the FDA.  Our HyperSound product advertising is regulated by the Federal Trade Commission (the “FTC”), which requires all advertising be truthful, not deceptive or unfair, and evidence based.
In addition, HyperSound Clear 500P is regulated by the FDA as a medical device pursuant to the Federal Food, Drug, and Cosmetic Act, or FDCA, and implementing regulations. HyperSound Clear 500P has received 510(k) clearance permitting over‑the‑counter (“OTC”) commercial distribution for use as a group auditory trainer or group hearing aid. Recently, FDA exempted group hearing aids from the 510(k) requirement. Therefore, we may modify HyperSound Clear 500P in the future without seeking additional 510(k) clearance, provided that we do not alter its intended use or incorporate a fundamentally different scientific technology, either of which would require a new 510(k) clearance or premarket approval.
We continue to be subject to FDA’s requirements for marketed medical devices, such as the Quality System Regulation, or QSR (which imposes procedural, documentation and record keeping requirements regarding the manufacture of medical devices); the Medical Device Reporting regulation (which requires that manufacturers report to the FDA if their device may have caused or contributed to a death or serious injury or malfunctioned in a way that would likely cause or contribute to a death or serious injury if it were to recur); and the Reports of Corrections and Removals regulation (which requires manufacturers to report recalls and field actions to the FDA if initiated to reduce a risk to health posed by the device or to remedy a violation of the FDCA that may pose a risk to health). FDA enforces these requirements by inspection and market surveillance. If the FDA finds a violation, it can institute a wide range of enforcement actions, ranging from a public warning letter to more severe sanctions such as fines, penalties, suspension or withdrawal of regulatory approvals, product recalls, seizure of products, operating restrictions or total shutdown of production, and criminal prosecution.
In the European Union we are subject to similar government regulation regarding medical device safety and effectiveness and ongoing certification and related costs. In the European Union and in other markets we may enter we will be subject to numerous and varying governmental requirements. The timing and expense to obtain or maintain any required clearances or approvals in foreign markets are difficult to estimate and may be significant. It may also be costly for us to comply with any applicable regulations and postmarket requirements in each country where we do business. If we fail to do so, we may be subject to fines, suspension or withdrawal of regulatory approvals, product recalls, seizure of products, operating restrictions or total shutdown of production, and criminal prosecution.
Our products may be subject to warranty claims, product liability and product recalls.
We may be subject to product liability or warranty claims that could result in significant direct or indirect costs, or we could experience greater returns from retailers than expected, which could harm our net sales. The occurrence of any quality problems due to defects in our products could make us liable for damages and warranty claims in excess of any existing reserves. In addition to the risk of direct costs to correct any defects, warranty claims, product recalls or other problems, any negative publicity related to the perceived quality of our products could also affect our brand image, decrease retailer and distributor demand and our operating results and financial condition could be adversely affected.
We could incur unanticipated expenses in connection with warranty or product liability claims relating to a recall of one or more of our products, including the recent XO FOUR Stealth headset recall, which could require significant expenditures to defend. Additionally, we may be required to comply with governmental requirements to remedy the defect and/or notify consumers of the problem that could lead to unanticipated expense, and possible product liability litigation against a customer or us. As of December 31, 2015 and the date of this report, the Company has not received notice of any law suits against the Company in connection with any recall actions.
Changes in laws or regulations or the manner of their interpretation or enforcement could adversely impact our financial performance and restrict our ability to operate our business or execute our strategies.
New laws or regulations, or changes in existing laws or regulations or the manner of their interpretation or enforcement, may create uncertainty for public companies, increase our cost of doing business and restrict our ability to operate our business

17



or execute our strategies. This could include, among other things, compliance costs and enforcement under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). For example, under Section 1502 of the Dodd-Frank Act, the SEC has adopted additional disclosure requirements related to the source of certain “conflict minerals” for issuers for which such “conflict minerals” are necessary to the functionality or production of a product manufactured, or contracted to be manufactured, by that issuer. The metals covered by the rules include tin, tantalum, tungsten and gold. Our suppliers may use some or all of these materials in their production processes. The rules require us to conduct a reasonable country of origin inquiry to determine if we know or have reason to believe any of the minerals used in the production process may have originated from the Democratic Republic of the Congo or an adjoining country. If we are not able to determine the minerals did not originate from a covered country or conclude that there is no reason to believe that the minerals used in the production process may have originated in a covered country, we would be required to perform supply chain due diligence on members of our supply chain. Global supply chains can have multiple layers, thus the costs of complying with these new requirements could be substantial. These new requirements may also reduce the number of suppliers who provide conflict free metals, and may affect our ability to obtain products in sufficient quantities or at competitive prices. Compliance costs such as these could have a material adverse effect on our results of operations.
We continually evaluate and monitor developments with respect to new and proposed laws, regulations, standards and rules and cannot predict or estimate the amount of the additional costs we may incur or the timing of such costs. Any such new or changed laws, regulations, standards and rules may be subject to varying interpretations and as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. This could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices. We are committed to maintaining high standards of corporate governance and public disclosure. If our efforts to comply with new or changed laws, regulations and standards differ from the activities intended by regulatory or governing bodies due to ambiguities related to practice, regulatory authorities may initiate legal proceedings against us and we may be harmed.
We are subject to various environmental laws and regulations that could impose substantial costs on us and may adversely affect our business, operating results and financial condition.
Our operations and some of our products are regulated under various federal, state, local and international environmental laws. In addition, regulatory bodies in many of the jurisdictions in which we operate propose, enact and amend environmental laws and regulations on a regular basis. The environmental laws and regulations applying to our business include those governing the discharge of pollutants into the air and water, the management, disposal and labeling of, and exposure to, hazardous substances and wastes and the cleanup of contaminated sites. If we were to violate or become liable under these environmental laws, we could be required to incur additional costs to comply with such regulations and may incur fines and civil or criminal sanctions, third-party property damage or personal injury claims, or could be required to incur substantial investigation or remediation costs. Liability under environmental laws may be joint and several and without regard to comparative fault. The ultimate costs under environmental laws and the timing of these costs are difficult to predict. Although we cannot predict the ultimate impact of any new environmental laws and regulations, such laws may result in additional costs or decreased revenue, and could require that we redesign or change how we manufacture our products, any of which could have a material adverse effect on our business. Additionally, to the extent that our competitors choose not to abide by these environmental laws and regulations, we may be at a cost disadvantage, thereby hindering our ability to effectively compete in the marketplace.
Failure to comply with the U.S. Foreign Corrupt Practices Act or other applicable anti-corruption legislation could result in fines, criminal penalties and an adverse effect on our business.
We operate in 44 countries, including countries known to have a reputation for corruption. We are committed to doing business in accordance with applicable anti-corruption laws. We are subject, however, to the risk that our officers, directors, employees, agents and collaborators may take action determined to be in violation of such anti-corruption laws, including the U.S. Foreign Corrupt Practices Act of 1977, the U.K. Bribery Act 2010 and the European Union Anti-Corruption Act, or that subjects us to trade sanctions administered by the Office of Foreign Assets Control and the U.S. Department of Commerce. Any such violation could result in substantial fines, sanctions, civil and/or criminal penalties or curtailment of operations in certain jurisdictions, and might adversely affect our results of operations. In addition, actual or alleged violations could damage our reputation and ability to do business.

18



Risks Related to Ownership of our Common Stock
Ownership of our common stock is highly concentrated, and we are a “controlled company” within the meaning of the corporate governance standards of NASDAQ and, as a result, qualify for, and rely on, exemptions from certain corporate governance requirements.
Certain Turtle Beach stockholders acting as a group beneficially own or control approximately 68% of our common stock. Accordingly, these stockholders, acting as a group pursuant to a stockholder agreement, have substantial influence over the outcome of our corporate actions requiring stockholder approval, including the election of directors, any merger, consolidation or sale of all or substantially all of our assets or any other significant corporate transaction. These stockholders also may exert influence in delaying or preventing a change in control of the Company, even if such change in control would benefit our other stockholders. In addition, the significant concentration of stock ownership may affect adversely the market value of our common stock due to investors’ perception that such conflicts of interest may exist or arise.
Additionally, we have elected to be treated as a “controlled company” under NASDAQ rules. A “controlled company” under NASDAQ rules is a listed company more than 50% of the voting power of which is held by an individual, a group or another company (and which elects to be treated as a “controlled company”). Certain stockholders of Turtle Beach constitute a group controlling more than 50% of the voting power of our voting stock. As a “controlled company,” we are permitted to, and have, opted out of certain NASDAQ rules that would otherwise require (i) a majority of the members of our board to be independent, (ii) that our compensation committee be comprised entirely of independent directors and (iii) that we establish a nominating and governance committee comprised entirely of independent directors, or otherwise ensure that director nominees are determined or recommended to our board by the independent members of our board. Accordingly, our stockholders may not have the same protections afforded to stockholders of companies that are subject to all of the corporate governance requirements of NASDAQ.
If we cannot meet Nasdaq’s continuing listing requirements and Nasdaq rules, Nasdaq may delist our securities, which could negatively affect us, the price of our securities and your ability to sell our securities.
Although our shares are currently in compliance with requirements and currently listed on Nasdaq, we may not be able to meet the continued listing requirements of Nasdaq in the future, which require, among other things, a minimum bid price of $1.00 per share for common shares listed on the exchange. While we would consider implementation of customary options, including a reverse stock split, if our common stock does not trade at the required level that regains compliance, if our efforts are unsuccessful or we are otherwise unable to satisfy the Nasdaq criteria for maintaining our listing, our securities could be subject to delisting. As a consequence of any such delisting, our shareholders would likely find it more difficult to dispose of, or to obtain accurate quotations as to the prices of our securities. In the event of a delisting, we could face significant material adverse consequences including a limited availability of market quotations for our securities; a limited amount of news and analyst coverage for our company; and a decreased ability to issue additional securities or obtain additional financing in the future.

Item 1B - Unresolved Staff Comments

None.

Item 2 - Properties

The table below describes our principal facilities as of December 31, 2015 .
Location
State or Country
Principal Business Activity
Approx. Square Feet
Owned or Expiration Date of Lease
San Diego
CA
Corporate Headquarters
30,000

2020
Valhalla
NY
Administration
21,000

2019
Basingstoke
U.K.
Administration
6,850

2021
Poway
CA
Administration
2,830

2016
San Jose
CA
Research & Development

3,500

2018
Darlington
U.K.
Warehouse
120,000

2018


19



Item 3 - Legal Proceedings
 The Company is subject to various legal proceedings and claims that arise in the ordinary course of its business. Although the amount of any liability that could arise with respect to these actions cannot be determined with certainty, in the Company’s opinion, any such liability will not have a material adverse effect on its consolidated financial position, consolidated results of operations or liquidity.
On August 5, 2013, VTBH and the Company (f/k/a Parametric) announced that they had entered into the Merger Agreement pursuant to which VTBH would acquire an approximately 80% ownership interest and existing shareholders would maintain an approximately 20% ownership interest in the combined company. Following the announcement, several shareholders filed class action lawsuits in California and Nevada seeking to enjoin the Merger. The plaintiffs in each case alleged that members of the Company’s Board of Directors breached their fiduciary duties to the shareholders by agreeing to a Merger that allegedly undervalued the Company. VTBH and the Company were named as defendants in these lawsuits under the theory that they had aided and abetted the Company's Board of Directors in allegedly violating their fiduciary duties. The plaintiffs in both cases sought a preliminary injunction seeking to enjoin closing of the Merger, which by agreement was heard by the Nevada court with the California plaintiffs invited to participate. On December 26, 2013, the court in the Nevada cases denied the plaintiffs’ motion for a preliminary injunction. Following the closing of the Merger, the Nevada plaintiffs filed a second amended complaint, which made essentially the same allegations and sought monetary damages as well as an order rescinding the Merger. The California plaintiffs dismissed their action without prejudice, and sought to intervene in the Nevada action, which was granted. Subsequent to the intervention, the plaintiffs filed a third amended complaint, which made essentially the same allegations as prior complaints and sought monetary damages. On June 20, 2014, VTBH and the Company moved to dismiss the action, but that motion was denied on August 28, 2014. That denial is currently under review by the Nevada Supreme Court, which held a hearing on the Company's petition for review on September 1, 2015. After the hearing, the Nevada Supreme Court requested a supplemental briefing, which the parties completed on October 13, 2015. The Nevada Supreme Court also invited the Business Law Section of the Nevada State Bar to submit an amicus brief by December 3, 2015 and briefing was completed on February 23, 2016. The Company believes the plaintiff's claims against it are without merit.
On February 18, 2015, Dr. John Bonanno, a minority shareholder of VTBH, filed a complaint in Delaware Chancery Court alleging breach of contract against VTBH. According to the complaint, the Merger purportedly triggered a contractual obligation for VTBH to redeem Dr. Bonanno's stock. Dr. Bonanno requests a declaratory judgment stating that he is entitled damages including a redemption of his stock for the redemption value of $15.1 million (equal to the original issue price of his stock plus accrued dividends) as well as other costs and expenses. On February 8, 2016, the Delaware Chancery Court granted VTBH's motion to dismiss for improper venue, and Dr. Bonnano's complaint was dismissed without prejudice. VTBH maintains that the Merger did not trigger any obligation to redeem Dr. Bonanno's stock.

The Company will continue to vigorously defend itself in the foregoing matters. However, litigation and investigations are inherently uncertain. Accordingly, the Company cannot predict the outcome of these matters. The Company has not recorded any accrual at  December 31, 2015  for contingent losses associated with these matters based on its belief that losses, while possible, are not probable. Further, any possible range of loss cannot be reasonably estimated at this time. The unfavorable resolution of these matters could have a material adverse effect on the Company’s business, results of operations, financial condition or cash flows. The Company is engaged in other legal actions not described above arising in the ordinary course of its business and, while there can be no assurance, believes that the ultimate outcome of these other legal actions will not have a material adverse effect on its business, results of operations, financial condition or cash flows.

Item 4 - Mine Safety Disclosures

Not applicable.


20



PART II

Item  5 - Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

The Company's stock is traded on NASDAQ under the symbol “HEAR” and prior to April 14, 2014 traded under the symbol “PAMT.” The following table sets forth the high and low sale prices per share of our common stock on the NASDAQ for the period indicated:
 
High
 
Low
Fiscal Year 2015
 
 
 
First Quarter
$
3.27

 
$
1.85

Second Quarter
3.29

 
1.75

Third Quarter
3.19

 
1.91

Fourth Quarter
3.72

 
1.86

 
Market Price
 
High
 
Low
Fiscal Year 2014
 
 
 
First Quarter
$
16.36

 
$
11.82

Second Quarter
14.75

 
7.58

Third Quarter
9.67

 
6.54

Fourth Quarter
7.62

 
2.75

The closing price of our common stock on February 29, 2016 was $1.01 per share. The number of holders of record of common stock at February 29, 2016 was 957.

Stock Performance Graph

Notwithstanding any statement to the contrary in any of our previous or future filings with the SEC, the following information relating to the price performance of our common stock shall not be deemed to be “filed” with the SEC for purposes of Section 18 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), to be “soliciting material” or subject to Rule 14A of the Exchange Act, or to be incorporated by reference into any of our filings under the Securities Act of 1933, as amended (the “Securities Act”) or the Exchange Act whether made before or after the date of this Report, except to the extent we specifically incorporate it by reference into such filing.

The following graph shows a comparison from January 15, 2014 (the date following the reverse acquisition) through December 31, 2015 of the cumulative total return assuming a $100 investment in our common stock, the S&P 500 Index and the S&P 500 Consumer Durables Index. In accordance with the rules of the Securities and Exchange Commission, the returns are indexed to a value of $100 at December 31, 2013 and assume that all dividends, if any, were reinvested. The comparisons in this graph below are based on historical data and are not intended to forecast or be indicative of future performance of our common stock.

21



Dividend Policy

We have not paid regular cash dividends on our common stock and do not anticipate paying cash dividends in the foreseeable future. Any future determination to pay cash dividends will be at the discretion of our board of directors and will depend on our financial condition, operating results, capital requirements and such other factors as our board of directors deems relevant.

Unregistered Sale of Equity Securities and Issuer Purchases of Equity Securities

We did not sell any unregistered equity securities or purchase any of our securities during the period ended December 31, 2015 .

Securities Authorized for Issuance under Equity Compensation Plans

See Part III, Item 12 of this annual report for disclosure relating to our equity compensation plans. Such information will be included in our Proxy Statement, which is incorporated herein by reference.


22



Item  6 - Selected Financial Data

The merger (the “Merger”) between VTB Holdings, Inc. and Parametric Sound Corporation (“Parametric”) was treated as a “reverse acquisition” with VTBH considered the accounting acquirer. Accordingly, VTBH's historical results of operations on a stand-alone basis replace Parametric’s historical results of operations for all periods on or prior to January 15, 2014, and for all periods following the Merger, the results of operations of both companies have been included.

The following table sets forth selected consolidated financial data for each of the five years ended  December 31, 2015 . This selected financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and the notes thereto included in this Report.

 
Year Ended December 31,
 
2015 (2)
 
2014 (1)
 
2013
 
2012
 
2011
 
(in thousands, except per share data)
Net Revenue
$
162,747

 
$
186,176

 
$
178,470

 
$
207,136

 
$
166,121

Cost of Revenue
122,056

 
135,509

 
128,141

 
132,795

 
96,536

Gross Profit
40,691

 
50,667

 
50,329

 
74,341

 
69,585

Gross Margin
25.0
 %
 
27.2
 %
 
28.2
%
 
35.9
%
 
41.9
%
Operating income (loss)
(74,399
)
 
(13,825
)
 
1,598

 
42,910

 
38,268

Operating Margin
(45.7
)%
 
(7.4
)%
 
0.9
%
 
20.7
%
 
23.0
%
Net income (loss)
$
(82,907
)
 
$
(15,486
)
 
$
(6,163
)
 
$
26,460

 
$
21,554

 
 
 
 
 
 
 
 
 
 
Net earnings (loss) per share:
 
 
 
 
 
 
 
 
 
Basic
$
(1.96
)
 
$
(0.39
)
 
$
(0.49
)
 
$
0.13

 
$
1.70

Diluted
$
(1.96
)
 
$
(0.39
)
 
$
(0.49
)
 
$
0.13

 
$
1.70

Weighted average number of shares:
 
 
 
 
 
 
 
 
 
Basic
42,269

 
39,665

 
12,700

 
12,700

 
12,700

Diluted
42,269

 
39,665

 
12,700

 
12,700

 
12,700

 
 
 
 
 
 
 
 
 
 
Balance Sheet Data
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
7,114

 
7,908

 
6,509

 
5,219

 
15,942

Total Assets
173,851

 
246,968

 
127,307

 
134,195

 
105,165

Total Debt
66,197

 
44,555

 
64,578

 
74,250

 
37,200

Series B Redeemable Preferred Stock
16,145

 
14,916

 
13,713

 
12,703

 
13,648

Series A Convertible Preferred Stock

 

 
24,345

 
24,345

 
24,345


(1) In 2014, we completed the merger with Parametric, which contributed revenue of $0.7 million in the year and $129.1 million of total assets on date of the merger.

(2) Includes goodwill impairment charge of $49.8 million


23



Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with our consolidated financial statements and the notes thereto. This discussion summarizes the significant factors affecting our results of operations and the financial condition of our business during each of the fiscal years in the three-year period ended  December 31, 2015

On January 15, 2014 the Company completed the merger (the “Merger”) with VTB Holdings, Inc. which was treated as a “reverse acquisition” with VTBH considered the accounting acquirer and surviving entity, as a wholly-owned subsidiary of the Company (f/k/a Parametric Sound Corporation), a publicly-traded company. Accordingly, VTBH's historical results of operations on a stand-alone basis replace Parametric’s historical results of operations for all periods on or prior to January 15, 2014 , and for all periods following the Merger, the results of operations of both companies have been included.

Turtle Beach Corporation (herein referred to as the “Company,” “we,” “us,” or “our”), headquartered in San Diego, California and incorporated in the state of Nevada in 2010, is a premier audio technology company with expertise and experience in developing, commercializing and marketing innovative products across a range of large addressable markets operating under two reportable segments, Turtle Beach® (“Headset“) and HyperSound®.
Turtle Beach is a worldwide leading provider of feature-rich headset solutions for use across multiple platforms, including video game and entertainment consoles, handheld consoles, personal computers, tablets and mobile devices.
HyperSound technology is an innovative patent-protected sound technology that delivers immersive, directional audio offering unique potential benefits in a variety of commercial settings and consumer devices. The recent launch of the HyperSound Clear™ 500P product has transitioned the business to the hearing healthcare market, where we believe a large percentage of people with hearing loss could use the product to improve their listening experiences from sources such as TV, CD/DVD players and stereo systems.
Business Trends
Headset
Sales in the gaming accessories market, which includes headsets and other peripherals such as gamepads, specialty controllers, adapters, batteries, memory and interactive gaming toys are heavily dependent on the global video game console industry. In 2013, the gaming industry experienced a cyclical event as Microsoft and Sony each announced new consoles for the first time in eight years, and the consumer response to the Xbox One and PlayStation®4 (the “new generation” or “new-gen” consoles) has been overwhelmingly positive, creating a growing installed base of gamers and a market for new-gen headsets. In 2016, we anticipate that Xbox 360 and Playstation®3 (the “old generation” or “old-gen” consoles) will take a final, large drop as the market completes the transition to new-gen compatible headsets.


Cumulative New Generation Console Sales (in millions)

Source: DFC Intelligence Forecasts: Worldwide Console Forecast, May 2015.

24



In 2015, new-gen active installed base surpassed old-gen active installed base with, according to May 2015  Intelligence: Worldwide Console Forecast  report by DFC Intelligence Forecasts, or “DFC,” over 60% of cumulative new generation console sales still to come including over 30 million consoles expected to be sold worldwide next year. Further, DFC estimates that cumulative new generation consoles will exceed $65 billion by 2018.
HyperSound
Hearing Health Care. Gradual hearing loss can affect individuals of all ages, varying from mild to profound and is a growing, widespread issue. In the United States, there are nearly 50 million people with some degree of hearing loss significant enough to require a hearing aid. 
Source: World Health Organization, 2013.
HyperSound technology offers a fundamentally new way to deliver sound, and our research indicates that it improves the home listening experience. We believe that a large percentage of people with hearing loss may be able to use HyperSound Clear 500P to improve their listening experiences from sources such as TV, CD/DVD players and stereo systems.
Commercial. We are currently marketing our HyperSound technology to retailers and audio-visual integrators for use in settings where directed audio and sound zones are beneficial, such as digital signage and interactive retail displays. Convenience retailers and fast moving consumer good brands face ever-greater challenges as competition for customers intensifies, and as shoppers increasingly rely on in-store cues. As a result, digital signage is a growing form of direct advertising, capturing an increasing share of advertising spending as restaurants, banks, retail outlets, museums and other outlets and organizations employ commercial displays to communicate with patrons.

Results of Operations
Management Overview
Our net revenues, which decreased $23.4 million , or 12.6% , were impacted by several external factors, including the impact of the strong dollar on our international business and a more rapid than expected decline in old-gen revenues, which were down $40 million from 2014 to end at less than 12% of revenues. However, we completed our new-gen headset portfolio, launching seven new models, which resulted in a $23.8 million or 23.8% increase year-over-year, and continued to execute on initiatives to drive sustained growth and improved profitability, such as our global logistics partnership with Keuhne + Nagel and the transition of certain headset models to the world's largest contract manufacturer, Foxconn.
Despite the product mix shift to higher margin new-gen headsets, gross profit as a percentage of net revenue decreased to 25.0% from 27.2% in the prior year. In addition to lower revenues, margins were negatively impacted by higher promotional credits to clear old-gen and licensed headset inventory, incremental costs associated with our new refurbishment model, contract manufacture transition costs and higher third party licensing and royalty costs associated with discontinued legacy license agreements. Looking ahead, we believe that margins and profitability will increase significantly as old-gen is now expected to be well under 10% of our headset business revenues in 2016.
For 2015, our reported net loss increased to $82.9 million driven largely by the Headset revenue decline, the negative non-cash impacts of the valuation allowance and goodwill impairment and, an increased investment in the HyperSound business ahead of the HyperSound Clear 500P launch. Diluted net loss per share of $1.96 was down compared to the prior year diluted net loss per share of $0.39 .

25



In 2016, we believe that old-gen headset sales will take a final, large drop, which we expect to be roughly offset by continued strong growth in our new-gen headset business as our new core models capture further revenue share and, the initial full year of revenues from the HyperSound Clear 500P product, which will include the launch in Europe as well as continued channel expansion.

Key Performance Indicators and Non-GAAP Measures

Management routinely reviews key performance indicators including revenue, operating income and margins, earnings per share, among others. In addition, we believe certain other measures provide useful information to management and investors about us and our financial condition and results of operations for the following reasons: (i) it is one of the measures used by our board of directors and management team to evaluate our operating performance; (ii) it is one of the measures used by our management team to make day-to-day operating decisions; (iii) the adjustments made are often viewed as either non-recurring or not reflective of ongoing financial performance or have no cash impact on operations; and (iv) it is used by securities analysts, investors and other interested parties as a common operating performance measure to compare results across companies in our industry by backing out potential differences caused by variations in capital structures (affecting relative interest expense), and the age and book value of facilities and equipment (affecting relative depreciation and amortization expense). These metrics, however, are not measures of financial performance under accounting principles generally accepted in the United States of America (“GAAP”) and, given the limitations of these metrics as analytical tools, should not be considered a substitute for gross profit, gross margins, net income (loss) or other consolidated income statement data as determined in accordance with GAAP. We consider the following non-GAAP measure, which may not be comparable to similarly titled measures reported by other companies, to be key performance indicators:

Adjusted EBITDA is defined as net income (loss) before interest, taxes, depreciation and amortization, stock-based compensation (non-cash) and, certain special items that we believe are not representative of core operations.
Cash Margins is defined as gross margin excluding depreciation and amortization, and stock-based compensation.
Adjusted EBITDA
Adjusted EBITDA (and a reconciliation to Net loss , the nearest GAAP financial measure) for the years ended December 31, 2015 , 2014 and 2013 are as follows:
 
 
Year Ended
 
 
December 31,
 
 
2015

2014
 
2013
 
 
(in thousands)
Net loss
 
$
(82,907
)
 
$
(15,486
)
 
$
(6,163
)
Interest expense
 
5,099

 
7,209

 
6,626

Depreciation and amortization
 
7,916

 
6,866

 
5,345

Stock-based compensation
 
5,897

 
5,194

 
2,563

Income tax expense (benefit)
 
2,393

 
(6,272
)
 
1,090

Impairment charge
 
49,822

 

 

Business transaction costs
 

 
3,744

 
3,864

Restructuring charges
 
399

 
747

 

Payments to founders
 

 

 
527

Adjusted EBITDA
 
$
(11,381
)
 
$
2,002

 
$
13,852

Comparison of the Year Ended December 31, 2015 to the Year Ended December 31, 2014

For the year ended December 31, 2015 , Adjusted EBITDA on a consolidated basis was $(11.4) million , including investments of $13.8 million in the HyperSound business, compared to Adjusted EBITDA on a consolidated basis of $2.0 million , including investments of $10.0 million in the HyperSound business from the year ended December 31, 2014 .

Headset Adjusted EBITDA totaled approximately $2.4 million in the year ended December 31, 2015 compared to $12.0 million in the prior year, which included the initial sell-in of the Company's and the industry’s first ever Xbox One compatible headsets.

26



In addition to the lower sales volume driven primarily by the strong dollar on our international business, the current period was negatively impacted by promotional credits to continue to clear channel inventory and higher third party licensing and royalty costs which included $1.3 million of reserves for products associated with certain discontinued legacy license agreements.

Comparison of the Year Ended December 31, 2014 to the Year Ended December 31, 2013

Adjusted EBITDA decreased for the year ended December 31, 2014 as compared to the year ended December 31, 2013 driven largely by our investment in the HyperSound business and an increased net loss reflecting the negative impact of costs to package the Microsoft Xbox One Headset Chat Adapter with our headsets and ship them to retailers, increased air freight usage to ensure certain new headsets were in the market for the holiday and in response to the labor uncertainty at the West Coast ports, and initial costs to support being a public company.
Financial Results
The following table sets forth the Company’s statements of operations for the periods presented:
 
Year Ended
 
December 31,
 
2015
 
2014
 
2013
 
(in thousands)

Net Revenue
$
162,747

 
$
186,176

 
$
178,470

Cost of Revenue
122,056

 
135,509

 
128,141

Gross Profit
40,691

 
50,667

 
50,329

Gross Margin
25.0
%
 
27.2
%
 
28.2
%
 
 
 
 
 
 
Operating expenses
115,090

 
64,492

 
48,731

Operating income (loss)
(74,399
)
 
(13,825
)
 
1,598

Interest expense
5,099

 
7,209

 
6,626

Other non-operating expense, net
1,016

 
724

 
45

Gain on bargain purchase from acquisition

 

 

Loss before income tax expense (benefit)
(80,514
)
 
(21,758
)
 
(5,073
)
Income tax expense (benefit)
2,393

 
(6,272
)
 
1,090

Net loss
$
(82,907
)
 
$
(15,486
)
 
$
(6,163
)
Net Revenue and Gross Profit
Headset Segment

The following table summarizes net revenue and gross profit for the periods presented:
 
December 31,
 
2015
 
2014
 
2013
 
(in thousands)

Net Revenue
$
161,835

 
$
185,469

 
$
178,470

Gross Profit
42,832

 
50,550

 
50,329

Gross Margin
26.5
%
 
27.3
%
 
28.2
%
Cash Margin  (1)
27.5
%
 
27.5
%
 
28.3
%
(1) Excludes non-cash charges of $1.7 million , $0.5 million and $0.2 million , respectively.

Comparison of Fiscal Years 2015 and 2014

Net revenues for year ended December 31, 2015 , which decreased $23.4 million , or 12.6% , were negatively impacted by a more rapid than expected decline in old-gen revenues, which were down over $40 million compared to 2014 and, the strong dollar on our international business that declined 29.0% in the United Kingdom and 28.0% in Europe. These declines were

27



offset, in part, by a 27.0% increase in new-gen revenues reflecting the continued positive consumer reaction to the XO ONE, XO FOUR Stealth and Stealth 500P headsets and the strong performance of our new products as we completed our headset portfolio transition with the launch of five new headsets for the holiday season.
Despite the benefit of the product mix shift to higher margin new-gen headsets during the second half of the year, for the year ended December 31, 2015 , gross profit as a percentage of net revenue decreased to 26.5% from 27.3% in the prior year. The year-over-year decrease in gross margin performance was primarily due to higher promotion credits to clear, and subsequent excess reserves of, old-gen and licensed headsets, incremental costs associated with our refurbishment model and contract manufacture transitions and, higher third party licensing and royalty costs. Excluding the impact of $1.8 million previous generation and licensed headset charges, gross profit as a percentage of net sales would have been 27.6% driven largely by sales of higher margin headsets.
Comparison of Fiscal Years 2014 and 2013

In spite of challenging overall market conditions that included a rapid decline in active user bases for Xbox 360 and PlayStation®3 and a more promotional environment, net revenues for year ended December 31, 2014 increased $7.7 million, or 4.3%, compared to the prior year on the strength of our new generation headset portfolio and the expansion of our international headset business with strong growth in several markets, including a 11.3% increase in the United Kingdom business and 29.7% in Europe, as well as the initial sales of our Xbox One headsets in China. Domestic sales increased 5.6% on strong consumer response to our new more advanced headsets. These gains were offset in part by a decline in sales to our Canadian distributor as fiscal 2013 included incremental initial stock orders.
Our strategy to deliver innovative headsets across all price points drove a 6.6% increase in total Xbox compatible headsets sales as new generation console headsets bolstered by the launch of the XO FOUR, XO SEVEN, XO ONE and Stealth 500X outpaced the decline in previous generation headset sales. Sales of PlayStation® compatible headsets remained steady through the console transition on continued positive consumer reaction to the PX22 headset and the release of the ELITE 800, Stealth 500P, Ear Force Stealth 400 and P12 headsets.
For the year ended December 31, 2014, gross profit as a percentage of net revenue decreased to 27.2% from 28.2% in the prior year. In 2014, gross profit as a percentage of net revenue was negatively impacted by $2.5 million of incremental shipping and handling costs related to the Microsoft Xbox One Headset Chat Adapter necessary to have our headsets in retail stores for when Microsoft turned on gaming headset audio which had been delayed at the product launch and $3.4 million of incremental air freight costs to get certain new products (ELITE 800, Stealth 500X and XO ONE) to market for the holiday and in response to abnormal West Coast port delays due to labor disputes during contract negotiations. Excluding the impact of these additional shipping costs, gross profit as a percentage of net sales would have been 30.2% driven largely by sales of higher margin headsets.
HyperSound Segment

 
December 31,
 
2015
 
2014
 
2013
 
 
 
 
HyperSound
912

 
707

 

Gross Profit
(2,141
)
 
117

 

Gross Margin
(234.8
)%
 
16.5
%
 
%
Cash Margin
(105.8
)%
 
31.3
%
 
%
(1) Excludes non-cash charges of $1.2 million , $0.1 million and $0.0 million , respectively.

Comparison of Fiscal Years 2015 and 2014

Net revenues for the year ended December 31, 2015 were $0.9 million and reflect the initial sales of the HyperSound Clear 500P product that launched in November 2015, compared to $0.7 million in the prior year primarily from the first wide-scale deployment of the commercial product in Activision Call of Duty® retail displays.

As a result of certain start-up costs related to the HyperSound Clear 500P product, including the incremental amortization expense related to technological feasibility of the purchased in-process research and development intangible asset, gross profit

28



as a percentage of net revenue was negative for the year ended December 31, 2015 . Excluding these costs, the cash margin was 39.8% reflecting the initial shipments of the higher margin HyperSound Clear 500P product.

Operating Expenses
 
Year Ended
 
December 31,
 
2015
 
2014
 
2013
 
(in thousands)
Selling and marketing
$
31,829

 
$
33,442

 
$
31,645

Research and development
11,556

 
9,400

 
4,873

General and administrative
21,484

 
17,159

 
8,349

Business transaction costs

 
3,744

 
3,864

Goodwill impairment
49,822

 

 

Restructuring charges
399

 
747

 

Total operating expenses
$
115,090

 
$
64,492

 
$
48,731

Operating expenses increased largely due to additional costs associated with the expansion of the HyperSound business and additional headcount required of a public company partially offset by cost reductions in marketing.
Selling and Marketing
Selling and marketing expense for the year ended December 31, 2015 totaled $31.8 million , or 19.6% as a percentage of net revenues, compared to $33.4 million , or 18.0% as a percentage of net revenues, for the prior year. The 4.8% decrease was primarily due to lower direct media spend and licensing costs ($1.5 million) and a reduction in trade show spend ($0.9 million) in connection with a strategic shift to more targeted promotional activity, partially offset by incremental marketing costs and additional sales force related to the HyperSound Clear 500P product launch.
Selling and marketing expense for the year ended December 31, 2014 totaled $33.4 million, or 18.0% as a percentage of net revenues, compared to $31.6 million, or 17.7% as a percentage of net revenues, for the prior year. The increase in expense was primarily due to $5.1 million of incremental costs related to the HyperSound business and higher depreciation driven by the addition of interactive retail display kiosks into two large retailers in the fourth quarter of 2013, partially offset by reduced trade show expenses ($0.7 million), direct media spend ($1.2 million) and, advertising and promotional expenses ($1.6 million) related to the media series headsets post their market launch in 2013.
Research and Development
The increase in research and development expenses for the year ended  December 31, 2015  versus the prior year was primarily due to increased staffing levels to support the development of the HyperSound Clear 500P product ($1.9 million) as well as new advanced audio and wireless development initiatives to expand our Xbox One compatible headset portfolio and launch of our true multiplatform headset - the EarForce PX24 ($0.3 million).

The increase in research and development expenses for the year ended December 31, 2014 versus the comparable prior year was primarily due to HyperSound product development efforts ($3.6 million), increased staffing levels to support the development of technology leading headsets for the new generation consoles and, an investment in product development for the HyperSound Clear 500P product.

General and Administrative
General and administrative expenses for the year ended December 31, 2015 increased $4.3 million to $21.5 million compared to $17.2 million for the year ended December 31, 2014 . The year over year increase was primarily driven by higher employee costs as a result of the full year impact of additional headcount required of a public company ($1.5 million), legal fees associated with recent public filings in connection with our stock option exchange and financing activities ($0.7 million) and higher stock compensation expense ($0.7 million).

General and administrative expenses for the year ended December 31, 2014 increased $8.8 million to $17.2 million compared to $8.3 million for the year ended December 31, 2013. The year over year increase was primarily driven by increased external

29



expenses to be a public company ($3.2 million), incremental costs related to HyperSound ($2.3 million), higher stock compensation expense ($1.1 million) and, additional headcount to build our internal capabilities and higher consultant fees for debt and equity capital activities ($1.4 million).
Goodwill Impairment
As a result of our annual impairment test, we recorded a $49.8 million goodwill impairment charge in connection with the decline in implied fair value of the HyperSound reporting unit. There were no such charges in 2014 or 2013.

Business Transaction
Business transaction expenses for the year ended December 31, 2014 incurred in connection with the Merger included investment banker success fees of $2.2 million payable upon the close of the merger and legal and accounting fees required to complete the transaction compared to $3.9 million for the year ended December 31, 2013 related to due diligence and legal costs related to the acquisition of the HyperSound business that closed in January 2014.
Restructuring Charges
During 2014, we began to focus on company-wide overhead and operating expense cost reduction activities, such as closing excess facilities and reducing redundancies. In connection with our efforts to improve our operating efficiency and reduce costs, over the past two years, we completed the closure of certain warehouse operations and the production operations at one of our contract manufacturing operations in China.

Interest Expense
Interest expense decreased $2.1 million for the year ended  December 31, 2015 primarily due to the write-off of $2.2 million of unamortized debt issuance costs related to the refinancing of our credit facility in the comparable period. Excluding this item, interest expense increased $0.1 million as additional interest related to the issuance of the Term Loan Due 2019 and subordinated notes offset by savings associated with rate reductions and lower average borrowings on our revolving line of credit.
Interest expense increased $0.6 million for the year ended December 31, 2014 primarily due to higher deferred finance fees that included the write-off of $2.2 million of unamortized debt issuance costs related to the refinancing of our credit facility on March 31, 2014 and additional interest of $0.8 million related to the issuance of the subordinated notes. These factors were offset by rate reductions and lower average borrowings on our revolving line of credit.
Income Taxes
During 2015, as a result of cumulative losses in recent years primarily due to incremental costs associated with the console transition, acquisition costs and initial investments in the HyperSound business, the Company concluded that a full valuation allowance is required on its net deferred tax assets.

Income tax expense for the year ended December 31, 2015 was $2.4 million at an effective tax rate of (3.0)% compared to income tax benefit $6.3 million for the year ended December 31, 2014 at an effective tax rate of 28.8% . The effective tax rate was primarily impacted by two discrete items, the release of certain reserves related to uncertain tax positions due to the closure of an IRS examination and the establishment of a valuation allowance on all of our deferred tax assets in the United States and the United Kingdom

Income tax benefit for the year ended December 31, 2014 was $6.3 million at an effective tax rate of 28.8% compared to income tax expense of $1.1 million for the year ended December 31, 2013 at an effective tax rate of 21.5%. The Company’s effective tax rate for this year differed from the U.S. federal statutory rate of 35% primarily due to differences in book and tax treatment of transaction costs, interest on the Series B Redeemable Preferred Stock and other non-deductible expenses.

Liquidity and Capital Resources
Our primary sources of working capital are cash flow from operations and availability of capital under our revolving credit facility. We have funded operations and acquisitions in recent periods with operating cash flows, and proceeds from debt and equity financings.


30



The following table summarizes our sources and uses of cash:

 
2015
 
2014
 
2013
 
(in thousands)
Cash and cash equivalents at beginning of period
$
7,908

 
$
6,509

 
$
5,219

Net cash provided by (used for) operating activities
(15,133
)
 
(14,834
)
 
18,290

Net cash provided by (used for) investing activities
(6,693
)
 
557

 
(6,167
)
Net cash provided by (used for) financing activities
21,134

 
15,969

 
(11,017
)
Effect of foreign exchange on cash
(102
)
 
(293
)
 
184

Cash and cash equivalents at end of period
$
7,114

 
$
7,908

 
$
6,509

Operating activities
Cash used for operating activities for the year ended  December 31, 2015 was $15.1 million , a decline of $0.3 million as compared to $14.8 million for the year ended December 31, 2014 . The year-over-year decrease is primarily the result of lower net income adjusted for non-cash expenses and higher year-over-year payments of accounts payable due to incremental expenses incurred in connection with the launch of the HyperSound Clear 500P product. These impacts were offset, in part, by the valuation allowance recorded on the Company's deferred tax assets.

Cash used for operating activities for the year ended December 31, 2014 was $14.8 million, a decline of $33.1 million as compared to cash provided by operating activities of $18.3 million for the year ended December 31, 2013. The year-over-year decrease is primarily the result of lower net income adjusted for non-cash expenses and a reduction in net working capital (defined as accounts receivable and inventories less accounts payable). The reduction in net working capital was driven by payments of accounts payable that had increased during our debt refinancing process that started in late 2013 and was completed in March 2014.

Investing activities
Cash used for investing activities was $6.7 million during the year ended December 31, 2015 compared to cash provided by investing activities of $0.6 million in 2014, which included $4.1 million of cash acquired in the Merger. Capital expenditures increased $3.2 million compared to the prior year to $6.7 million primarily due to expenditures on tooling related to the expansion of our headset portfolio and the initial production line for HyperSound Clear 500P as well as interactive display purchases in connection with our initial international headset display units.
Cash provided by investing activities was $0.6 million during the year ended December 31, 2014 compared to cash used for investing activities of $6.2 million during the year ended December 31, 2013, as a result of $4.1 million of cash acquired in the Merger. During 2013, we refreshed demonstration units at key retailers and purchased new convention booth equipment in advance of the new generation console releases, and as such capital expenditures declined in the year ended December 31, 2014 to $3.5 million from $6.2 million in 2013.
Financing activities
Net cash provided by financing activities was $21.1 million during the  year ended December 31, 2015 compared to $16.0 million and $11.0 million of cash used in financing activities during the years ended December 31, 2014 and 2013 , respectively. Financing activities in 2015 included the issuance of a $15 million term loan and $16.3 million principal amount of subordinated notes, partially offset by repayments of term loans and net payments on our revolving credit facilities of $8.8 million .
Financing activities in 2014 included $37.2 million of proceeds from the sale of common stock, the issuance of $7.0 million principal amount of subordinated notes and a $7.7 million term loan borrowing partially offset by (i) net payments on our revolving credit facilities of $2.9 million, (ii) repayment of our $14.5 million legacy term loan and (iii) repayment of $18.5 million of outstanding subordinated notes.
Net cash used in financing activities during the year ended December 31, 2013 was primarily related to net repayments of the legacy revolving line of credit and term loan, and was partially offset by the issuance of $10 million principal amount of subordinated notes.

31



Management assessment of liquidity
Management believes that our current cash and cash equivalents, the amounts available under our revolving credit facility, the impact of the proceeds from our recent term loans and subordinated notes, and equity raise and cash flows derived from operations will be sufficient to meet anticipated cash needs for working capital and capital expenditures for at least the next 12 months. Significant assumptions underlie this belief, including, among other things, that there will be no material adverse developments in our business, liquidity or capital requirements.
On February 5, 2016, we received approximately $6.2 million in net proceeds in connection with the successful closure of a public offering of 5.0 million shares of common stock and a separate, concurrent, side-by-side private placement of 1.7 million shares of common stock at a price of $1.00 per share. In accordance with certain amendments to our Credit Facility, these proceeds were applied against the outstanding principal balance of the working capital line of credit.

We believe the combination of our revolving credit facility, long-term debt and cash flow generated by our gaming headset business will cover incremental costs related to the continued launch of the HyperSound Clear 500P product and provide the necessary liquidity to fund our annual working capital needs, particularly during the gaming industry’s seasonal slow period in the first half of the year.

Foreign cash balances at  December 31, 2015  and December 31, 2014 were  $0.2 million and $2.5 million , respectively.

Revolving Credit Facility
On March 31, 2014, Turtle Beach and certain of its subsidiaries entered into a new asset-based revolving credit agreement (“Credit Facility”) with Bank of America, N.A., as Agent, Sole Lead Arranger and Sole Bookrunner, which replaced the then existing loan and security agreement. The Credit Facility, which expires on  March 31, 2019 , provides for a line of credit of up to $60 million inclusive of a sub-facility limit of $10 million for TB Europe, a wholly owned subsidiary of Turtle Beach. The Credit Facility may be used for working capital, the issuance of bank guarantees, letters of credit and other corporate purposes.
The maximum credit availability for loans and letters of credit under the Credit Facility is governed by a borrowing base determined by the application of specified percentages to certain eligible assets, primarily eligible trade accounts receivable and inventories, and is subject to discretionary reserves and revaluation adjustments.

Amounts outstanding under the Credit Facility bear interest at a rate equal to either a rate published by Bank of America or the LIBOR rate, plus in each case, an applicable margin, which is between 1.00% to 1.50% for U.S. base rate loans and between  2.00% to 2.50% for U.S. LIBOR loans and U.K. loans. As of December 31, 2015 , interest rates for outstanding borrowings were 5.00% for base rate loans and 2.92% for LIBOR rate loans. In addition, Turtle Beach is required to pay a commitment fee on the unused revolving loan commitment at a rate ranging from  0.25%  to 0.50% , and letter of credit fees and agent fees.

If certain availability thresholds are not met, meaning that the Company does not have receivables and inventory which are eligible to borrow on under the Credit Facility in excess of amounts borrowed, the Credit Facility requi res the Company and its restricted subsidiaries to maintain a fixed charge coverage ratio. The fixed charge ratio is defined as the ratio, determined on a consolidated basis for the most recent four fiscal quarters, of (a) EBITDA minus capital expenditures, excluding those financed through other instruments, and cash taxes paid, and (b) Fixed Charges defined as the sum of cash interest expense plus scheduled principal payments.
The Credit Facility also contains affirmative and negative covenants that, subject to certain exceptions, limit our ability to take certain actions, including our ability to incur debt, pay dividends and repurchase stock, make certain investments and other payments, enter into certain mergers and consolidations, engage in sale leaseback transactions and transactions with affiliates and encumber and dispose of assets. Obligations under the Credit Facility are secured by a security interest and lien upon substantially all of the Company's assets.
In March 2015, Bank of America notified the Company that certain events of default had occurred and were continuing under the Credit Agreement, including (i) the Company’s failure to deliver in a timely matter certain monthly financial statements in accordance with the Credit Agreement, (ii) the Company’s failure to deliver in a timely matter certain financial projections in accordance with the Credit Agreement, (iii) the Company’s failure to repay an over-advance of approximately  $100,000 that existed between March 6, 2015 and March 9, 2015, and (iv) the Company’s failure to satisfy the fixed charge coverage ratio under the Credit Agreement for certain measurement dates during the fourth quarter of 2014 (in part as a result of certain

32



retroactive changes to the calculation of such ratio pursuant to the second amendment, dated December 29, 2014) (the “Existing Events of Default”).

On March 16, 2015, the Company entered into a third amendment (the “Third Amendment”) to the Credit Facility pursuant to which Bank of America and the lenders under the Credit Facility agreed to waive the Existing Events of Default.  In addition, the Third Amendment amends certain other provisions of the agreement and requires that we maintain an EBITDA ratio at the end of each month beginning April 30, 2015 on a cumulative basis through the remainder of 2015 and thereafter on a trailing twelve-month basis, our EBITDA (as defined under the Credit Facility) must be in an amount equal to at least 75% of our monthly projected EBITDA as set forth in projections delivered pursuant to the Credit Facility.  The current fixed charge coverage ratio of at least 1.15 to 1.00 on the last day of each month while a Covenant Trigger Period (as defined in the agreement) is in effect will become effective again after the Company has complied with such ratio for six consecutive months.

On November 2, 2015, the Company entered into a sixth amendment to the Credit Facility that modified certain provisions to provide (i) that the Company will make certain periodic reports with respect to certain financial metrics, (ii) that the existing financial covenants are suspended and replaced by amended EBITDA levels during the months ended September 30, 2015 through the month ending November 30, 2015, and (iii) that the loan availability is decreased by an additional block.

On December 1, 2015, in connection with the sixth amendment, the Company further amended certain provisions of the Credit Facility to, among other things, amend the definition of EBITDA to exclude certain non-recurring expenses and replace certain financial covenants by amended EBITDA levels each month beginning with the month ended December 31, 2015 through (and including) the month ending March 31, 2017 (with revised financial covenants to be agreed based on new financial projections after such date) on both an overall and segment-by-segment basis.

On February 1, 2016, the Company further amended certain provisions of the Credit Facility to, among other things, provide that, on or prior to February 5, 2016, the Company receive net proceeds of not less than $6.0 million of additional equity capital or additional third lien debt financing and apply such proceeds against the outstanding principal balance of the working capital line of credit, amend the definition of EBITDA to exclude certain non-recurring expenses and replace certain financial covenants by amended EBITDA levels. The Company satisfied its paydown obligation with the proceeds from the recent offering and private placement.

As of December 31, 2015 , the Company was in compliance with all the amended financial covenants, and excess borrowing availability was approximately $3.8 million , net of the outstanding Term Loan Due 2018 (as defined below) that is considered to be an additional outstanding amount under the Credit Facility.
Term Loans

Term Loan Due 2018

On December 29, 2014, the Company amended the Credit Facility to permit the repayment of $7.7 million of existing subordinated debt and accrued interest with the proceeds of an additional loan (the “Term Loan”). The Term Loan will result in modified financial covenants while it is outstanding, will bear interest at a rate of LIBOR for the applicable interest period plus 5% and will be repaid in equal monthly installments beginning on April 1, 2015 and ending on April 1, 2018. As of December 31, 2015 , the outstanding principal balance was $5.8 million ,

Term Loan Due 2019

On July 22, 2015, the Company and its subsidiaries, entered into a term loan, guaranty and security agreement (the “Term Loan Due 2019”) with Crystal Financial LLC, as agent, sole lead arranger and sole bookrunner, Crystal Financial SPV LLC and the other persons party thereto (“Crystal”), which provides for an aggregate term loan commitment of $15 million that bears interest at a rate per annum equal to the 90-day LIBOR rate plus 10.25% . Under the terms of the Term Loan Due 2019, the Company is required to make payments of interest in arrears on the first day of each month beginning August 1, 2015 and will repay the principal in monthly payments beginning January 1, 2016, with a final payment on June 28, 2019 , the maturity date.

The Term Loan Due 2019 is secured by a security interest in substantially all of the Company and each of its subsidiaries' working capital assets and is subject to the first-priority lien of Bank of America , N.A., as agent, under the Credit Facility, other than with respect to equipment, fixtures, real property interests, intellectual property, intercompany property, intercompany indebtedness, equity interest in their subsidiaries, and certain other assets specified in an inter-creditor agreement between Bank of America and Crystal.


33



The Company and its subsidiaries are required to comply with various customary covenants including, (i) maintaining minimum EBITDA and Headset EBITDA (each as defined in the Term Loan Due 2019) in each trailing twelve month period beginning August 31, 2015, (ii) maintaining a Consolidated Leverage Ratio (as defined in the Term Loan Due 2019) to be measured on the last day of each month while the term loans are outstanding of no more than 5.75 :1 beginning December 31, 2015 with periodic step-downs to 3.00 :1 on January 31, 2017, (iii) not making capital expenditures in excess of $11 million in the year ending December 31, 2015 and in excess of $7 million in each of the years ending December 31, 2016, 2017, 2018 and 2019, (iv) restrictions on the Company’s and its subsidiaries ability to prepay its subordinated notes, pay dividends, incur debt, create or suffer liens and engage in certain fundamental transactions and (v) an obligation to provide certain financial and other information. The agreement permits certain equity holders of the Company to contribute funds to the Company to cure certain financial covenant defaults.

The Term Loan Due 2019 contains customary representations, mandatory prepayment events and events of default, including defaults triggered by the failure to make payments when due, breaches of covenants and representations, material impairment in the perfection of Crystal’s security interest in the collateral and events related to bankruptcy and insolvency of the Company and its subsidiaries. Upon an event of default, Crystal may declare all outstanding obligations immediately due and payable (along with a prepayment fee), a default rate of an additional 2.0% may be applied to amounts outstanding and may take other actions including collecting or taking such other action with respect to the collateral pledged in connection with the term loan.

On February 1, 2016, the Company entered into a third amendment to amend certain provisions to, among other things, provide that net proceeds from additional equity capital or additional third lien debt financing are applied against the outstanding principal balance of the working capital line of credit, amend the definition of EBITDA to exclude certain non-recurring expenses and replace certain financial covenants by amended EBITDA levels each month beginning with the month ended December 31, 2015 and on a trailing twelve-month period basis beginning with the period ending October 31, 2016, through the termination date on both an overall and segment-by-segment basis.

As of December 31, 2015 , the Company was in compliance with the amended financial covenants, and outstanding principal balance was $12.6 million .
Subordination Agreement
On November 16, 2015, as a condition precedent to our lenders permitting certain subordinated notes, we entered into a subordinated agreement with and between certain parties that our obligations under any such notes would be subordinated in right of payment in full of all the Company's obligations under the Credit Facility and Term Loan Due 2019.
Subordinated Notes - Related Party
Concurrently with the completion of the Term Loan Due 2019, the Company amended and restated each of its outstanding subordinated notes (the “Amended Notes”). The $13.8 million obligation of the Company under the Amended Notes is subordinate and junior to the prior payment of amounts due under the Credit Facility and Term Loan Due 2019. In addition, the stated maturity date of the Amended Notes was extended to September 29, 2019 , subject to acceleration in certain circumstances, such as a change of control in the Company. The Amended Notes bear interest at a rate per annum equal to LIBOR plus 10.5% and shall be paid-in-kind by adding the amount to the principal amount due. Further, as consideration for the concessions in the Amended Notes, the Company issued warrants to purchase 1.7 million of the Company’s common stock at an exercise price of $2.54 per share.

On November 16, 2015, the Company issued a $2.5 million subordinated note (the “November Note”) to SG VTB, the proceeds of which, as set forth in the amendment to the Term Loan Due 2019, were applied against the outstanding balance of the Term Loan Due 2019. The November Note will bear interest at a rate of 15% per annum until its maturity date, which is September 29, 2019 , and is subordinated to all senior debt of the Company. In connection with the November Note, the Company issued a warrant to purchase 1.4 million shares of the Company’s common stock at an exercise price of $2.00 per share.

SG VTB is an affiliate of Stripes Group LLC (“Stripes”), a private equity firm focused on internet, software, healthcare IT and branded consumer products businesses. Kenneth A. Fox, one of our directors, is the managing general partner of Stripes and the sole manager of SG VTB and Ronald Doornink, our Chairman of the Board, is an operating partner of Stripes.


34



Series B redeemable preferred stock
In September 2010, VTBH issued 1,000,000 shares of its Series B Redeemable Preferred Stock with a fair value of $12.4 million. We are required to redeem the Series B Redeemable Preferred Stock on the earlier to occur of September 28, 2030 or the occurrence of a liquidation event (as defined in VTBH's Certificate of Incorporation) at its original issue price of $12.425371 per share plus any accrued but unpaid dividends. The redemption value was $16.1 million and $14.9 million as of December 31, 2015 and December 31, 2014, respectively.
Critical Accounting Estimates
Our discussion and analysis of our results of operations and capital resources are based on our condensed consolidated financial statements, which have been prepared in conformity with GAAP. The preparation of these condensed consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses and the disclosure of contingent assets and liabilities. Management bases its estimates, assumptions and judgments on historical experience and on various other factors that it believes to be reasonable under the circumstances.
Different assumptions and judgments would change the estimates used in the preparation of the condensed consolidated financial statements, which, in turn, could change the results from those reported. Management evaluates its estimates, assumptions and judgments on an ongoing basis.
Based on the above, we have determined that our most critical accounting policies are those related to revenue recognition and sales return reserve, inventory valuation, asset impairment, and income taxes.
Revenue Recognition and Sales Return Reserve
Revenue is recognized when products are shipped and title has been transferred to a customer, the sales price is fixed and determinable, and collection is reasonably assured.  Product is considered delivered to the customer once it has been shipped and title and risk of loss have been transferred. Net revenue for on-line purchases is recognized when products are shipped from our distribution facilities.
Provisions for cash discounts, quantity rebates, and sales returns in the period the sale is recorded, based upon our prior experience and current trends, as a reduction of revenue.  These revenue reductions are established based upon management’s best estimates at the time of sale following the historical trend, adjusted to reflect known changes in the factors that impact such reserves and allowances, and the terms of agreements with customers.
Inventory Valuation
Inventories are valued at the lower of weighted average cost or market, at the individual item level. Market is determined based on the estimated net realizable value, which is generally the selling price. Inventory levels are monitored to identify slow-moving items and markdowns are used to clear such product. Physical inventory counts are performed annually in January and estimates are made for any shortage between the date of the physical inventory count and the balance sheet date.
Asset Impairment
We have significant long-lived tangible and intangible assets, including goodwill with indefinite lives, which are susceptible to valuation adjustments as a result of changes in various factors or conditions. We assess the potential impairment of intangible and fixed assets whenever events or changes in circumstances indicate that full recoverability of net asset balances through future cash flows is in question. Goodwill and indefinite-lived intangible assets are assessed at least annually, but also whenever events or changes in circumstances indicate the carrying values may not be recoverable. Factors we consider important, which could trigger an impairment of such assets include significant underperformance relative to historical or projected future operating results; significant changes in the manner of or use of the acquired assets or the strategy for our overall business; significant negative industry or economic trends; significant decline in our stock price for a sustained period; and a decline in our market capitalization below net book value.

Management estimates future pre-tax cash flows based on historical experience, knowledge and market data. Estimates of future cash flows require that we make assumptions and apply judgment, including forecasting future sales and expenses and estimating useful lives of the assets. These estimates can be affected by factors such as future product development and economic conditions that can be difficult to predict, as well as other factors such as those outlined in “Risk Factors.” If the expected future cash flows related to the long-lived assets are less than the assets’ carrying value, an impairment loss would be recognized for the difference between estimated fair value and carrying value.


35



In connection with the Merger, the Company performed a valuation of the acquired goodwill and intangible assets and recorded $81.0 million of goodwill based on the fair values of the assets acquired and liabilities assumed. The Company conducted its annual impairment assessment as of November 1, 2015, and based on the two-step impairment test, recorded a $49.8 million goodwill impairment charge, which resulted in a $31.2 million remaining carrying value as of December 31, 2015. Refer to Note 1 , “Summary of Significant Accounting Policy” for further details.
Management's forecasts of planned revenue are largely dependent on the market acceptance and continued channel expansion of the Company's recently launched HyperSound Clear 500P product to generate the projected revenue in subsequent years. If the performance of the Company's HyperSound Clear 500P product in the hearing healthcare market does not meet expectations based on initial market data, a future impairment charge could result for a portion or all of the remaining goodwill. The amount of any impairment is dependent on the performance of the business which is dependent upon a number of variables which cannot be predicted with certainty.
Income Taxes
We account for income taxes using the asset and liability method. Under the asset and liability method, deferred tax assets and liabilities are recognized based on the differences between the financial statement carrying value of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates and laws expected to be in effect when the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date. Inherent in the measurement of these deferred balances are certain judgments and interpretations of existing tax law and other published guidance as applied to our operations. Our effective tax rate considers our judgment of expected tax liabilities in the various jurisdictions within which we are subject to tax.
The determination of the need for a valuation allowance on deferred tax assets requires Management to make assumptions and to apply judgment, including forecasting future earnings, taxable income, and the mix of earnings in the jurisdictions in which we operate. During 2015, as a result of cumulative losses in recent years primarily due to incremental costs associated with the console transition, acquisition costs and initial investments in the HyperSound business, the Company concluded that a full valuation allowance is required on its net deferred tax assets.
The tax effects of uncertain tax positions taken or expected to be taken in income tax returns are recognized only if they are “more likely-than-not” to be sustained on examination by the taxing authorities, based on the technical merits as of the reporting date. The tax benefits recognized in the financial statements from such positions are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. We recognize estimated accrued interest and penalties related to uncertain tax positions in income tax expense.
We are currently under examination by certain state and local taxing jurisdictions. Further, at any given time, multiple tax years may be subject to examination by various taxing authorities. The recorded amounts of income tax are subject to adjustment upon examination, changes in interpretation and changes in judgment utilized in determining estimates.
See Note 1 , “Summary of Significant Accounting Policy,” in the notes to the consolidated financial statements for a complete discussion of recent accounting pronouncements. We are currently evaluating the impact of certain recently issued guidance on our financial condition and results of operations in future periods.
Off-Balance Sheet Arrangements
Off balance sheet arrangements are transactions, agreements, or other contractual arrangements with an unconsolidated entity for which we have an obligation to the entity that is not recorded in the consolidated financial statements. As of December 31, 2015 , there are no significant off-balance sheet arrangements.

36



Contractual Obligations
Our principal commitments primarily consist of obligations for minimum payment commitments to leases for office space, redeemable preferred stock and the revolving credit facility. As of December 31, 2015 , the future non-cancelable minimum payments under these commitments were as follows:
 
 
Payments Due by Period
 
 
(in thousands)
 
 
Total
 
Less Than One Year
 
1 - 3 Years
 
3 - 5 Years
 
More Than Five Years
Contractual Obligations: (1)
 
 
 
 
 
 
 
 
 
 
Operating lease obligations (2)
 
$
8,750

 
$
1,608

 
$
3,369

 
$
2,360

 
1,413

Series B Redeemable Preferred Stock (3)
 
51,928

 

 

 

 
51,928

Long term debt (4)
 
68,079

 
37,267

 
7,705

 
23,107

 

Interest payments on long-term debt (5)
 
13,386

 
1,449

 
1,810

 
10,127

 

Total
 
$
142,143

 
$
40,324

 
$
12,884

 
$
35,594

 
$
53,341

(1) Contractual obligations exclude tax liabilities of $1.5 million related to uncertain tax positions because we are unable to make a reasonably reliable estimate of the timing of settlement, if any, of these future payments.
(2) Operating lease agreements represent obligations to make payments under non-cancelable lease agreements for its facilities.
(3) In September 2010, VTBH issued shares of its Series B Redeemable Preferred Stock. If the Series B Redeemable Preferred Stock is still outstanding as of October 2030 or if the Company experiences a liquidation event as defined in VTBH's Certification of Incorporation, the Company will be required to redeem the shares for an aggregate of $51.9 million, which is comprised of the aggregate purchase price of $12.4 million plus cumulative preferred dividends of 8.0% per annum, or $39.5 million in the aggregate. See Note 13 , “Commitments and Contingencies” , for further information.
(4) On March 31, 2014 the Company entered into the Credit Facility that expires March 31, 2019. However, due to certain terms of the facility, the indebtedness is required to be classified as a current liability. Long term debt includes scheduled principal payments only. See Note 7 , “Credit Facilities and Long-Term Debt” for further information.
(5) These amounts reflect estimated interest payments under our outstanding long-term debt agreements based on the applicable rates in effect as of December 31, 2015, except for interest payments under our Credit Facility because the amount that will be borrowed in future years is uncertain.

37



Item 7A - Qualitative and Quantitative Disclosures about Market Risk
 
Market risk represents the risk of loss that may impact its financial position due to adverse changes in financial market prices and rates. The Company's market risk exposure is primarily a result of fluctuations in interest rates, foreign currency exchange rates and inflation.

To date, the Company has used derivative financial instruments, specifically foreign currency forward and option contracts, to manage exposure to foreign currency risks, by hedging a portion of its forecasted expenses denominated in British Pounds expected to occur within a year. The effect of exchange rate changes on foreign currency forward and option contracts is expected to offset the effect of exchange rate changes on the underlying hedged item. The Company does not use derivative financial instruments for speculative or trading purposes. As of December 31, 2015 , we do not have any derivative financial instruments.
Interest Rate Risk
The Company's total variable rate debt is comprised of $32.5 million outstanding under the Credit Facility, $18.4 million presented as term loans and $14.7 million of Subordinated Notes. A hypothetical 10% increase in borrowing rates at December 31, 2015 would have resulted in a $0.6 million annual increase in interest expense on the existing principal balance.
Foreign Currency Exchange Risk
The Company has exchange rate exposure, primarily, with respect to the British Pound. As of December 31, 2015 , 2014 and 2013, our monetary assets and liabilities which are subject to this exposure are immaterial, therefore the potential immediate loss to us that would result from a hypothetical 10% change in foreign currency exchange rates would not be expected to have a material impact on our earnings or cash flows. This sensitivity analysis assumes an unfavorable 10% fluctuation in the exchange rates affecting the foreign currencies in which monetary assets and liabilities are denominated and does not take into account the offsetting effect of such a change on our foreign currency denominated revenues.

Inflation Risk
The Company is exposed to market risk due to the possibility of inflation, such as increases in the cost of its products. Although the Company does not believe that inflation has had a material impact on its financial position or results of operations to date, a high rate of inflation in the future may have an adverse effect on the Company’s ability to maintain current levels of gross margin and selling, general and administrative expenses as a percentage of net revenue if the selling prices of products do not increase with these increased costs.

38



Item 8. Financial Statements and Supplementary Data

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 
 
 
 
Page
 
 
Consolidated Financial Statements:

 


39


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of
Turtle Beach Corporation
San Diego, California

We have audited the accompanying consolidated balance sheets of Turtle Beach Corporation as of December 31, 2015 and 2014 and the related consolidated statements of operations, comprehensive loss, convertible preferred stock and stockholders’ equity, and cash flows for the years then ended. In connection with our audits of the financial statements, we have also audited the financial statement schedules listed in the accompanying index. These financial statements and schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and schedules. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Turtle Beach Corporation at December 31, 2015 and 2014, and the results of its operations and its cash flows for the years in the years then ended, in conformity with accounting principles generally accepted in the United States of America.
Also, in our opinion, the financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

/s/ BDO USA, LLP
Stamford, Connecticut
March 30, 2016


40


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders
VTB Holdings, Inc.
We have audited the accompanying consolidated statements of operations, comprehensive income (loss), convertible preferred stock and stockholders’ equity (deficit), and cash flows for the year ended December 31, 2013, of VTB Holdings, Inc. Our audit also included the financial statement schedule listed in the accompanying index. These consolidated financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and schedule based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the results of operations of VTB Holdings, Inc. and its cash flows for the year ended December 31, 2013, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
We have also audited the adjustments to the 2013 consolidated financial statements to retrospectively adjust the common shares outstanding on the consolidated statement of convertible preferred stock and stockholders’ equity (deficit) and the net loss per share disclosure (consolidated statements of operations and Note 10) as a result of the all-stock merger transaction between Turtle Beach Corporation (formerly Parametric Sound Corporation) and VTB Holdings, Inc. as discussed in Notes 1 and 2 to the consolidated financial statements. Our procedures included (1) comparing the amounts shown in the net loss per share disclosures for 2013 to the Company's underlying accounting analysis, (2) comparing the previously reported shares outstanding and statement of operations amounts per the Company's accounting analysis to the previously issued consolidated financial statements, and (3) recalculating the additional shares to give effect to the merger exchange ratio and testing the mathematical accuracy of the underlying analysis. In our opinion, such retrospective adjustments are appropriate and have been properly applied.

/s/ FREED MAXICK CPAs, P.C.
Buffalo, New York
March 28, 2014, except for Note 10 and
Supplemental Schedule as to which the date is March 30, 2015



41



Turtle Beach Corporation
Consolidated Balance Sheets

 
December 31, 2015

December 31, 2014
ASSETS
(in thousands, except par value and share amounts)
Current Assets:
 

 
 

Cash and cash equivalents
$
7,114


$
7,908

Accounts receivable, less allowances for $13,829 and $9,806 in 2015 and 2014, respectively
57,192

 
61,059

Inventories
26,146

 
38,400

Deferred income taxes

 
4,930

Prepaid income taxes
260

 
1,482

Prepaid expenses and other current assets
4,191

 
3,818

Total Current Assets
94,903

 
117,597

Property and equipment, net
6,859

 
6,722

Goodwill
31,152

 
80,974

Intangible assets, net
37,956

 
39,726

Deferred income taxes

 
1,128

Other assets
2,981

 
821

Total Assets
$
173,851

 
$
246,968

LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 

Current Liabilities:
 
 
 

Revolving credit facilities
$
32,453

 
$
36,863

Term loans
4,814

 
1,923

Accounts payable
17,680

 
35,546

Other current liabilities
14,236

 
14,525

Total Current Liabilities
69,183

 
88,857

Term loans, long-term portion
13,565


5,769

Series B redeemable preferred stock
16,145

 
14,916

Deferred income taxes
4

 
648

Subordinated notes - related party
15,365

 

Other liabilities
2,937

 
5,592

Total Liabilities
117,199

 
115,782

Commitments and Contingencies


 


Stockholders' Equity
 

 
 

Common stock, $0.001 par value - 100,000,000 and 50,000,000 shares authorized; 42,529,502 and 42,027,991 shares issued and outstanding as of December 31, 2015 and 2014, respectively
43

 
42

Additional paid-in capital
136,693

 
128,084

Retained earnings (accumulated deficit)
(79,618
)
 
3,289

Accumulated other comprehensive loss
(466
)
 
(229
)
Total Stockholders' Equity
56,652

 
131,186

Total Liabilities and Stockholders' Equity
$
173,851

 
$
246,968










See accompanying Notes to the Consolidated Financial Statements

42



Turtle Beach Corporation
Consolidated Statements of Operations

 
Year Ended
 
December 31, 2015

December 31, 2014
 
December 31, 2013
 
(in thousands, except share and per share data)
Net Revenue
$
162,747

 
$
186,176

 
$
178,470

Cost of Revenue
122,056

 
135,509

 
128,141

Gross Profit
40,691

 
50,667

 
50,329

Operating expenses:
 
 
 
 
 
Selling and marketing
31,829


33,442

 
31,645

Research and development
11,556


9,400

 
4,873

General and administrative
21,484


17,159

 
8,349

Goodwill impairment
49,822

 

 

Restructuring charges
399

 
747

 

Business transaction costs

 
3,744

 
3,864

Total operating expenses
115,090


64,492

 
48,731

Operating income (loss)
(74,399
)
 
(13,825
)
 
1,598

Interest expense
5,099

 
7,209

 
6,626

Other non-operating expense, net
1,016

 
724

 
45

Loss before income tax expense (benefit)
(80,514
)
 
(21,758
)
 
(5,073
)
Income tax expense (benefit)
2,393


(6,272
)

1,090

Net loss
$
(82,907
)

$
(15,486
)
 
$
(6,163
)
 
 
 
 
 
 
Net loss per share :
 
 
 
 
 
Basic
$
(1.96
)
 
$
(0.39
)
 
$
(0.49
)
Diluted
$
(1.96
)
 
$
(0.39
)
 
$
(0.49
)
Weighted average number of shares:
 
 
 
 
 
Basic
42,269

 
39,665

 
12,700

Diluted
42,269

 
39,665

 
12,700

 



















See accompanying Notes to the Consolidated Financial Statements

43



Turtle Beach Corporation
Consolidated Statements of Comprehensive Income (Loss)

 
Year Ended
 
December 31, 2015
 
December 31, 2014
 
December 31, 2013
 
(in thousands)
Net loss
$
(82,907
)
 
$
(15,486
)
 
$
(6,163
)
 
 
 
 
 
 
Other comprehensive income (loss):

 
 
 
 
 
Foreign currency translation adjustment
(237
)
 
(334
)
 
184

Other comprehensive income (loss)

(237
)
 
(334
)
 
184

Comprehensive loss
$
(83,144
)
 
$
(15,820
)
 
$
(5,979
)










































See accompanying Notes to the Consolidated Financial Statements

44



Turtle Beach Corporation
Consolidated Statements of Cash Flows
 
Year Ended December 31,
 
2015
 
2014
 
2013
CASH FLOWS FROM OPERATING ACTIVITIES
(in thousands)
Net loss
$
(82,907
)
 
$
(15,486
)
 
$
(6,163
)
Adjustments to reconcile net loss to net cash provided by (used for) operating activities:
 
 
 
 
 
Depreciation and amortization
5,901

 
5,800

 
4,422

Amortization of intangible assets
2,015

 
1,066

 
923

Amortization of deferred financing costs
360

 
2,621

 
1,556

Stock-based compensation
5,897

 
5,194

 
2,563

Accrued interest on Series B redeemable preferred stock
1,230

 
1,203

 
1,010

Paid in kind interest
947

 
1,138

 
342

Deferred income taxes
5,414

 
(9,998
)
 
3,353

Provision for (Reversal of) sales returns reserve
2,113

 
(2,111
)
 
(1,482
)
Provision for (Reversal of) doubtful accounts
2

 
37

 
(235
)
Provision for obsolete inventory
1,107

 
532

 
93

Loss on disposal of property and equipment
76

 
9

 
108

Loss on impairment of assets
49,822

 

 

Changes in operating assets and liabilities:
 
 
 
 
 
Accounts receivable
1,752

 
(10,396
)
 
18,761

Inventories
11,147

 
11,363

 
(9,030
)
Accounts payable
(17,287
)
 
(10,552
)
 
19,946

Due to shareholders

 
(3,125
)
 
(3,125
)
Prepaid expenses and other assets
(712
)
 
(212
)
 
(1,778
)
Income taxes payable
(1,700
)
 
4,704

 
(9,780
)
Other liabilities
(310
)
 
3,379

 
(3,194
)
Net cash provided by (used for) operating activities
(15,133
)
 
(14,834
)
 
18,290

CASH FLOWS FROM INVESTING ACTIVITIES
 
 
 
 
 
Purchase of property and equipment
(6,693
)
 
(3,536
)
 
(6,167
)
Cash acquired in business combinations

 
4,093

 

Net cash provided by (used for) investing activities
(6,693
)
 
557

 
(6,167
)
CASH FLOWS FROM FINANCING ACTIVITIES
 
 
 
 
 
Borrowings on revolving credit facilities
217,644

 
157,982

 
51,250

Repayment of revolving credit facilities
(222,054
)
 
(160,855
)
 
(44,514
)
Repayment of capital leases
(40
)
 
(34
)
 

Borrowings on term loan
15,110

 
7,692

 

Repayment of term loan
(4,423
)
 
(14,500
)
 
(26,750
)
Repayment of subordinated notes

 
(18,481
)
 

Proceeds from sale of common stock, net of issuance costs

 
37,230

 

Proceeds from exercise of stock options
731

 
1,618

 

Debt financing costs
(2,134
)
 
(1,683
)
 
(1,003
)
Proceeds from issuance of subordinated notes
16,300

 
7,000

 
10,000

Net cash provided by (used for) financing activities
21,134

 
15,969

 
(11,017
)
Effect of exchange rate changes on cash and cash equivalents
(102
)
 
(293
)
 
184

Net increase (decrease) in cash and cash equivalents
(794
)
 
1,399

 
1,290

Cash and cash equivalents - beginning of period
7,908

 
6,509

 
5,219

Cash and cash equivalents - end of period
$
7,114

 
$
7,908

 
$
6,509

 
 
 
 
 
 
SUPPLEMENTAL DISCLOSURE OF INFORMATION
 
 
 
 
 
Cash paid for interest
$
1,731

 
$
3,209

 
$
3,694

Cash paid for income taxes
$
16

 
$
554

 
$
8,224

Accrual for purchases of property and equipment
$
841

 
$
1,420

 
$
1,104

Value of shares issued to acquire HyperSound business
$

 
$
113,782

 
$

Conversion of Series A Preferred Stock
$

 
$
24,345

 
$

Issuance of warrants
$
1,983

 
$

 
$


See accompanying Notes to the Consolidated Financial Statements

45



Turtle Beach Corporation
Consolidated Statement of Convertible Preferred Stock and Stockholders' Equity (Deficit)

 
Series A Convertible Preferred Stock
 
Common Stock
 
Additional Paid-In Capital
 
Retained Earnings
 
Accumulated Other Comprehensive Income (Loss)
 
Total
 
Shares
Amount
 
Shares
Amount
 
 
 
 
 
(in thousands)
Balance at December 31, 2012
48,690

$
24,345

 
12,700

$
13

 
$
(56,594
)
 
$
24,938

 
$
(79
)
 
$
(31,722
)
Net loss


 


 

 
(6,163
)
 

 
(6,163
)
Other comprehensive loss


 


 

 

 
184

 
184

Stock-based compensation


 


 
2,563

 

 

 
2,563

Balance at December 31, 2013
48,690

24,345

 
12,700

13

 
(54,031
)
 
18,775

 
$
105

 
(35,138
)
Net loss


 


 

 
(15,486
)
 

 
(15,486
)
Other comprehensive income


 


 

 

 
(334
)
 
(334
)
Adjustment for reverse merger
 
 
 
7,275

7

 
113,775

 
 
 

 
113,782

Conversion of Series A Preferred
(48,690
)
(24,345
)
 
17,527

18

 
24,327

 
 
 

 
24,345

Cashless exercise of warrants


 
24


 

 

 

 

Sale of common stock, net of issuance costs


 
4,000

4

 
37,226

 

 

 
37,230

Stock options exercised


 
502


 
1,593

 

 

 
1,593

Stock-based compensation


 


 
5,194

 

 

 
5,194

Balance at December 31, 2014


 
42,028

42

 
128,084

 
3,289

 
$
(229
)
 
131,186

Net loss


 


 

 
(82,907
)
 

 
(82,907
)
Other comprehensive loss


 


 

 

 
(237
)
 
(237
)
Stock options exercised


 
502

1

 
729

 

 

 
730

Issuance of warrants


 


 
1,983

 

 

 
1,983

Stock-based compensation


 


 
5,897